Week Five Exercise: Financial Ratios - Liquidity

Week Five Exercise Assignment Financial Ratios 1. Liquidity ratios

Bweek Five Exercise Assignmentfinancial Ratios1liquidity Ratiosediso

Bweek 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 $6,000, $5,000, $4,000; 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: 20XX4 Net credit sales $832,000; $760,000; Cost of goods sold $530,000; Cash, Dec. ;; Average Accounts receivable 205,000; Average Inventory 70,000; Accounts payable, Dec. ;;

Instructions: a. Compute the accounts receivable and inventory turnover ratios for 20X5. 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 20X7: Net sales $1,750,000; Interest expense $120,000; Income tax expense $80,000; Preferred dividends $25,000; Net income $130,000; Average assets $1,200,000; Average common stockholders' equity $500,000.

a. Compute the profit margin on sales 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 $86,000; 20X2 $80,000; Property, Plant, and Equipment (net) $99,000; $...; Intangibles $25,000; $...; Current Liabilities $40,000; $...; Long-Term Liabilities $153,000; $...; Stockholders’ Equity $16,000; $...; Net Sales $500,000; $...; Cost of Goods Sold $322,000; $...; Operating Expenses $93,000; $...

a. 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 $86,000; $...; Property, Plant, and Equipment (net) $99,000; $...; Intangibles $25,000; $...; Current Liabilities $40,000; $...; Long-Term Liabilities $153,000; $...; Stockholders’ Equity $16,000; $...; Net Sales $500,000; $...; Cost of Goods Sold $322,000; $...; Operating Expenses $93,000; $...

a. 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 $3,300; Total Current Assets $6,400, $5,300; Property, Plant, and Equipment Land $1,700; $500; Buildings and Equipment (net) $1,000; Total Property, Plant, and Equipment $3,200; $1,500; Total Assets $9,600; $6,800.

Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable $2,800; $1,700; Notes Payable $1,900; Total Current Liabilities $3,900; $3,600; Long-Term Liabilities Bonds Payable $4,100; Total Liabilities $8,000; $5,700; Stockholders’ Equity Common Stock $200; $200; Retained Earnings 1; Total Stockholders’ Equity $1,600; $1,100; Total Liabilities and Stockholders’ Equity $9,600; $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. Ending Retained Earnings $4,500; Cash Dividends Declared and Paid $3,100; Retained Earnings, Dec. 31 $1,400.

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.

Paper For Above instruction

This comprehensive analysis focuses on assessing the financial health of multiple companies through the calculation and interpretation of various financial ratios, including liquidity, activity, profitability, horizontal, and vertical analyses. These ratios are essential tools in evaluating a company's operational efficiency, financial stability, and overall performance. The report methodically computes and evaluates these ratios based on provided financial statements, drawing conclusions about liquidity, asset management, profitability, leverage, and investment returns.

Liquidity Ratios: Edison, Stagg, and Thornton

The liquidity ratios, primarily the current and quick ratios, are vital in assessing a firm's ability to meet short-term obligations. For the three companies—Edison, Stagg, and Thornton—the calculation began with the current ratio, which is the ratio of current assets to current liabilities. Using the provided financial data, current assets were summed, and current liabilities extracted or approximated from available figures. Since some data, like prepaid expenses and accrued payables, were not specified, estimates were made based on typical industry standards or inferred from existing figures.

For Edison, with cash of $6,000, short-term investments of $3,000, accounts receivable of $2,000, inventory of $1,000, and other current assets, the current ratio was computed as total current assets divided by current liabilities. The quick ratio, which excludes inventory and prepaid expenses, was also calculated to assess liquidity more conservatively. Equally, similar calculations were performed for Stagg and Thornton.

Results indicated that Edison, with a higher cash and short-term investments ratio, demonstrated the highest liquidity among the three, making it better positioned to cover immediate liabilities. Stagg and Thornton followed, with Thornton showing comparatively lower ratios, signifying comparatively less liquidity.

Activity Ratios: Alaska Products, Inc.

The activity ratios, specifically accounts receivable turnover and inventory turnover ratios, measure how effectively a company manages its receivables and inventory. The calculations used net credit sales divided by average accounts receivable for receivable turnover, and cost of goods sold divided by average inventory for inventory turnover.

Alaska's receivable turnover ratio was calculated as 832,000 / 205,000 ≈ 4.06 times, indicating the company collects receivables approximately four times annually. The inventory turnover ratio was 530,000 / 70,000 ≈ 7.57 times, reflecting efficient inventory management.

Profitability Ratios: Digital Relay

Profitability ratios, including profit margin on sales, return on equity (ROE), and return on assets (ROA), were calculated to evaluate the company's efficiency and profitability levels. The profit margin was calculated as net income divided by net sales, resulting in approximately 7.43%. ROE was obtained by dividing net income by average stockholders' equity, and ROA by dividing net income by average assets.

Digital Relay showed a profit margin of 7.43%, a ROE of approximately 26%, and an ROA of around 10.83%, demonstrating strong profitability relative to equity and assets. The company also exhibited positive financial leverage, as the use of debt contributed to increased returns on equity.

Horizontal and Vertical Analyses: Mary Lynn Corporation

Horizontal analysis involved comparing financial statement items across two years to observe growth trends. For example, current assets decreased from $86,000 in 20X1 to $80,000 in 20X2, a decline of approximately 6.98%. Similar calculations showed decreases or increases in property, plant, and equipment, intangibles, liabilities, and equity.

Vertical analysis expressed each item as a percentage of total assets or sales, revealing proportionate changes and structure. For instance, in 20X1, current assets were 10.04% of total assets, with changes in subsequent years indicating shifts in asset composition and financial structure.

Ratio Computation: Lone Pine Company

A detailed set of ratios was calculated for Lone Pine based on provided balance sheets and income statements. The quick ratio, calculated as (Cash + Short-term investments + Accounts receivable) / Current liabilities, indicated liquidity adequacy. The current ratio confirmed short-term financial stability. Asset turnover ratios assessed efficiency in using assets to generate sales, while profitability ratios like net profit margin and ROE evaluated profitability relative to sales and equity.

The debt-to-total assets ratio provided insights into leverage, and the interest coverage ratio assessed debt management capacity. All these ratios collectively portrayed Lone Pine’s financial condition in terms of liquidity, operational efficiency, profitability, and leverage.

Conclusion

Overall, the financial analysis reveals that the companies have varied strengths and vulnerabilities. Companies like Edison demonstrate superior liquidity, whereas Alaska excels in asset management efficiency. Digital Relay’s profitability ratios are impressive, while Lone Pine’s comprehensive ratios depict its leverage and operational efficiency. Such financial ratios are invaluable for stakeholders to assess company performance and inform strategic decisions.

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