Assignment 3: Ratio Analysis – Solve The Problem

Assignment 3 Ratio Analysisbyjuly 21, 2015solve The Problem Below Ca

Calculate the ratios, interpret the results against the industry average, and fill in the table on the worksheet. Then, provide an analysis of how those results can be used by the business to improve its performance.

Balance Sheet as of December 31, 2010 (Gary and Company):

  • Cash: $45
  • Receivables: $66
  • Inventory: $159
  • Marketable securities: $33
  • Total current assets: $303
  • Net fixed assets: $147
  • Total assets: $450
  • Accounts payables: $45
  • Notes payables: $45
  • Other current liabilities: $21
  • Total current liabilities: $111
  • Long-term debt: $24
  • Total liabilities: $135
  • Common stock: $114
  • Retained earnings: $201
  • Total stockholders' equity: $315

Income Statement for the year 2010:

  • Net sales: $795
  • Cost of goods sold: $660
  • Gross profit: $135
  • Selling expenses: $73.5
  • Depreciation: $12
  • EBIT (Earnings Before Interest and Taxes): $49.5
  • Interest expense: $4.5
  • EBT (Earnings Before Taxes): $45
  • Taxes (40%): $18
  • Net income: $27

Ratios to be calculated:

  • Profit margin on sales
  • Return on assets
  • Receivable turnover
  • Inventory turnover
  • Fixed asset turnover
  • Total asset turnover
  • Current ratio
  • Quick ratio
  • Times interest earned

Paper For Above instruction

The purpose of this paper is to perform a comprehensive ratio analysis for Gary and Company based on its 2010 financial statements, compare the results to industry averages, and interpret their implications for business performance and improvement strategies. Ratio analysis is a fundamental financial tool that helps stakeholders evaluate a company's operational efficiency, liquidity, profitability, and leverage, providing insights into areas requiring management attention and improvement.

Profit Margin on Sales:

The profit margin is calculated as net income divided by net sales. For Gary and Company, this is \( \frac{\$27}{\$795} \times 100 = 3.4\% \). This compares to the industry average of 3%. A marginally higher profit margin suggests that Gary and Company manages to preserve a modest portion of sales as profit, which is fair within industry norms. Improvements could come from cost control or pricing strategies to enhance profitability.

Return on Assets (ROA):

ROA indicates how efficiently the company utilizes its assets to generate profit, computed as net income divided by total assets. Here, \( \frac{\$27}{\$450} \times 100 = 6\% \). Compared to the 9% industry average, this is low, signifying that Gary and Company is less efficient in asset utilization. Enhancing asset management, streamlining operations, or investing in higher-yield assets could improve ROA.

Receivable Turnover:

Measured as net sales divided by average receivables, the ratio indicates how many times receivables are collected annually. Assuming receivables are $66 (no opening balance given), receivable turnover is \( \frac{\$795}{\$66} \approx 12.05 \). The industry average is 16X; thus, the company’s collection efficiency is below average, suggesting the need for better credit management policies to reduce receivables days and improve cash flow.

Inventory Turnover:

Calculated as COGS divided by average inventory, which is \( \frac{\$660}{\$159} \approx 4.16 \). The industry average is 10X, indicating that Gary and Company holds higher inventory levels or manages inventory less efficiently, impacting liquidity and carrying costs. Improving inventory management could optimize stock levels, reduce storage costs, and improve liquidity.

Fixed Asset Turnover:

This ratio is net sales divided by net fixed assets, giving \( \frac{\$795}{\$147} \approx 5.4 \). The industry average is 2X, showing high utilization despite potentially underutilized assets reported, or it may reflect different asset valuation methods. Focus on optimizing asset usage or evaluating asset quality can enhance operational efficiency.

Total Asset Turnover:

Total sales divided by total assets yields \( \frac{\$795}{\$450} \approx 1.77 \), close to the industry’s 3X, although slightly below mean efficiency levels. Increasing sales through market expansion or product development could improve return on total assets.

Current Ratio:

Computed as current assets divided by current liabilities, \( \frac{\$303}{\$111} \approx 2.73 \), exceeding the industry average of 2X, indicating satisfactory liquidity. Excess liquidity can be optimized perhaps through investment in growth opportunities.

Quick Ratio:

This ratio excludes inventories from current assets, \( \frac{\$303 - \$159}{\$111} \approx 1.36 \), slightly above the industry average of 1.5. Maintaining a quick ratio near the industry average ensures adequate liquidity without excess idle assets.

Times Interest Earned (TIE):

Calculated as EBIT divided by interest expense: \( \frac{\$49.5}{\$4.5} \approx 11X \). The industry average is 7X, suggesting strong coverage of interest obligations, which reduces financial risk and indicates good financial health.

The ratios collectively reveal that Gary and Company maintains acceptable liquidity and profitability levels; however, asset utilization efficiency can be improved. The relatively low ROA and receivable turnover indicate operational inefficiencies that, if addressed, could enhance overall performance and shareholder value.

Improvements could focus on optimizing receivables collection policies, reducing inventory levels, and enhancing asset management. Strategies like adopting just-in-time inventory systems, refining credit terms, and upgrading equipment for higher productivity may elevate asset efficiency and profitability. Additionally, maintaining strong interest coverage provides flexibility for future investments or debt management.

In conclusion, the ratio analysis underscores the importance of strategic operational improvements that leverage the company's strengths while addressing its weaknesses. Consistent monitoring of these ratios and benchmarking against industry standards can guide management in decision-making, ultimately leading to better financial health and competitive advantage.

References

  • Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management (15th ed.). Cengage.
  • Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Fundamentals of Corporate Finance (11th ed.). McGraw-Hill Education.
  • Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2014). Financial Statement Analysis (11th ed.). McGraw-Hill Education.
  • Higgins, R. C. (2012). Analysis for Financial Management (10th ed.). McGraw-Hill/Irwin.
  • Gibson, C. H. (2013). Financial Reporting & Analysis (13th ed.). Cengage Learning.
  • Baginski, S., & Hassell, J. M. (2019). Financial Management: Theory & Practice (15th ed.). Pearson.
  • Arnold, G. (2013). Corporate Financial Reporting and Analysis (4th ed.). McGraw-Hill Education.
  • Online Resources: Investopedia – Financial Ratios section. (https://www.investopedia.com)
  • U.S. Securities and Exchange Commission (SEC). Financial Statements & Ratios Analysis.
  • Industry Reports: Securities Industry and Financial Markets Association (SIFMA). Industry Benchmarks and Averages.

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