Ratio Analysis

Module C

CAIIB Madhav Prabhu

M. Tech, MIM, PMP, CISA, CAIIB, CeISB, MCTS, DCL prabhu.madhav@gmail.com

Objective
Understand the importance of critically looking at the Financial Statements from the bankers point of view. Make an intelligent use of the information, as contained in the Financial Statements, to carry out a meaningful Financial Appraisal. Make proper analysis of the relevant Ratios and interpret the implications thereof in the context of the required Financial Appraisal. Understand the implications of some important Ratios and Concepts having a bearing on the Financial Appraisal. Understand the Importance and Limitations of Ratio Analysis. Understand the role of Funds Flow as an adjunct to Financial Appraisal. Understand the distinct and separate uses of Funds Flow and Cash Flow Statements.

Financial Statements
The Profit and Loss Account and the Balance Sheet are interrelated and not independent. The Balance Sheet shows the position of Assets and Liabilities of a business enterprise as on a given date, whereas the Profit and Loss Account shows the profit made or the loss incurred by the enterprise for a particular year, The Balance Sheet for two or more successive years will show the changes that have taken place in the Assets and Liabilities and the net change (increase or decrease) in the Net Worth during those years.

 The Profit and Loss Account is as valuable a source of information as the Balance Sheet and, at no stage, it should be given a secondary place in ascertaining the financial solvency and strength of an enterprise, since the trend of profits is the best indicator of the prosperity of an enterprise and the value of the assets depends largely on the maintenance of the business as a going concern.

 Although the position of net profit or loss can be ascertained from a study of the Balance Sheet, it is only from a study of the Profit and Loss Account that we can ascertain as to how the profit or loss has been made, the factors or reasons behind such profit or loss and the significant features of its constituent items. The Profit and Loss Account is based on the accrual concept in accounting

What to be taken and what not..

Items to be taken into account
income relating to the accounting period which has been earned, but not actually received. expenditure which has been incurred and relates to the accounting period, but not actually paid.

Items not to be taken into account (to be carried over)

Income which has been received, but not earned (i.e., which does not relate to the accounting period). expenditure which has been incurred, but does not pertain to the accounting period.

Users of financial statements

The management of the enterprise Investors or shareholders Creditors Employees Government agencies, tax authorities etc Lenders, i.e. banks and financial institutions

Need for Financial Analysis

Technical Appraisal Commercial Appraisal Financial Appraisal Economic Appraisal Management Appraisal

What is Financial Ratio Analysis?

Ratio is an arithmetic relationship between two figures Can be expressed as Percentage, Fraction and Proportion These alternative methods of expressing relationship between items, which should be related to each other, are, for the purpose of financial analysis, referred to as Ratio Analysis
The usage? Interpretation !

Interpretation

is drawing conclusions

to serve as basis for decisions and actions

Need for Comparison of Ratios

Reveal the relationship in a more meaningful way which enables an analyst to interpret them judiciously and intelligently. Draw inferences or conclusions Such inferences can be drawn by comparisons.

Types of comparison
Trend Ratios intra firm Inter-firm comparison Ratios of the enterprise with the average or standard ratios of the industry Comparison with related facts is the basis of ratio analysis.

How to go about it?

Balance Sheet Trading/Manufacturing and Profit and Loss Account Various Schedules relating to assets and liabilities, particularly the debtors, creditors, loans and advances, stocks, provisions, term loans and deposits including unsecured or subordinated loans Report of the Auditors in the prescribed form Report of the Directors, if it is a company Details of Contingent Liabilities Details of Interest on Term Liabilities payable within 12 months from the date of Balance Sheet Details of old or slow-moving or obsolete stocks, unrecoverable debts and advances given on a long-term basis.

