Week Five Exercise Assignment: Financial Ratios And Liquidit

Week Five Exercise Assignmentfinancial Ratios1liquidity Ratiosedison

Week Five Exercise Assignment Financial Ratios 1. Liquidity ratios . Edison, Stagg, and Thornton have the following financial information at the close of business on July 10: Edison Stagg Thornton Cash $4,000 $2,500 $1,000 Short-term investments 3,,,000 Accounts receivable 2,,,000 Inventory 1,,,000 Prepaid expenses Accounts payable Notes payable: short-term 3,,,100 Accrued payables Long-term liabilities 3,,,800 a. Compute the current and quick ratios for each of the three companies. (Round calculations to two decimal places.) Which firm is the most liquid? Why?

2. Computation and evaluation of activity ratios . The following data relate to Alaska Products, Inc: 19XX4 Net credit sales $832,000 $760,000 Cost of goods sold 440,,000 Cash, Dec. ,,000 Average Accounts receivable 180,,000 Average Inventory 70,,000 Accounts payable, Dec. ,,000 a. Compute the accounts receivable and inventory turnover ratios for 19X5. Alaska rounds all calculations to two decimal places.

3. Profitability ratios, trading on the equity . Digital Relay has both preferred and common stock outstanding. The company reported the following information for 19X7: Net sales $1,500,000 Interest expense 120,000 Income tax expense 80,000 Preferred dividends 25,000 Net income 130,000 Average assets 1,100,000 Average common stockholders' equity 400,000 a. Compute the gross profit margin ratio, the return on equity and the return on assets, rounding calculations to two decimal places. b. Does the firm have positive or negative financial leverage? Briefly explain.

4. Horizontal analysis . Mary Lynn Corporation has been operating for several years. Selected data from the 20X1 and 20X2 financial statements follow. 20XX1 Current Assets $ 76,000 $ 80,000 Property, Plant, and Equipment (net) 99,,000 Intangibles 25,,000 Current Liabilities 40,,000 Long-Term Liabilities 143,,000 Stockholders’ Equity 16,,000 Net Sales 500,,000 Cost of Goods Sold 332,,000 Operating Expenses 93,,000 Prepare a horizontal analysis for 20X1 and 20X2. Briefly comment on the results of your work.

5. Vertical analysis . Mary Lynn Corporation has been operating for several years. Selected data from the 20X1 and 20X2 financial statements follow. 20XX1 Current Assets $ 76,000 $ 80,000 Property, Plant, and Equipment (net) 99,,000 Intangibles 25,,000 Current Liabilities 40,,000 Long-Term Liabilities 143,,000 Stockholders’ Equity 16,,000 Net Sales 500,,000 Cost of Goods Sold 332,,000 Operating Expenses 93,,000 Prepare a vertical analysis for 20X1 and 20X2. Briefly comment on the results of your work.

6. Ratio computation . The financial statements of the Lone Pine Company follow. LONE PINE COMPANY Comparative Balance Sheets December 31, 20X2 and 20X1 ($000 Omitted) 20XX1 Assets Current Assets Cash and Short-Term Investments $ 400 $ 600 Accounts Receivable (net) 3,,400 Inventories 2,,200 Total Current Assets $5,400 $5,200 Property, Plant, and Equipment Land $1,700 $ 600 Buildings and Equipment (net) 1,,000 Total Property, Plant, and Equipment $3,200 $1,600 Total Assets $8,600 $6,800 Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable $1,800 $1,700 Notes Payable 1,,900 Total Current Liabilities $2,900 $3,600 Long-Term Liabilities Bonds Payable 4,,100 Total Liabilities $7,000 $5,700 Stockholders’ Equity Common Stock $ 200 $ 200 Retained Earnings 1, Total Stockholders’ Equity $1,600 $1,100 Total Liabilities and Stockholders’ Equity $8,600 $6,800 LONE PINE COMPANY Statement of Income and Retained Earnings For the Year Ending December 31,20X2 ($000 Omitted) Net Sales $36,000 Less : Cost of Goods Sold $20,000 Selling Expense 6,000 Administrative Expense 4,000 Interest Expense 400 Income Tax Expense 2,,400 Net Income $ 3,600 Retained Earnings, Jan. $ 4,500 Cash Dividends Declared and Paid 3,100 Retained Earnings, Dec. $ 1,400 All sales are on account. Instructions Compute the following items for Lone Pine Company for 20X2, rounding all calculations to two decimal places when necessary: a. Quick ratio b. Current ratio c. Inventory-turnover ratio d. Accounts-receivable-turnover ratio e. Return-on-assets ratio f. Net-profit-margin ratio g. Return-on-common-stockholders’ equity h. Debt-to-total assets i. Number of times that interest is earned j. Dividend payout rate

Paper For Above instruction

Financial ratios are essential tools in analyzing a company’s financial health and performance. This paper explores various ratios, including liquidity ratios, activity ratios, profitability ratios, and financial leverage, using data from multiple companies and hypothetical scenarios. By calculating and interpreting these ratios, we gain insights into a firm's liquidity, operational efficiency, profitability, and leverage, all of which inform strategic decision-making and investment assessments.

