Question

Gap, Inc

Ratios	Industry Average Ratio	Three Year Company Ratio Results
		2018	2017	2016
	Year(s)	Year	Year	Year
1. Working Capital	$                               1,806,333.33	$                               2,107,000.00	$                               1,862,000.00	$                               1,450,000.00
2. Current Ratio	1.72907289	1.856156034	1.759070526	1.57199211
3. Acid Test	0.784732954	0.839089801	0.863432532	0.651676529
4. Fixed Assets to Long-term Liabilities	1.176228714	1.17659396	1.161118509	1.190973673
5. Debt to Equity Ratio	1.699299909	1.541030534	1.620523416	1.936345776
6. Return on Equity	0.287131047	0.28042328	0.248118921	0.332850941

Discuss what each ratio reveals about the company?

Discuss how each ratio improved or worsened over time? Explain why you think this happened.

Compare each company ratio results with the industry average ratios. What do the numbers reveal?

Answer 1

(1): Working capital = current assets – current liabilities and this ratio reveals the liquidity position. Positive working capital is a good sign of the short-term financial health for a company because it has enough liquid assets remaining to pay off short-term bills and to internally finance the growth of their business.

Current ratio = current assets/current liabilities. This ratio reveals the liquidity position of a company and determines the short term solvency.

Acid test ratio = (Current assets – inventories)/current liabilities. This ratio is a stringent measure of liquidity and determines short term solvency on a fairly strict terms.

Fixed asset to long term liabilities = fixed assets/long term liabilities. This ratio is another measure of a company’s solvency. A company's long-term debts are often secured with fixed assets, which is why creditors are interested in this ratio.

Debt to equity ratio = Total debt/Total equity. This ratio is a leverage ratio and the lower the ratio the higher is the degree of protection enjoyed by creditors.

Return on equity = Net income/Net worth. This is a profitability ratio and determines the profitability of equity funds invested in a firm.

(2): We can see that GAP’s working capital is increasing each year from 2016 onwards and this augurs well for the company as this means it has sufficient amount of current assets to meet its short term obligations. The company’s increasing current ratio indicates improving liquidity position of GAP. Acid test ratio increased in 2017 and then declined in 2018 by a marginal basis. This is not a cause of concern as the decline can be due to high amount of inventory in its books in 2018. Fixed assets to long term liabilities ratio for GAP declined in 2017 and then increased again in 2018. GAP would like to have a high fixed assets to long term liabilities ratio and the improvement in 2018 augurs well for the company as it showcases its increased ability to cover long term liabilities. Debt to equity ratio has been constantly declining for GAP and this is a good sign as the company is relying less on debt and so its leverage is reducing. Lastly the company’s return on equity declined in 2017 and then increased in 2018. This is a profitability measure and GAP would like to see its ROE to continue to increase in future.

(3): Gap’s working capital, current ratio and acid test ratios for 2018 are higher than industry average and this indicates better liquidity position for GAP when compared to the industry average. The company’s fixed asset to long term liabilities is marginally higher than the industry average in 2018 and this indicates that GAP is at par with the industry with regards to its ability to cover its long term liabilities. The company’s debt/equity ratio for 2018 is lower than industry figure and shows that GAP makes less use of debt on a relative basis and hence has lower degree of associated risks. The company’s ROE is slightly less than the industry average in 2018 and this means the GAP is lagging the industry in terms of ability to earn profits on its equity funds.