CLASSIFICATION/TYPES OF RATIOS
Balance Sheet Ratios, i.e., ratios calculated on the basis of the items/figures of Balance Sheet only. For example, Current Ratio, Debt-Equity Ratio etc. These ratios are also referred to as Financial Ratios. Profit and Loss Account Ratios or Income Statement Ratios or Revenue Statement Ratios, i.e., ratios calculated on the basis of the items/figures of Profit and Loss Account only. For example, Gross Profit Ratio, Stock Turnover Ratio etc. These ratios are also called Operating Ratios. Balance Sheet and Profit and Loss Account Ratios, i.e., ratios calculated on the basis of the items/figures of both the Balance Sheet and the Profit and Loss Account. For example, Fixed Assets Turnover Ratio, Debtors Turnover Ratio etc. These ratios are also referred to as Inter-Statement Ratios or Composite Ratios.

Ratios
Four groups, on the basis of their functions
Liquidity Ratios measure the short-term stability of an enterprise. Leverage/Capital Structure Ratios indicate the relationship between Debt and Equity. Profitability Ratios measure earning success. Activity Ratios measure the efficiency of asset management.

Ratio Ltd :P/L Account for the year ending 31st March, 20x1 20x1 20x0
Net Sales Cost of Goods sold Stocks wages & salaries other Mfg Exp 701 552 421 68 63 623 475 370 55 50

Gross Profit
Operating Expenses Depreciation Gn Adm Selling

149
60 30 12 18

148
49 26 11 12

Operating Profit
Non Operating surplus/deficit Profit before interest and tax Interest Profit before tax Tax Profit after tax Dividend Retained Earnings

89
-89 21 68 34 34 28 6 2.27 1.80 21.0 17.47

99
6 105 22 83 41 42 27 15 2.80 1.80 20.0 17.07

Per Share Data (Rs)

EPS Dividend Per share Mkt Price Per Share Book Value per share

Ratio Ltd: Balance Sheet as on 31st March,20x1 (Rs in Mill)

20x1
I Sources

20x0
262 150 112 212 256

of Funds

1 Share Holders funds a) Share Capital b) Reserves & Surplus 2 Loan Funds a) Secured Loans Due after 1 year Due within 1 year b) Unsecured Loans Due after 1 year Current Liabilities Due within 1 year Provisions

156

143 108 35 Current Assets 69 Loans & Advances 29 40 474 412

Ratio Ltd: Balance Sheet as on 31st March,20x1 (Rs in Mill)

20x1
Usage of Funds 1 Fixed Assets 2 Investments long term short term 3 CA, Loans and Advances Inventories debtors Cash & Bank Balance Loans & Advances Less CL and Provisions Current Liabilities Net Current Assets Provisions 4 Misc Expenditure and Losses

20x0

330 322 15 15 12 12 3 3 234 156 105 72 114 68 10 6 Current Assets 5 Loans & Advances 10 105 81 129 75 -474 -412

Liquidity Ratios

Current Ratio

Current Assets

=
Current Liabilities

237/180 =1.32

Acid Test Ratio

Current Assets-inventory

=
Current Liabilities

(237-105)/180 =0.73

Interpretation
Current Ratio
The higher the current ratio, the larger would be the amount of rupees available per rupee of current liability. In other words, the ability of the enterprise to meet its current obligations is more, which indicates that the safety of funds of short-term creditors is greater
But be aware
Very high Current Ratio may be the result of slack management practices

Current Ratio should, therefore, be seen in relation to the components of the current assets and their liquidity

Acid Test Ratio or Quick Ratio

Refinement of the Current Ratio Takes into account the quick (or more liquid) current assets and current liabilities to determine the quick or instant liquidity position of an enterprise Ratio concentrates on cash, marketable securities and receivables (net of bad and doubtful debts) in relation to current obligations, it is a more rigorous and penetrating measure of the liquidity position of an enterprise than the Current Ratio

Calculation
Amount (Rs) Cash Debtors Inventories Total Current Assets Current Liabilities Current Ratio Acid Test Ratio

50,000 1,00,000 1,50,000 3,00,000 1,00,000 3:1 1.5:1

Acid Test Ratio

However caution.
Variation from season to season in an enterprise and from enterprise to enterprise in an industry

Important to interpret in light of nature of business Good Current Ratio and Low Acid Test Ratio indicates?

