Question

One of the most important applications of ratio analysis is to compare a company’s performance with that of other players in the industry or to compare its own performance over a period of time. Such analyses are referred to as a comparative analysis and trend analysis, respectively.

A common size analysis requires the representation of financial statement data relative to a single financial statement item (or base account or value).

What is the most commonly used base item for a common size balance sheet?

Net sales

Earnings before interest and taxes

Net income

Total assets

Suppose you are conducting an analysis of the financial performance of Cute Camel Woodcraft Company over the past three years.

The company did not issue new shares during these three years, and has faced some operational difficulties. The company has thus pilot tested some new forecasting strategies for better operations management. You have collected the company’s relevant financial data, made reasonable assumptions based on the information available, and calculated the following ratios.

Ratios Calculated

	Year 1	Year 2	Year 3
Price-to-free-cash-flow	4.00	2.80	2.24
Inventory turnover	8.00	6.40	5.12
Debt-to-equity	0.50	0.40	0.32

Based on the preceding information, your calculations, and your assumptions, which of the following statements can be included in your analysis report? Check all that apply.

A decline in the inventory turnover ratio can be explained by the new inventory management system that the company recently adopted, which led to more efficient inventory management.

A plausible reason why Cute Camel Woodcraft Company’s price to free cash flow ratio has decreased is that investors expect lower cash flow per share in the future.

Cute Camel Woodcraft Company’s ability to meet its debt obligations has improved since its debt-to-equity ratio decreased from 0.50 to 0.32.

A decline in the debt-to-equity ratio implies a decline in the creditworthiness of the firm.

Answer 1

The most commonly used base for a common size Balance sheet is

Total Assets

Net sales is used for Common sized Income Statement

The correct statements are:

A plausible reason why Cute Camel Woodcraft Company’s price-to-cash-flow ratio has decreased is that investors expect lower cash flow per share in the future.

Cute Camel Company’s ability to meet its debt obligations has improved since its debt to equity ratio decreased from 0.50 to 0.32

Decline in Debt equity ratio does not mean decline in credit worthiness

Cute Camel Woodcraft Company’s ability to meet its debt obligations has improved since its debt-to-equity ratio decreased from 0.50 to 0.32.

Higher the inventory turnover ratio, better it is

Hence, decline In the ratio does not represent efficiency