Assignment 3: Ratio Analysis By Wednesday, September 14, 201

Assignment 3 Ratio Analysisbywednesday September 14, 2016solve The P

Calculate the following ratios AND interpret the result against the industry average: Profit margin on sales, Return on assets, Receivable turnover, Inventory turnover, Fixed asset turnover, Total asset turnover, Current ratio, Quick ratio, Times interest earned. Then, provide an analysis of how those results can be used by the business to improve its performance. Use the provided financial statements of Gary and Company for the year 2010 to perform these calculations and analyses.

Paper For Above instruction

Financial ratio analysis serves as a vital tool for evaluating a company's financial health and operational efficiency. In the case of Gary and Company, a comprehensive calculation of key ratios, followed by comparison with industry averages, offers insightful understanding into areas of strength and potential improvement. The ratios selected—profit margin on sales, return on assets, receivable turnover, inventory turnover, fixed asset turnover, total asset turnover, current ratio, quick ratio, and times interest earned—cover profitability, liquidity, and leverage, providing a well-rounded financial assessment.

Profit Margin on Sales

The profit margin on sales indicates how much profit a company makes from its revenues. It is calculated as (Net Income / Net Sales) x 100. For Gary and Company, the net income is $27, and net sales are $795. Therefore, the profit margin is (27 / 795) x 100 = approximately 3.4%. Comparatively, if the industry average is about 5%, Gary's profit margin is slightly below average, categorized as "Fair" or "Low". This suggests that although the company is profitable, its margins are narrower than typical industry standards, indicating potential pricing issues or higher expenses that may need addressing.

Return on Assets (ROA)

ROA measures how efficiently a company utilizes its assets to generate profit. It is calculated as (Net Income / Total Assets) x 100. For Gary and Company, the ROA is (27 / 450) x 100 = 6%. Compared with an industry average of about 9%, the company's ROA is below average, indicating less efficient asset utilization, likely affecting overall profitability. Improving asset management or increasing sales relative to asset base could enhance this ratio.

Receivable Turnover

The receivable turnover ratio indicates how many times a company collects its average receivables annually. It is calculated as Net Sales / Accounts Receivable. For Gary and Company, it is 795 / 66 ≈ 12.0X. The industry average is 16X, suggesting that Gary's collection process or credit policies might be less effective, leading to slower receivable collection, which could impact liquidity.

Inventory Turnover

The inventory turnover ratio measures how many times a company's inventory is sold and replaced over a period. It is calculated as Cost of Goods Sold / Inventory. For Gary and Company, it is 660 / 159 ≈ 4.15X. Compared to an industry average of 10X, this indicates slower inventory turnover, possibly resulting in excess inventory, higher storage costs, or obsolete stock. Improving inventory management could free up cash and reduce costs.

Fixed Asset Turnover

This ratio indicates how effectively a company uses its fixed assets to generate sales, calculated as Net Sales / Net Fixed Assets. For Gary and Company, it is 795 / 147 ≈ 5.41X. The industry average is around 2X, signaling that Gary is exceptionally efficient in utilizing its fixed assets, or possibly leveraging a different sales strategy. Maintaining or enhancing asset productivity is beneficial.

Total Asset Turnover

It measures overall asset efficiency, calculated as Net Sales / Total Assets. For Gary and Company, it is 795 / 450 ≈ 1.77X. With an industry average around 3X, this indicates room for significant improvement in leveraging total assets to generate sales, perhaps through marketing or expansion strategies.

Current Ratio

The current ratio assesses liquidity by dividing current assets by current liabilities. For Gary and Company, it is 303 / 111 ≈ 2.73X. The industry average is 2X, so Gary's liquidity is strong. This indicates a good capacity to meet short-term obligations, which supports financial stability.

Quick Ratio

This ratio refines liquidity assessment by excluding inventory from current assets. It is calculated as (Current Assets - Inventory) / Current Liabilities. For Gary, (303 - 159) / 111 ≈ 1.35X, slightly above the industry average of 1.5X. This suggests that the company's quick liquidity position is adequate but could be slightly improved, possibly by converting receivables to cash faster.

Times Interest Earned

This ratio measures ability to cover interest expenses, calculated as EBIT / Interest Expense. For Gary and Company, 49.5 / 4.5 ≈ 11X. The industry benchmark is around 7X, so the company is comfortably covering its interest obligations, indicating good leverage management and financial stability.

Analysis and Recommendations

The ratio analysis reveals that Gary and Company demonstrates strong liquidity, highlighted by a high current ratio, and efficient utilization of fixed assets, with a fixed asset turnover well above industry average. However, profitability margins and asset turnover ratios are below industry norms, indicating inefficiencies and areas where performance can be improved.

To enhance profitability, Gary and Company could focus on increasing net sales through marketing and expanding customer base, potentially raising margins by controlling costs or adjusting pricing strategies. Improving receivable collection efficiency will directly impact liquidity and cash flow, enabling better working capital management. Slower inventory turnover suggests excess stock; implementing just-in-time inventory systems or refining inventory management can reduce holding costs and improve cash flow.

Additionally, the company should analyze its asset utilization further, possibly investing in newer, more productive assets or restructuring existing assets to generate higher sales. Strengthening operational efficiency in production and sales processes can lead to better margins and asset turnover ratios. Addressing these areas will position Gary and Company for sustainable growth and competitiveness within its industry.

Conclusion

Overall, Gary and Company's financial ratios depict a business with strong liquidity and asset efficiency but relatively poor profitability and asset utilization compared to industry benchmarks. By focusing on strategic sales growth, cost management, inventory optimization, and receivables collection, the company can leverage its strengths and improve areas of weakness, thus fostering better overall financial performance and long-term success.

References

  • Brigham, E. F., & Ehrhardt, M. C. (2013). Financial Management: Theory & Practice. Cengage Learning.
  • Gibson, C. H. (2012). Financial Statement Analysis. South-Western Cengage Learning.
  • Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.
  • White, G. I., Sondhi, A. C., & Fried, D. (2003). The Analysis and Use of Financial Statements. John Wiley & Sons.
  • Penman, S. H. (2013). Financial Statement Analysis and Security Valuation. McGraw-Hill Education.
  • Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013). Corporate Finance. McGraw-Hill Education.
  • Lambert, R. A. (2014). Financial Ratio Analysis: The Complete Guide. Routledge.
  • Wild, J., Subramanyam, K. R., & Halsey, R. (2014). Financial Statement Analysis. McGraw-Hill Education.
  • Penman, S. (2012). Financial Statement Analysis and Security Valuation. McGraw Hill.
  • Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2013). Introduction to Financial Accounting. Pearson.

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