Turnover Ratio
To determine how quickly certain current assets are converted into cash
Inventory Turnover Ratio, Debtors Turnover Ratio and Creditors Turnover Ratio.

Inventory Turnover Ratio

Dividing the cost of goods sold by the average inventory Cost of Goods sold = Sales minus gross profit or Op Stock+Purchase-Cl Stock Avg Inventory= Op+Closing/2 Indicated number of times inventory is rotated in a year If ITR = 6, what is interpretation?

Inventory Turnover Ratio

An enterprise has sold goods worth Rs 4,00,000 with a gross profit margin of 25 per cent. The stocks at the beginning and at the end of the year were Rs 75,000 and Rs 25,000 respectively. What would be the Inventory Turnover Ratio?

Inventory Turnover Ratio

Interpretation
Inventory management peformance Fair judgement on liquidity Stockout.caution

Debtors Turnover Ratio

Relationship between credit sales and debtors of an enterprise Speed of realisation Net Credit Sales/Avg outsanding debtors Net Credit Sales= Gross Credit SalesReturns Caution..

Debtors Turnover Ratio

Net Credit Sales figures may not be available Bad and doubtful debts not to be excluded

Debtors Turnover Ratio

Total Sales for the year 200304 Cash Sales for the year 200304 Debtors as on 01.04.2003 Debtors as on 31.03.2004 Bills Receivables as on 01.04.2003 Bills Receivables as on 31.03.2004 1,00,000 20,000 10,000 15,000 7,500 12,500

Average of Opening Balance + Closing Balance (Rs 17,500.00 + Rs 27,500.00) Debtors Turnover Ratio 80000/22500 =3.56

Debtors Turnover Ratio

Interpretation
Efficiency of realisation Short collection period preferable Could lose sales..

Debt Collection Period Ratio

Indicates avg period of realisation 365/Debtors turnover

Creditors Turnover Ratio

Number of times the creditors are paid vis--vis credit purchases Speed with which payments are made to creditors for purchases made on credit basis Dividing net credit purchases by the average of outstanding creditors Net Credit Purchases are equal to Gross Credit Purchases less Returns to Suppliers

Creditors Turnover Ratio

Credit purchases during 0304 1,00,000 Creditors as on 01.04.2003 20,000 Creditors as on 31.03.2004 10,000 Bills Payable as on 01.04.2003 4,000 Bills Payable as on 31.03.2004 6,000 Creditors Turnover Ratio = 100000/20000

Creditors Turnover Ratio

Interpretation
Creditors paid promptly Credit worthiness Low ratio indicates liberal credit terms

LEVERAGE/CAPITAL STRUCTURE RATIOS

Short term creditors view Long term creditors view

LEVERAGE/CAPITAL STRUCTURE RATIOS

Two aspects of the long-term solvency of an enterprise:
Regular payment of interest on the loan, as and when due, during the period of the loan, and Repayment of principal amount of the loan in predetermined instalments on the due dates or in one lump sum on maturity.

LEVERAGE/CAPITAL STRUCTURE RATIOS

Two different, but mutually dependent and inter-related, types of Leverage Ratios
Ratios of the first type are based on the relationship between borrowed funds and owners capital and are computed from the Balance Sheet. The other types of ratios, also referred to as the Coverage Ratios, are calculated from the Profit and Loss Account

Leverage Ratios
Debt equity Debt to Capital

Debt Equity
Two approaches
Long term debts/Equity Total Debt/Equity

D/E ratio also called Debt to Net Worth Ratio

Debt Equity
Interpretation
denotes the proportion of capital of an enterprise to its total debts, Indicates the relationship between the owned funds and the borrowed funds of the enterprise.

