Question

DIRECTIONS: Summarize these notes

The Current Ratio measures a firm’s ability to pay off its short-term obligations. It is calculated as follows: Current Ratio = Current Assets/Current liabilities

Ideally, current ratio of 2 is desirable. Current ratio for both Lockheed Martin and Raytheon is less than 2. Moving from 2016 to 2017, the current ratio for both the companies improves indicating increase in current assets or decrease in current liabilities or both. For Lockheed Martin the current ratio improves from 1.2 to 1.38 and for Raytheon it moves from 1.54 to 1.66. Between the two companies, Raytheon is better placed as it has higher current ratios in both 2016 and 2017. Quick Ratio measures a firm's ability to meet current liabilities with its most liquid assets. It is calculated as: Quick Ratio = Current Assets excluding inventories/Current liabilities

A quick ratio above 1 is considered safe as liabilities can be safely paid back using liquid assets. Raytheon's quick ratio in 2016 and 2017 is 1.35 and 1.49. The company is well poised. Its quick ratio is improving year to year. Quick ratio less than 1 indicates that the firm cannot fully pay back its liabilities with its most liquid assets. Lockheed Martin has quick ratio of 0.80 and 0.91 in 2016 and 2017. This is a worrisome situation for Lockheed Martin. Even though the quick ratio is improving, it is still less than 1. Raytheon is in a better position than Lockheed Martin as far as liquidity is concerned.

From the above ratios, it can be observed that Lockheed is better in terms of asset turnover meaning that it is more efficient in using its assets. Whereas, Raytheon fairs a lot better in terms of converting its account receivables into cash. Raytheon takes about 17 days to do so which contrasts with Lockheed's 60 days.

Based on Net Profit Margin, Lockheed Martin performs better than Raytheon as Lockheed Martin’s was 11.22% whereas Raytheon’s was just 7.98% only. Higher Net Profit Margin implies that the firm generates more net profit from each dollar sales it makes. Based on Total Assets turnover, Lockheed Martin performs better than Raytheon as Lockheed Martin’s was .98 whereas Raytheon was just .83. Higher total asset turnover implies that the firm generates more revenue from each dollar asset it has invested in the firm. Based on equity multiplier, Equity multiplier does not always explain about firm’s profitability. Instead, it explains the ratio of total assets of the firm versus total equity for the respective period. Higher the ratio, lower the firm’s dependency on equity capital and vice-versa. Lockheed Martin’s equity multiplier of 21.03 implies that the firm depends very less on its equity capital when compared to Raytheon.

Answer 1

Current Ratio(CR):

CR - This ratio evaluates a company's current assets versus current liabilities. This ratio indicates how well a company is equipped to pay off its short term obligations i.e, those ranging upto 12 months/ 1year, by using its curent assets.

- In the year 2016:

CR for Lockheed Martin = 1.2

CR = 1.2 = Current assets/ current liabilities

Therefore, Current assets = 1.2 * current liabilities

CR for Raytheon = 1.54

Similarly, Current assets = 1.54 * current liabilities

Explanation:

For both these two companies, CR is less than the standard. But, going by the above equations, we can say that Raytheon is in a better situation than Lockheed Martin when it comes to paying off current liabilities.

- In the year 2017:

CR for Lockheed Martin = 1.38

CR = 1.38 = Current assets/ current liabilities

Therefore, Current assets = 1.38 * current liabilities

CR for Raytheon = 1.66

Similarly, Current assets = 1.66 * current liabilities

Explanation:

In the year 2017 also, Raytheon is in a better position to pay off its current liabilities.

Quick Ratio(QR):

- In the year 2016:

QR for Lockheed Martin = 0.80

Therefore, liquid assets = 0.80 * current liabilities

QR for Raytheon = 1.35

Therefore, liquid assets = 1.35 * current liabilities

Explanation:

QR for Lockheed is less than standard. it has only 0.80 which means it can pay only 80% of its current liabilities by its liquid assets. Whereas QR for Raytheon is 1.35 which means it is well covered when it comes to paying short term obligations by liquid assets.

- In the year 2017:

QR for Lockheed Martin = 0.91

Therefore, liquid assets = 0.91 * current liabilities

QR for Raytheon = 1.49

Therefore, liquid assets = 1.49 * current liabilities

Explanation:

QR for Lockheed is less than standard. it has only 0.91 which means it can pay only 91% of its current liabilities by its liquid assets. Whereas QR for Raytheon is 1.49 which means it is well covered when it comes to paying short term obligations by liquid assets.

In both the years, Raytheon is well covered by its liquid assets to pay off current liabilities than Lockheed and for Lockheed Martin, the situation is more severe.

Account receivables ratio:

Lockheed takes 60 days to convert its account receivables into cash whereas Raytheon takes 17 days to do so. We can say that Lockheed has a loose credit policy than Raytheon which has tight credit policy. Lockheed gives more time to its debtors to pay than Raytheon.

Net profit margin:

Lockheed has a higher net profit margin which is 11.22% than Raytheon which has only approximately 8%. This implies that bottom line beneficiary of Lockheed Martin is in a better position as they will have a better chance to get more than Raytheon.

Total assets turnover:

For Lockheed Martin = 0.98

For Raytheon = 0.83

Total assets turnover ratio is better for Lockheed than Raytheon which implies Lockheed has used its total assets better than Raytheon to generate the revenue which can also be seen from higher net profit margin for Lockheed.

Equity multiplier:

It indicates the amount of total assets that has been financed by shareholders. It implies the dependency on shareholders to finance the assets.

Lockheed depends very less on its equity capital than Raytheon that means equity multiplier for Lockheed is higher than Raytheon. As higher the ratio, lower the dependency and vice-versa. Here we can say that Raytheon's assets are financed more by shareholders than Lockheed Martin.