Compute Key Financial Ratios And Perform Analysis Of Westwar

Compute key financial ratios and perform analysis of Westward Corporation

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The condensed financial statements of Westward Corporation for 2006 are presented below. Westward Corporation's balance sheet and income statement for 2006 and comparative data for 2005 are provided. You are asked to compute certain financial ratios for 2005 and 2006, perform horizontal and vertical analysis, and assess the company's financial performance based on these analyses.

Paper For Above instruction

Financial analysis is crucial in evaluating a company's performance and financial position. It involves calculating various ratios, analyzing financial statements, and making informed judgments about the company's strength and weaknesses. In this paper, we will compute selected financial ratios for Westward Corporation for the years 2005 and 2006, perform horizontal and vertical analyses, and interpret the results to assess the company's financial health.

1. Calculation of Financial Ratios for 2005 and 2006

To evaluate Westward Corporation's financial performance, we calculate the following ratios: current ratio, debt to total assets, times interest earned, inventory turnover, profit margin ratio, return on common stockholders' equity, and return on assets. Supporting calculations are provided below.

a) Current Ratio

The current ratio indicates a firm's ability to meet its short-term obligations. It is calculated as:

Current Ratio = Current Assets / Current Liabilities

2005: $280,000 / $140,000 = 2.0

2006: $220,000 / $80,000 = 2.75

b) Debt to Total Assets

This ratio measures financial leverage:

Debt to Total Assets = (Long-term Liabilities + Current Liabilities) / Total Assets

2005: ($320,000 + $140,000) / $1,080,000 ≈ 0.4074 or 40.74%

2006: ($300,000 + $80,000) / $1,000,000 = 0.38 or 38%

c) Times Interest Earned

This ratio shows the company's ability to cover interest expenses:

Times Interest Earned = Income Before Income Taxes / Interest Expense

2005: $220,000 / $30,000 ≈ 7.33

2006: $395,000 / $30,000 ≈ 13.17

d) Inventory Turnover

This ratio indicates how efficiently inventory is managed:

Inventory Turnover = Cost of Goods Sold / Average Inventory

2005: $1,750,000 / (($150,000 + $100,000)/2) = $1,750,000 / $125,000 = 14

2006: $1,080,000 / (($120,000 + $150,000)/2) = $1,080,000 / $135,000 ≈ 8

e) Profit Margin Ratio

This measures profitability:

Profit Margin = Net Income / Revenues

2005: $143,000 / $2,500,000 ≈ 5.72%

2006: $255,000 / $2,000,000 = 12.75%

f) Return on Common Stockholders' Equity

This shows the return to shareholders:

ROE = Net Income / Average Stockholders' Equity

2005: (since equity data is only available for 2004 and 2005, approximate using 2005 equity)

2005: $143,000 / $620,000 ≈ 23.06%

2006: $255,000 / $620,000 ≈ 41.13%

g) Return on Assets

This indicates how efficiently assets generate profit:

ROA = Net Income / Total Assets

2005: $143,000 / $1,080,000 ≈ 13.24%

2006: $255,000 / $1,000,000 = 25.5%

2. Horizontal and Vertical Analysis

Horizontal Analysis

Horizontal analysis compares financial data over time, highlighting trends and growth patterns. For Westward Corporation, we compare key line items between 2005 and 2006.

• Assets: Decreased from $1,080,000 in 2005 to $1,000,000 in 2006, a decrease of $80,000 or approximately 7.41%.
• Revenues: Declined from $2,500,000 in 2005 to $2,000,000 in 2006, a decrease of $500,000 or 20%.
• Net Income: Increased from $143,000 to $255,000, a growth of $112,000 or 78.32%.

Vertical Analysis

Vertical analysis expresses each line item as a percentage of a base figure—total assets for balance sheet items and revenues for income statement items.

2005 Balance Sheet:

• Cash, investments: $40,000 / $1,080,000 ≈ 3.70%
• Accounts receivable: $90,000 / $1,080,000 ≈ 8.33%
• Inventories: $150,000 / $1,080,000 ≈ 13.89%
• Total assets: 100%

2006 Balance Sheet:

• Cash, investments: $30,000 / $1,000,000 = 3%
• Accounts receivable: $70,000 / $1,000,000 = 7%
• Inventories: $120,000 / $1,000,000 = 12%
• Total assets: 100%

Income Statements:

2005:

• Cost of goods sold: $1,750,000 / $2,500,000 = 70%
• Selling and administrative expenses: $500,000 / $2,500,000 = 20%
• Interest expense: $30,000 / $2,500,000 ≈ 1.2%
• Net income: $143,000 / $2,500,000 ≈ 5.72%

2006:

• Cost of goods sold: $1,080,000 / $2,000,000 = 54%
• Selling and administrative expenses: $495,000 / $2,000,000 = 24.75%
• Interest expense: $30,000 / $2,000,000 = 1.5%
• Net income: $255,000 / $2,000,000 = 12.75%

3. Financial Performance Assessment

The comprehensive analysis indicates that Westward Corporation improved its profitability and liquidity from 2005 to 2006. The current ratio increased significantly, reflecting enhanced short-term liquidity. The debt to total assets decreased slightly, indicating a modest reduction in leverage and financial risk. Notably, the times interest earned ratio improved markedly, signaling better capacity to cover interest obligations.

Profitability ratios like profit margin, return on assets, and return on equity all exhibit positive trends, underscoring increased efficiency and profitability. The substantial growth in net income, despite declining revenues, suggests improved cost management and operational efficiencies.

Horizontal analysis reveals a decline in total assets and revenues, but the significant increase in net income suggests that Westward became more efficient in generating profit relative to its size. Vertical analysis further emphasizes the company's ability to control expenses, as the proportion of cost of goods sold to revenue decreased, and profit margins improved.

Overall, Westward demonstrated strong financial health in 2006 compared to 2005, with increased profitability, efficient asset utilization, and manageable leverage. These indicators suggest that the company was on a positive trajectory, capable of meeting its obligations and delivering value to shareholders.

References

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• Penman, S. H. (2012). Financial Statement Analysis and Security Valuation. McGraw-Hill Education.
• Westward Corporation Annual Reports (2005 & 2006). Company Publications.
• Gibson, C. H. (2013). Financial Reporting and Analysis (13th ed.). Cengage Learning.
• Ross, S. A., Westerfield, R., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
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