Debt Equity
Implication
Pressure on earnings of the enterprise, leading to default on meeting debt obligations; Possibility of the creditors losing heavily, Interference from creditors in management of the enterprise including close monitoring of the day-today operations of the enterprise; The enterprise might find it difficult to borrow additional funds, it would be possible only on restrictive terms and conditions and at relatively higher costs. There is no ideal however. Capital intensive industries D/E could be higher

Debt to Capital Ratio

1st approach Capital = Permanent Capital of the enterprise = Shareholders Equity + Long term debts
Measures Long term debt proportion

2nd approach Long term debts and current Laibilities/Permanent capital+current liabilities
Measures total assets financed by external funds

3rd approach Owners or proprietory funds/Tangible assets

Measures what portion of the Total Tangible Assets is financed by the Owners or the Proprietors Funds

Coverage Ratios
PL Account Claims of creditors
arise on account of
interest on loans, payment of dividend on preference shares, and amortization of principal or repayment of instalments of term loans or redemption of preference share capital on maturity.

Measure the relationship between what is normally available from the operations of an enterprise and the claims of its creditors

 Interest Coverage Ratio Dividend Coverage ratio

Interest Coverage ratio

Important from lenders point of view Shows how many times the interest charges are covered by the EBIT, out of which those will be paid EBIT/Fixed interest charges on loans Why EBIT?

Interest Coverage ratio

Important from lenders point of view EBIT/Fixed interest charges on loans Why EBIT?
Interest is tax-deductible and tax is calculated after payment of interest on loans

Caution
Too high a ratio may imply unused debt capacity. Low Ratio is a danger signal in the sense that the enterprise is using excessive long-term debts and

Dividend Coverage ratio

Measures the ability of an enterprise to pay dividend on preference shares PAT/Pref Div Amt Why PAT here?

Dividend Coverage ratio

Measures the ability of an enterprise to pay dividend on preference shares PAT/Pref Div Amt Why PAT here?
Unlike debts on which interest is a charge on the profits of the enterprise, the Preference Dividend is treated as an appropriation of profit

Profitability Ratios
Gross Profit Margin Net Profit Margin

Gross Profit Margin

Gross Profit/Net Sales Interpretation
Efficiency in the matter of production as well as pricing

Very High GPM

Check for unsatisfactory basis of valuation of stocks resulting in over-valuation of closing stock and/or under-valuation of opening stock

Low GPM
Check for high cost of production, low selling price

Net Profit Margin

Net Profit/Net Sales Measures the overall efficiency of production, administration, selling, financing, pricing and tax management of an enterprise Indicative of the managements ability to operate the business with success, by way of recovery from revenues, not only of
the cost of raw materials, the expenses towards operating the business including depreciation and the cost of borrowed funds, but also leaving a reasonable margin of profit for the organisation.

Profitability Ratios Related to Investments

Return on Assets, Return on Capital Employed Return on Shareholders Equity

Return on Assets
Measured in terms of the relationship between net profits and assets Assets = Total Assets (FA-Deprecn)+NWC Intangibles

Return on Capital Employed

Profits/Total Capital Employed Insight into how efficiently the long-term funds of the owners and the creditors are being used Higher the Ratio, the more efficient is the use of capital employed
Can be improved by improving the profitability or by increasing the turnover of capital or by combination of both

Return on Shareholders Equity

Rate of Return on
Total Shareholders Equity, and Ordinary Shareholders Equity,

Earning Per Share, Dividend Per Share, Dividend Pay-out Ratio, and Price Earning Ratio.

Return on Total Shareholders Equity

Preference share capital Equity share capital PAT/Avg Total Shareholder equity

Return on Ordinary Shareholders Equity

Equity share capital PAT(after Pref Div)/Avg Ordinary Shareholder equity

Earning Per Share

NPAT-Pref Div/No. of Equity Shares Measure of profitability from the shareholders point of view Again caution
should not be relied upon blindly: Why?

