Calculate The Ratios And Interpret The Results

Calculate the Ratios Interpret The Results A

Solve the problem below, 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 Accounts payables $45 Receivables $66 Notes payables $45 Inventory $159 Other current liabilities $21 Marketable securities $33 Total current liabilities $111 Total current assets $303 Net fixed assets $147 Long Term Liabilities Total Assets $450 Long-term debt $24 Total Liabilities $135 Owners Equity Common stock $114 Retained earnings $201 Total stockholders’ equity $315 Total liabilities and equity $450 Income Statement Year 2010 Net sales $795 Cost of goods sold 660 Gross profit 135 Selling expenses 73.5 Depreciation 12 EBIT 49.5 Interest expense 4.5 EBT 45 Taxes (40%) 18 Net income 27 1. Calculate the following ratios AND interpret the result against the industry average : Ratio Your Answer Industry Average Your Interpretation (Good-Fair-Low-Poor) Profit margin on sales 3% Return on assets 9% Receivable turnover 16X Inventory turnover 10X Fixed asset turnover 2X Total asset turnover 3X Current ratio 2X Quick ratio 1.5X Times interest earned 7X 2. Analysis: Give your interpretation of what the ratios calculations show and how the business can use this information to improve its performance. Justify all answers.

Paper For Above instruction

The financial analysis of Gary and Company, based on their balance sheet and income statement for the year 2010, provides critical insights into their operational efficiency, liquidity, profitability, and overall financial health. This assessment involves calculating key financial ratios, comparing them with industry averages, and interpreting their implications for strategic decision-making and performance improvement.

Profit Margin on Sales

The profit margin on sales measures the company's ability to convert sales into net income, reflecting overall profitability. It is calculated as Net Income divided by Net Sales:

Profit Margin = (Net Income / Net Sales) × 100

For Gary and Company:

Profit Margin = (27 / 795) × 100 ≈ 3.39%

Compared to the industry average of 3%, Gary and Company exceeds slightly, indicating a fair to good profitability position. This suggests the company manages its costs effectively relative to its sales, but there is room for improvement to enhance margins further.

Return on Assets (ROA)

ROA shows how efficiently the company employs its assets to generate net income. It is calculated as Net Income divided by Total Assets:

ROA = (Net Income / Total Assets) × 100

Calculation:

ROA = (27 / 450) × 100 = 6%

Compared to the industry average of 9%, Gary and Company exhibits a lower ROA, indicating underutilization of assets or inefficient asset management. Strategies to optimize asset use could enhance profitability.

Receivable Turnover

Receivable turnover indicates how many times receivables are collected during a period, reflecting credit policy effectiveness:

Receivable Turnover = Net Sales / Average Accounts Receivable

Given data:

Accounts Receivable = $66

Receivable Turnover = 795 / 66 ≈ 12.05X

Compared to the industry average of 16X, Gary and Company’s collections are less efficient, suggesting potential improvements in credit policies or collection efforts to reduce days sales outstanding.

Inventory Turnover

This ratio measures how many times inventory is sold and replaced over a period:

Inventory Turnover = Cost of Goods Sold / Average Inventory

Calculation:

Inventory Turnover = 660 / 159 ≈ 4.16X

Compared to the industry average of 10X, the turnover is notably lower, implying inventory accumulation or slow sales. Improved inventory management could free up cash and reduce holding costs.

Fixed Asset Turnover

It assesses how well the company utilizes fixed assets to generate sales:

Fixed Asset Turnover = Net Sales / Net Fixed Assets

Calculation:

Fixed Asset Turnover = 795 / 147 ≈ 5.41X

Compared to the industry average of 2X, Gary and Company’s ratio is higher, indicating effective use of fixed assets in generating sales.

Total Asset Turnover

This ratio shows how efficiently the company uses all its assets to produce sales:

Total Asset Turnover = Net Sales / Total Assets = 795 / 450 ≈ 1.77X

Compared to the industry average of 3X, the company's asset utilization is below average, which may reflect investment in assets that are not yet fully productive or inefficiencies in operating assets.

Liquidity Ratios

Current Ratio

The current ratio measures liquidity, the ability to meet short-term obligations:

Current Ratio = Total Current Assets / Total Current Liabilities = 303 / 111 ≈ 2.73X

Higher than the industry average of 2X, indicating a strong liquidity position, which reduces financial risk and enhances flexibility.

Quick Ratio

The quick ratio assesses immediate liquidity, excluding inventories:

Quick Ratio = (Total Current Assets - Inventories) / Total Current Liabilities = (303 - 159) / 111 ≈ 1.35X

Compared to the industry average of 1.5X, it is slightly below, suggesting the company has sufficient liquid assets but could improve on quick liquidity.

Times Interest Earned

This ratio measures how comfortably the company can cover interest obligations:

Times Interest Earned = EBIT / Interest Expense = 49.5 / 4.5 ≈ 11X

Significantly higher than the industry average of 7X, indicating strong earnings relative to interest expenses, reflecting low financial risk.

Summary and Strategic Recommendations

Overall, Gary and Company demonstrates a strong liquidity position and efficient use of fixed assets, yet exhibits weaknesses in asset utilization efficiency as seen in the lower ROA and total asset turnover, as well as in receivable and inventory management. The company's profit margin aligns with industry standards, and its interest coverage is more than adequate, reducing bankruptcy risk.

To enhance overall performance, the company should focus on improving receivable collection processes to boost receivable turnover, tighten inventory management to increase inventory turnover, and optimize asset utilization to raise ROA and total asset turnover. These improvements can lead to increased profitability, faster growth, and greater competitiveness in the industry.

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