Question

FINANCIAL STATEMENT ANALYSIS

RC Inc. manufactures a variety of consumer products. The company’s founders have run the company for 30 years and are now interested in retiring. Consequently, they are seeking a purchaser who will continue its operations, and a group of investors, Stewart Inc, is looking into the acquisition of RC. To evaluate its financial stability and operating efficiency, RC was requested to provide the latest financial statements and selected financial ratios. Summary information provided by RC is as follows:

RC INC.

Income Statement

For the Year Ended November 30, 2015

(in thousands)

Sales (net)	30,500
Interest income	500
Total Revenue	31,000
Cost and expenses
Cost of goods sold	17,600
Selling and general administrative expenses	3,550
Depreciation and amortization expenses	1,890
Interest Expense	900
Total costs and expenses	23,940
Income before taxes	7,060
Income taxes	2,800
Net income	4,260

RC INC.

Balance Sheet

As of November 30, 2015

(in thousands)

	2015	2014
Cash	400	500
Short-term investments	300	200
Accounts receivable (net)	3,200	2,900
Inventory	6,000	5,400
Total current assets	9,900	9,000
Property, plant, and equipment	7,100	7,000
Total assets	17,000	16,000
Accounts payable	3,700	3,400
Income taxes payable	900	800
Accrued expenses	1,700	1,400
Total current liabilities	6,300	5,600
Long-term debt	2,000	1,800
Total liabilities	8,300	7,400
Common stock ($1 par value)	2,700	2,700
Paid-in capital in excess in par	1,000	1,000
Retained earnings	5,000	4,900
Total stockholders’ equity	8,700	8,600
Total liabilities and equity	17,000	16,000

Selected Financial Ratios for RC, Inc.

	2014	2013	Current Industry Average
Current Ratio	1.61	1.62	1.63
Acid Test Ratio	.64	.63	.68
Times Interest Earned	8.55	8.50	8.45
Profit margin on sales	13.2%	12.1%	13.0%
Asset turnover	1.84	1.83	1.84
Inventory turnover	3.17	3.21	3.18

Question #1:

A. Calculate a new set of ratios for the fiscal year 2015 for RC based on the financial statements presented.

B. Explain the analytical use of each of the six ratios presented, describing what the investors can learn about RC’s financial stability and operating efficiency.

C. Identify and discuss three limitations of ratio analysis

Answer 1

A.)

Financial Rations of 2015

Current Ratio	1.57
Acid test Ratio	0.62
Times Interest earned	8.84
Profit margin on sales	13.97%
Asset turnover	1.84
Inventory turnover	3.09

Current Ratio = Current Assets/Current Liabilities = 9900/6300 = 1.57

Acid test ratio = (current assets - (inventory)/current liabilities = 9900-6000)/6300 = 0.62

Times Interest earned = (earning before tax + interest expense)/ interest = (7060+900)/900 = 8.84

Profit margin on sales = Net income/ net sales x 100 = 4260/30500 x 100 = 13.97%

Asset Turnover = Sales / Average Total Assets = 30500/16500 = 1.84

sales = 30500

Avg total assets = (opening assets + closing assets)/2 = (16000+17000)/2 = 1650

Inventory Turnover = Cost of goods sold/ Average inventory = 17600/5700 = 3.09

B.) Analytical use of ratios :-

Current Ratio - Current ratio shows hoe many times a company can pay its current debt based on its current assets. Current ratio more than 1 is considered good. RC Inc has current ratio of 1.57 which seems quite good.

Acid test ratio - Acid-Test ratio provides a more rigorous assessment of a company's ability to pay its current liabilities based on its most liquid assets generally Current assets excluding inventory. RC Inc has ratio of 0.62 which means for every $1 of Current debt it has $0.62 liquid assets.

Times interest earned - It analysis whether the company is earning enough to pay its interest liabilities. RC Inc has 8.82 ratio which is very good as higher the ratio means higher the company ability to pay its interest expense.

Profit margin on sales - It measures how much profits are produced at a certain level of sales. RC Inc has a profit margin on sales of 13.97% which is above average industry rates. That also means company is well managing its expenses relative to its net sales.

Asset Turnover - It shows for every $ invested in assets, how much it generated in sales. RC Inc has 1.84 Asset turnover which is as per average of industry.

Inventory turnover - Inventory turnover is the number of times a company sells and replaces its stock of goods during a period. HIgher the better. RC Inc has 3.09 which is good as per standars but little less than Average of industry.

From the above details, Investors can invest in this company as overall it is very financially stable and its operating efficiency is on a increasing trend.

C.) Limitations of ratio analysis :-

* Company can have some bad ratios and some good ratios which makes difficult to tell whether it is good company or bad.

* Inflation can have a huge impact on the ratios and profit as well.

* Seasonal factors can also distort ratio analysis. Understanding seasonal factors that affect a business can reduce the chance of misinterpretation

* Different policies used by company can have different ratio. like use of LIFO or FIFO in inventory valuation provides different results.