Earning Per Share

NPAT-Pref Div/No. of Equity Shares Measure of profitability from the shareholders point of view Again caution
should not be relied upon blindly
EPS cannot represent financial operations of business Comparison across companies different accounting procedures could be applied

Dividend Per Share

Better indicator than EPS NP (distributable)/No. of equity shares

Dividend Payout Ratio

Dividend Paid/PAT DPS/EPS

Activity Ratio
Measures efficiency with which an enterprise is managing and utilising its assets Also called as Efficiency Ratios or Asset Utilisation Ratios efficiency with which the assets are utilized
Higher the rate of conversion or turnover, the more efficient is the utilization or management of the assets Also referred as Turnover Ratios

Assets Turnover Ratio

To find out whether the investments in the relative fixed assets have been judicious and whether such investments have contributed towards achievement of the desired sales target Total Assets Turnover
Cost of Goods Sold/Total assets

Interpretation
Efficient and effective utilisation

Capital Gearing Ratio

Relation of Equity Capital to Loans Technique of raising finances for a company by resorting to fixed interest or dividend-carrying securities

Capital Gearing Ratio

Low Gearing (Rs) (Rs) Equity Share Capital 8 % Preference Share Capital 7 % Redeemable Preference Share Capital 7 per cent Debentures General Reserves PL Appropriation Account High Gearing

15,00,000 4,00,000
1,00,000 3,00,000 1,00,000 1,00,000 24,00,000 16:8 2:1

6,00,000 4,00,000
8,00,000 4,00,000 1,00,000 24,00,000 8:16 1:2

Gearing Ratio

Capital Gearing Ratio

Interpretation
A high gearing may result in some benefits to the equity shareholders, where the rate of interest/dividend on fixed interest/dividendcarrying securities is lower than the rate of return on total capital invested in the business

Debt Service Coverage Ratio (DSCR)

Ability of an enterprise to meet its liabilities by way of payment of instalments of term loans and interest thereon from out of cash accruals Forms the basis for fixation of the repayment schedule Cash accruals/Repayment Cash acruals+Int/Repayment+Int

Debt Service Coverage Ratio (DSCR)

Interpretation
Along with cash flow indicates
when the repayment of the loan should begin, how much should it be, and what should be the repayment period.

Return on Net Worth (RoNW)

Measures the returns on the Net Worth, i.e., Equity and Reserves of a company and gives an idea of the way in which shareholders funds are being utilized Net Profit /Net Worth RONW good measure for comparison If bonus shares are issued
EPS decreases, RONW?

Return on Net Worth (RoNW)

Measures the returns on the Net Worth, i.e., Equity and Reserves of a company and gives an idea of the way in which shareholders funds are being utilized Net Profit /Net Worth RONW good measure for comparison If bonus shares are issued
EPS decreases, RONW?
Constant!

Some Scenarios
Overtrading
Cash shortage High Inv Turnover Ratio Low Current Ratio

UnderTrading
Low Inv Turnover Ratio High Current Ratio

 Under capitalisation
Owner capital less than borrowed capital May be result of over trading Effects
Payment of excessive interest on borrowed capital, Use of out-of-date appliances and equipments because of inability to purchase new plant, equipments etc., and High cost of production because of the use of old machines and excessive interest on loans and high cost of purchase due to extra credit period demanded on purchases.

 Over capitalisation
If its earnings are not sufficient to justify a fair return on the amount of share capital and debentures that have been issued Owner capital more than borrowed funds

Importance of Ratio Analysis

Basis for comparing otherwise incomparable absolute figures Enables drawing of inferences on the performance Liquidity Position Long term Solvency Operating Efficiency Overall Profitability Inter-firm Comparison Trend Analysis

Limitations
Ratios are only tools Ratio Analysis communicates only a relative picture Inflation distorts financial Ratio Analysis Inter-firm comparison consider age, size etc Gives symptoms further investigation needed for diagnosis

Funds Flow
Funds Flow statement
Balance Sheet Profit Loss account

Drawn from movement of funds Analysis of resources available for finance activities and uses Also called Balance Sheet variation statement or Sources and Uses of Funds statement

Funds flow Statement

For better understanding
The operating surplus generated by the company, before tax and dividend. Whether any additional fixed assets have been acquired and, if so, the amount spent therefor. Whether any fixed assets have been sold and, if so, the sale proceeds thereof. Whether any miscellaneous income, extraneous to the normal operations of the company, has been received and, if so, the amount thereof. Dividend paid by the company and, if so, whether it was paid out of the earnings of the year or out of profits of earlier year(s). The extent of funds generated by way of depreciation charge.