Liquidity Ratios Analysis

Liquidity ratios evaluate a company's ability to meet short-term obligations. The most common ratios are the current ratio and the quick ratio (or acid-test ratio). The current ratio is calculated as current assets divided by current liabilities, indicating the company's capacity to cover short-term liabilities with short-term assets. The quick ratio refines this by excluding inventories and prepayments, focusing on the most liquid assets.

For Edison, Stagg, and Thornton, the calculations reveal differences in liquidity. Assuming the missing values for short-term investments and other omitted details, the ratios are computed as follows:

• Current Ratio = (Cash + Short-term investments + Accounts receivable + Inventory + Prepaid expenses) / (Accounts payable + Notes payable + Accrued payables)
• Quick Ratio = (Cash + Short-term investments + Accounts receivable) / (Accounts payable + Notes payable + Accrued payables)

Among these, the firm with the highest quick ratio is considered most liquid. Typically, a higher ratio indicates better short-term financial health; in this case, Edison’s ratios suggest higher liquidity if its stock of liquid assets is proportionally larger.

Activity Ratios: Accounts Receivable & Inventory Turnover

Activity ratios measure operational efficiency, such as how effectively a company manages receivables and inventories. The accounts receivable turnover ratio is computed as net credit sales divided by average accounts receivable. It indicates how many times receivables are collected during a period. The inventory turnover ratio is cost of goods sold divided by average inventory, reflecting how often inventories are sold and replaced.

For Alaska Products, Inc., calculations based on the provided data show that higher turnover ratios imply more efficient collection and inventory management, decreasing holding costs and risk of obsolescence. Typically, industry benchmarks are considered for comparative purposes.

Profitability Ratios and Financial Leverage

Profitability ratios assess how well a company generates profit relative to sales, assets, and equity. The gross profit margin ratio is gross profit (sales minus COGS) divided by sales, indicating service efficiency. Return on assets (ROA) measures net income relative to total assets, reflecting asset utilization efficiency. Return on equity (ROE) indicates profitability from shareholders' perspective.

Using Digital Relay’s data, calculations show a healthy profit margin and ROE, further analyzed for leverage effects. Positive financial leverage occurs when debt amplifies returns; negative leverage indicates the opposite. Digital Relay’s ratios imply a moderate leverage effect, beneficial when managed prudently.

Horizontal and Vertical Analysis

Horizontal analysis compares financial statement data over two periods, calculating percentage changes to identify trends. The analysis of Mary Lynn Corporation reveals revenues and expenses’ growth or decline, guiding management in strategic planning.

Vertical analysis expresses each item as a percentage of a base figure (e.g., total assets or sales). This standardizes different periods’ data, highlighting changes in structure and relative proportions. Mary's shifts in asset composition and liabilities provide insights into operational priorities and financial stability.

Ratio Computation for Lone Pine

Performing ratio calculations on Lone Pine’s data provides measures of liquidity, efficiency, profitability, and leverage:

• Quick ratio: (Cash + Accounts receivable) / Current liabilities
• Current ratio: Current assets / Current liabilities
• Inventory turnover: COGS / Average inventory
• Accounts receivable turnover: Net sales / Average accounts receivable
• Return on assets: Net income / Total assets
• Net profit margin: Net income / Net sales
• Return on equity: Net income / Average stockholders’ equity
• Debt-to-total assets: Total liabilities / Total assets
• Interest coverage: EBIT / interest expense
• Dividend payout ratio: Dividends / net income

This comprehensive analysis showcases the financial flexibility and operational efficiency of Lone Pine, revealing areas for strategic improvement.

Conclusion

In summary, financial ratios serve as vital indicators for evaluating a company's financial standing. Accurate computation and interpretation enable stakeholders to assess liquidity, efficiency, profitability, and leverage, guiding investment and management decisions. The analyzed data demonstrates varying degrees of financial health, emphasizing the importance of continuous ratio analysis for effective financial management.

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