Question

Bonalli Shoe Company has been facing increased competition from overseas shoemak- ers. Its total assets and stockholders’ equity at the beginning of 2010 were $690,000 and $590,000, respectively. A summary of the firm’s data for 2010 and 2011 follows.

	2011	2010
Current Assets	$200,000	$170,000
Total Assets	880,000	710,000
Current Liabilities	90,000	50,000
Long-term liabilities	150,000	50,000
Stockholders’ equity	640,000	610,000
Sales	1,200,000	1,050,000
Net Income	60,000	80,000

Required:

Use (1) liquidity analysis and (2) profitability analysis to document Bonalli Shoe Company’s declining financial position.

Answer 1

1. Liquidity Ratios: Liquidity ratios measure the available current assets in the firm in comparison with the current liabilities. The higher the ratio, the better ability to pay off its short term debts timely.

a. Current ratio = Current Assets / Current liabilities
2010 = 170000 / 50000 = 3.4 : 1
2011 = 200000 / 90000 = 2.22 : 1

b. Debt to Equity ratio: (Total Liabilities / Total Equity)
2010 = (100000 / 610000) = 1 : 6.1
2011 = (240000 / 640000) = 1 : 2.67

c. Debt Ratio: (Total Liabilities / Total Assets)
2010= ( 100000 / 710000) = 1 : 7.1
2011 = (240000 / 880000) = 1 : 3.67

*Separately inventory and cash amount is not provided here. So the calculation of quick ratio & cash ratio are not possible.

Analysis: Definitely the ratio has gone down from 3.4 to 2.22, which clearly indicates the downtrend of the company to pay off its short term debts. But still there the ratio is 2.22 which indicates that there is enough current assets to pay off its current liabilities in near future.
Similarly in the case of Debt to Equity and Debt ratio, still there is enough assets or Equity are there in comparison with liabilities to pay off its debt well, but the ratio is falling drastically, and for this reasons maybe the investors in the future will not be ready to invest in this organisation. The situation need to be improved immediately.

2. Profitability Ratio: These ratios are mainly used to measure the business ability to create earning. These ratios are good when it is trending upward or are better than the competitors ratios.

a. Net Profit Ratio: (Net Income / Sales)*100
2010 = (80000 / 1050000)*100 = 7.62%
2011 = (60000 / 1200000)*100 = 5.00%

b. Return on Assets: (Net Income / Total Assets)*100
2010 = (80000 / 710000)*100 = 11.28%
2011 = (60000 / 880000)*100 = 6.82%

c. Return on Equity: (Net profit / Shareholders' equity)*100
2010 = (80000 / 610000)*100 = 13.11%
2011 = (60000 / 640000)*100 = 9.38%

Analysis: Profitability ratios are considered to be good when the trend is upward. But here all the ratios trend are falling in a high rate. Expenses are needed to be cut off immediately to survive in such situation. Excessive assets or investments can also be brought down to revive these ratios.