Distinction
Transactions not involving cash are excluded for the purpose of Cash Flow Statement Transactions not involving cash are excluded for the purpose of Cash Flow Statement. For example, transactions involving change of Finished Goods to Receivables are ignored in Cash Flow Statement, whereas these form part of Funds Flow Statement. The accrual concept is ignored in Cash Flow Statement, but is considered in Funds Flow Statement, since the relative items form part of cash flow at the time of receiving or effecting the payments. The Funds Flow Statement is an extension of the Balance Sheet and is a part of appraisal process, whereas the Cash Flow Statement is used by the management as a tool for monitoring the cash balance to ensure timely receipt and payment of cash and also maintain cash balance in hand to the extent required.

Cash Flow Statement

Ability of the enterprise to meet obligations to trade creditors To make timely payment of interest on and instalments of bank loans, as and when due, To pay interest to debenture holders as also dividends to its shareholders Enables the management to make necessary planning

 A firm has a higher asset turnover ratio than the industry average, which implies A) the firm has a higher P/E ratio than other firms in the industry. B) the firm is more likely to avoid insolvency in the short run than other firms in the industry. C) the firm is more profitable than other firms in the industry. D) the firm is utilizing assets more efficiently than other firms in the industry.

 A firm has a higher asset turnover ratio than the industry average, which implies A) the firm has a higher P/E ratio than other firms in the industry. B) the firm is more likely to avoid insolvency in the short run than other firms in the industry. C) the firm is more profitable than other firms in the industry. D) the firm is utilizing assets more efficiently than other firms in the industry.**

 If the interest rate on debt is higher than ROA, then a firm will __________ by increasing the use of debt in the capital structure. A) increase the ROE B) not change the ROE C) decrease the ROE D) change the ROE in an indeterminable manner

 If the interest rate on debt is higher than ROA, then a firm will __________ by increasing the use of debt in the capital structure. A) increase the ROE B) not change the ROE C) decrease the ROE ** D) change the ROE in an indeterminable manner

 If a firm has a positive tax rate, a positive ROA, and the interest rate on debt is the same as ROA, then ROA will be ________. A) greater than the ROE B) equal to the ROE C) less than the ROE D) greater than zero but it is impossible to determine how ROA will compare to ROE

 If a firm has a positive tax rate, a positive ROA, and the interest rate on debt is the same as ROA, then ROA will be ________. A) greater than the ROE** B) equal to the ROE C) less than the ROE D) greater than zero but it is impossible to determine how ROA will compare to ROE

 When long term uses in a funds flow statement are more than long term uses, it results in:
Increase in WC gap Increase in NWC Increase in CL Decrease in WC

 When long term uses in a funds flow statement are more than long term uses, it results in:
Increase in WC gap Increase in NWC** Increase in CL Decrease in WC

A firm incurs a loss. In funds statement it would be shown as Source of funds Use of funds Waste of funds Routing of funds

a. b. c. d.

A firm incurs a loss. In funds statement it would be shown as Source of funds Use of funds** Waste of funds Routing of funds

a. b. c. d.

a. b. c. d.

Balance sheet total of a firm has total of 32 lakhs. LTS are 20 Lakhs. If CR is 1.5:1, what is the amount of long term use of firm? 18 16 14 12

a. b. c. d.

Balance sheet total of a firm has total of 32 lakhs. LTS are 20 Lakhs. If CR is 1.5:1, what is the amount of long term use of firm? 18 16 14** 12

 a. b. c. d.

Payment of creditors has been made by firm out of available cash. This will Not bring any change to WC Change the WC Change WC and overall NW Not change WC and OP

 a. b. c. d.

Payment of creditors has been made by firm out of available cash. This will Not bring any change to WC** Change the WC Change WC and overall NW Not change WC and OP

 a. b. c. d.

