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The financial statements of ABC Co. and additional related information are provided to compute various financial ratios for the year 2014. These ratios include liquidity ratios, profitability ratios, efficiency ratios, and market value ratios, which offer insights into the company's financial health, operational efficiency, profitability, and shareholder returns.
Paper For Above instruction
To analyze the financial performance and position of ABC Co. for the year 2014, we will calculate ten key financial ratios using the provided financial statements and additional information. These ratios include the current ratio, return on common stockholders' equity, price earnings ratio, inventory turnover ratio, receivables turnover, times interest earned, profit margin ratio, average days in inventory, payout ratio, and return on assets. Each calculation will be supported with detailed steps, reflecting a comprehensive understanding of financial analysis concepts.
1. Current Ratio
The current ratio measures ABC Co.'s ability to pay its short-term obligations with its short-term assets. It is calculated as:
Current Ratio = Current Assets / Current Liabilities
From the balance sheet, current assets include Cash, Marketable Securities, Accounts Receivable, and Inventory:
- Cash = $25,000
- Marketable Securities = $20,000
- Accounts Receivable = $40,000
- Inventory = $150,000
Total current assets = $25,000 + $20,000 + $40,000 + $150,000 = $235,000
Current liabilities include Accounts Payable and Short Term Notes Payable:
- Accounts Payable = $25,000
- Short Term Notes Payable = $40,000
Total current liabilities = $25,000 + $40,000 = $65,000
Therefore,
Current Ratio = $235,000 / $65,000 ≈ 3.62
2. Return on Common Stockholders' Equity (ROE)
ROE measures profitability relative to shareholders’ equity, computed as:
ROE = Net Income / Average Shareholders' Equity
Shareholders’ equity at December 31, 2014, is:
- Common Stock = $175,000
- Retained Earnings = $90,000
Total equity at year-end = $175,000 + $90,000 = $265,000
Assuming beginning equity is the same as year-end for simplicity,
ROE = $75,000 / $265,000 ≈ 28.30%
3. Price Earnings (P/E) Ratio
The P/E ratio indicates market optimism about future growth, calculated as:
P/E Ratio = Market Price per Share / Earnings per Share (EPS)
Market price per share = $15
EPS = Net Income / Number of Shares Outstanding = $75,000 / 62,000 ≈ $1.21
Therefore,
P/E Ratio = $15 / $1.21 ≈ 12.40
4. Inventory Turnover Ratio
This ratio shows how many times inventory is sold and replaced over a period:
Inventory Turnover = Cost of Goods Sold / Average Inventory
Given COGS = $184,000 and Inventory at year-end = $150,000, assuming beginning inventory similar or slightly different, the average inventory can be approximated as the ending inventory for simplicity.
Inventory Turnover ≈ $184,000 / $150,000 ≈ 1.23 times
5. Receivables Turnover
Indicates how many times receivables are collected during the year:
Receivables Turnover = Net Sales / Average Accounts Receivable
Net Sales = $360,000; Accounts Receivable at year-end = $40,000
Assuming beginning receivables are similar, then:
Receivables Turnover ≈ $360,000 / $40,000 = 9 times
6. Times Interest Earned (Interest Coverage Ratio)
This ratio measures the company's ability to meet its interest obligations:
Times Interest Earned = Income Before Interest and Taxes / Interest Expense
Income before income taxes = $105,000; Interest Expense = $21,000
Times Interest Earned = $105,000 / $21,000 ≈ 5 times
7. Profit Margin Ratio
Shows net income as a percentage of sales:
Profit Margin = Net Income / Net Sales
Net Income = $75,000; Net Sales = $360,000
Profit Margin = $75,000 / $360,000 ≈ 20.83%
8. Average Days in Inventory
Indicates the average number of days inventory is held:
Days in Inventory = 365 / Inventory Turnover
Inventory Turnover ≈ 1.23, so:
Days in Inventory ≈ 365 / 1.23 ≈ 297 days
9. Payout Ratio
The proportion of earnings paid as dividends:
Payout Ratio = Dividends Paid / Net Income
Dividends paid = $50,000; Net Income = $75,000
Payout Ratio = $50,000 / $75,000 ≈ 66.67%
10. Return on Assets (ROA)
Indicates how efficiently assets are used to generate income:
ROA = Net Income / Average Total Assets
Total Assets at year-end = $405,000; assuming beginning assets similar,
ROA = $75,000 / $405,000 ≈ 18.52%
Conclusion
Analyzing these ratios provides insight into ABC Co.'s financial condition in 2014. The company exhibits strong liquidity with a current ratio of approximately 3.62, indicating ample short-term assets to meet liabilities. Profitability metrics such as ROE (~28.30%) and ROA (~18.52%) suggest efficient use of equity and assets to generate earnings. The market P/E ratio of about 12.40 reflects moderate market expectations. Efficiency ratios like inventory and receivables turnover reveal operational turnover periods, with inventory held roughly 297 days. The payout ratio indicates a significant portion of earnings are returned to shareholders, and the company's ability to meet interest obligations comfortably is demonstrated by a times interest earned ratio of about 5. Overall, these ratios depict a financially stable and profitable company with operational efficiencies, though inventory turnover suggests room for improving inventory management.
References
- Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice. Cengage Learning.
- Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
- Gibson, C. H. (2013). Financial Statement Analysis. Cengage Learning.