Solve The Problem Below: Calculate Ratios And Interpret
Solve The Problem Below Calculate The Ratios Interpret The Results A
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.
Given financial statements for Gary and Company as of December 31, 2010, including the balance sheet and income statement, calculate the specified financial ratios, compare them to industry averages, interpret the results, and analyze how the company can utilize these insights to enhance its performance.
Paper For Above instruction
Financial Ratio Analysis of Gary and Company: An Evaluation and Strategic Perspective
Financial ratio analysis is a vital tool used by managers, investors, and creditors to assess a company's operational efficiency, financial stability, and profitability. For Gary and Company, analyzing key ratios such as profit margin, return on assets, receivable turnover, inventory turnover, fixed asset turnover, total asset turnover, liquidity ratios, and the times interest earned ratio reveals essential insights into its financial health relative to industry benchmarks. These insights enable strategic decision-making aimed at improving business performance and ensuring long-term sustainability.
Calculation and Interpretation of Financial Ratios
Profit Margin on Sales
The profit margin indicates how much profit the company makes from its sales. It is calculated as Net Income divided by Net Sales:
Profit Margin = (Net Income / Net Sales) x 100
In this case: (27 / 795) x 100 ≈ 3.39%
Compared to the industry average of 3%, Gary and Company’s profit margin is slightly above industry standards, which is favorable. This suggests effective cost control or pricing strategies that allow the firm to retain more profit from sales.
Return on Assets (ROA)
The ROA measures how efficiently the company uses its assets to generate profit. Calculated as Net Income divided by Total Assets:
ROA = (Net Income / Total Assets) x 100
(27 / 450) x 100 ≈ 6%
The industry average is 9%, so Gary and Company’s ROA is below industry standards, indicating potential inefficiencies in asset utilization. Improving asset management could enhance overall profitability.
Receivable Turnover
This ratio assesses how many times receivables are collected during a period. Calculated as Net Sales divided by Accounts Receivables:
Receivable Turnover = Net Sales / Accounts Receivables
795 / 66 ≈ 12.05 times
The industry average is 1.6 times, but this appears inconsistent with typical receivable turnover calculations, suggesting perhaps a typo or misinterpretation. Assuming the correct industry average is 1.6 times, Gary’s high turnover indicates efficient collection processes, though this might also suggest that receivables are unusually low or the data needs reconciliation.
Inventory Turnover
Reflects how many times inventory is sold and replaced over a period. Calculated as Cost of Goods Sold divided by Inventory:
Inventory Turnover = COGS / Inventory
660 / 159 ≈ 4.16 times
The industry average is 10 times, indicating that Gary and Company holds inventory longer than the industry average, potentially tying up cash in inventory. Improving inventory management could boost sales efficiency.
Fixed Asset Turnover
This measures how efficiently the company utilizes fixed assets to generate sales. Calculated as Net Sales divided by Net Fixed Assets:
Fixed Asset Turnover = Net Sales / Net Fixed Assets
795 / 147 ≈ 5.41 times
The industry average is 2 times, so Gary and Company’s utilization of fixed assets is more efficient than the industry average, indicating effective use of capital assets.
Total Asset Turnover
Indicates the company's ability to generate sales from its assets. Calculated as Net Sales divided by Total Assets:
Total Asset Turnover = Net Sales / Total Assets
795 / 450 ≈ 1.77 times
The industry average of 3 times suggests Gary and Company may not be utilizing its total assets as efficiently as competitors, signaling room for operational improvements.
Liquidity Ratios
Current Ratio
The current ratio evaluates the company's ability to pay short-term obligations with its short-term assets:
Current Ratio = Total Current Assets / Total Current Liabilities
303 / 111 ≈ 2.73 times
Above the industry average of 2X, indicating solid liquidity and short-term financial health.
Quick Ratio (Acid-Test Ratio)
This ratio measures immediate liquidity, excluding inventories:
Quick Ratio = (Cash + Marketable Securities + Receivables) / Total Current Liabilities
(45 + 33 + 66) / 111 ≈ 1.57 times
Compared to the industry average of 1.5 times, the company's quick ratio suggests adequate liquidity with a slight cushion for immediate liabilities.
Times Interest Earned (TIE)
This ratio indicates how comfortably the company can meet interest obligations. Calculated as EBIT divided by interest expense:
Times Interest Earned = EBIT / Interest Expense
49.5 / 4.5 ≈ 11 times
Compared to the industry average of 7 times, Gary and Company has a strong capacity to meet interest payments, implying less financial risk.
Summary of Findings and Industry Comparison
Overall, Gary and Company's profitability margins are slightly better than industry averages, but efficiency ratios like ROA and total asset turnover reveal room for improvement. Its liquidity position appears robust, with above-average current and quick ratios, and the times interest earned ratio indicates low financial risk. Conversely, inventory turnover is lower than industry norms, signaling inventory management could be optimized to convert inventory into sales more efficiently.
Strategic Recommendations for Improving Performance
To enhance financial performance, Gary and Company should focus on:
- Asset Utilization: Improving asset management to increase ROA and total asset turnover. This could involve streamlining operations or investing in technology to better track and utilize assets.
- Inventory Management: Reducing inventory levels or improving inventory turnover can free up cash, reduce storage costs, and improve overall efficiency.
- Cost Control: While profit margins are adequate, continued focus on controlling costs, especially selling expenses, can further enhance profitability.
- Receivables Management: Although receivable turnover is high, maintaining efficient collection practices ensures steady cash flow.
- Leverage and Debt Management: The company’s strong interest coverage ratio suggests conservative debt levels; maintaining this discipline will help preserve financial stability.
Conclusion
Gary and Company's financial ratios present a picture of a relatively healthy business with effective liquidity and strong interest coverage but highlight areas such as asset utilization and inventory management where improvements can be targeted. By strategically focusing on these areas, the company can enhance its operational efficiency, profitability, and competitive positioning, leading to sustainable financial growth in alignment with industry standards and best practices.
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