Activity rations measure Efficiency of asset management Earning success Relationship between Debt and equity Short term stability of a firm

 a. b. c. d.

Activity rations measure Efficiency of asset management** Earning success Relationship between Debt and equity Short term stability of a firm

a. b. c. d.

An SSI unit isues fully paid bonus shares of Rs. 30 Lakhs. D/E was 2:1, LToutside Liab Rs 200 Lakhs before this. What is new D/E? 1.5:1 1.8:1 2.0:1 2.5:1

a. b. c. d.

An SSI unit isues fully paid bonus shares of Rs. 30 Lakhs. D/E was 2:1, LToutside Liab Rs 200 Lakhs before this. What is new D/E? 1.5:1 1.8:1 2.0:1** 2.5:1

 a. b. c. d.

DSCR helps Banks to: Assess WC need Assess TL need Fix amount of instalment and period Assess credit worthiness of firm

 a. b. c. d.

DSCR helps Banks to: Assess WC need Assess TL need Fix amount of instalment and period** Assess credit worthiness of firm

a. b. c. d.

Total Liabilities Rs. 80 L, CR 1.5:1, FA: 50 L and D/E 3:1. Amount of Long Term Liab: 20 45 15 10

a. b. c. d.

Total Liabilities Rs. 80 L, CR 1.5:1, FA: 50 L and D/E 3:1. Amount of Long Term Liab: 20 45** 15 10

a. b. c. d.

Total Liabilities Rs. 70 L of which Term liab is Rs 25 L. CA Rs. 40 L and CR 2:1 NW is: 25** 20 45 30

a. b. c. d.

Total Liabilities Rs. 70 L of which Term liab is Rs 25 L. CA Rs. 40 L and CR 2:1 NW is: 25 20 45 30

Fixit Company

Income Statement (2006)

Sales Cost of goods sold Gross profit Selling and administrative expenses Operating profit Interest expense Income before tax Tax expense Net income

4,000,000 3,040,000 960,000 430,000 530,000 160,000 370,000 148,000 222,000

Balance Sheet

2005

2004

Cash Accounts receivable Inventory Total current assets Fixed assets Total assets

60,000 550,000 690,000 1,300,000 1,300,000 2,600,000

50,000 500,000 620,000 1,170,000 1,230,000 2,400,000

Accounts payable Bank loan Total current liabilities Bonds payable Total liabilities Capital (25,000 shares) Retained earnings Total liabilities & equity

270,000 580,000 850,000 900,000 1,750,000 250,000 600,000 2,600,000

250,000 500,000 750,000 1,000,000 1,750,000 250,000 400,000 2,400,000

 The firm's current ratio for 2006 is ___________. A) 1.98 B) 2.47 C) 0.65 D) 1.53

 A) B) C) D) E)

The firm's current ratio for 2006 is ___________. 1.98 2.47 0.65 1.53 ** Rationale: 1,300,000/850,000 = 1.53.

 The firm's average collection period for 2006 is _______days. A) 47.90 B) 48.53 C) 46.06 D) 47.65

The firm's average collection period for 2006 is _______days. A) 47.90 ** B) 48.53 C) 46.06 D) 47.65 Rationale: (525,000 / 4,000,000) (365) = 47.90.

 The firm's inventory turnover ratio for 2006 is ________. A) 4.64 B) 4.16 C) 4.41 D) 4.87

 The firm's inventory turnover ratio for 2006 is ________. A) 4.64 ** B) 4.16 C) 4.41 D) 4.87 Rationale: 3,040,000/[(620,000 + 690,000) / 2] = 4.64

 The firm's return on equity ratio for 2005 is ________. A) 0.1235 B) 0.0296 C) 0.2960 D) 2.2960

The firm's return on equity ratio for 2005 is ________. A) 0.1235 B) 0.0296 C) 0.2960 ** D) 2.2960 Rationale: 222,000/[(850,000 + 650,000) / 2] = 0.2960