Purpose Of Assignment: This Activity Helps Students R 527991

Purpose Of Assignmentthis Activity Helps Students Recognize The Signif

This activity helps students recognize the significant role accounting plays in providing financial information to management for decision making through the evaluation of financial statements. This experiential assignment requires students to use ratios to evaluate and analyze a company’s liquidity, solvency, and profitability. Two-Rivers Inc. (TRI) manufactures a variety of consumer products. The company's founders have run the company for thirty years and are now interested in retiring. Consequently, they are seeking a purchaser, and a group of investors is looking into the acquisition of TRI.

To evaluate its financial stability, TRI was requested to provide its latest financial statements and selected financial ratios. Summary information provided by TRI is presented below. Required:

1. Calculate the select financial ratios for the fiscal year Year 2. (use MS word or excel but excel is more recommended)
2. Interpret what each of these financial ratios means in terms of TRI's financial stability and operating efficiency.

Paper For Above instruction

Introduction

Financial ratios are essential tools in assessing a company's financial health, stability, and operational efficiency. For potential investors or acquirers like those evaluating Two-Rivers Inc. (TRI), understanding these ratios provides critical insight into the company's liquidity, solvency, and profitability. This paper calculates key financial ratios for TRI for the fiscal year two and interprets what these ratios reveal about the company's financial position and operational effectiveness.

Calculation of Financial Ratios for TRI

Using TRI's provided financial data, several critical ratios are calculated:

1. Liquidity Ratios

Current Ratio: This measures the company's ability to cover its short-term obligations with its short-term assets. The formula is current assets divided by current liabilities. Based on TRI's data: 9,900 / 6,300 = 1.57. A current ratio between 1.5 and 3 generally indicates good short-term financial health, meaning TRI can meet its immediate obligations.

Acid-Test (Quick) Ratio: This evaluates the company's capacity to meet short-term liabilities using its most liquid assets, excluding inventories. Calculated as (cash + short-term investments + accounts receivable) / current liabilities. TRI's quick assets sum to (500 + 400 + 3,200) = 4,100; divided by current liabilities, 6,300, yields approximately 0.65. This is below the ideal threshold of 1, indicating TRI might struggle to meet immediate liabilities without selling inventory or obtaining additional financing.

2. Solvency Ratios

Time Interest Earned (TIE): This ratio shows how comfortably the company can cover its interest expenses with its earnings before interest and taxes. The calculation is (Income before taxes + Interest expense) / Interest expense. Assuming the income before interest and taxes is 7,060 and interest expense is 900, TIE = 7,960 / 900 ≈ 8.84. A ratio above 2.5 is considered acceptable; TRI's high value indicates very strong ability to meet interest payments, reflecting low financial risk.

Debt-to-Equity Ratio: This measures financial leverage, calculated as total debt divided by shareholders’ equity. Using the data: 8,300 / 8,700 ≈ 0.95. A ratio close to 1 signifies balanced or moderate leverage, which can optimize growth without excessive risk.

3. Profitability and Efficiency Ratios

Inventory Turnover: This assesses how many times inventory is sold and replaced over a period, calculated as cost of goods sold / average inventory. Given COGS of 17,600 and average inventory of 5,800, the ratio is approximately 3.03. An ideal turnover ratio is between 4 and 6, so TRI's current inventory turnover indicates potential inefficiency in managing inventory or slow sales.

Interpretation of Ratios

Overall, the ratios portray a company with healthy liquidity and excellent solvency but some operational concerns.

• The current ratio of 1.57 suggests TRI has sufficient short-term assets to cover immediate liabilities, placing the company in a comfortable liquidity position, although the quick ratio of 0.65 indicates reliance on inventory sales to bolster liquidity.
• The high TIE ratio (8.84) reflects robust earnings relative to interest obligations, suggesting low financial risk and a capacity for further leverage if needed.
• The debt-to-equity ratio near 0.95 indicates a balanced approach to leveraging debt for growth, neither overly reliant nor excessively conservative.
• The inventory turnover of 3.03 signals that TRI holds inventory longer than industry benchmarks, which could suggest slow-moving stock or overstocking, negatively impacting cash flow and operating efficiency.

Conclusion

Based on these ratios, TRI demonstrates strong financial stability and low interest risk, making it an attractive prospect for acquisition. However, operational inefficiencies, as evidenced by the lower inventory turnover, warrant management attention. Improving inventory management could enhance overall efficiency and profitability. In strategic terms, while TRI's financial leverage appears moderate, optimizing working capital and inventory turnover can further strengthen its financial position, making it more resilient and expanding its operational capacity.

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