Question

3. The following information is for the year 2018 for ABC and XYZ, which are in the same industry. ABC XYZ RM RM Current assets 20,000 75,000 Non-current assets 40,000 140,000 Current liabilities 8,000 60,000 Non-current liabilities 20,000 130,000 Sales 200,000 850,000 Net income 4,000 10,000 (a) Compute the following: (i) Current ratio (ii) Debt ratio (iii) Return on sales (iv) Asset turnover (v) Return on equity (b) Give a brief explanation of the interpretation of the above calculated ratios.

Answer 1

Calculation od Share Holders Equity

Share Holder's Equity = Total Assets - Total Liabilities

For ABC

Share Holder's Equity = ($20,000+$40,000) - ($8,000+$20,000)

= $60,000 - $28,000

Share Holder's Equity = $32,000

For XYZ

Share Holder's Equity = ($75,000+$140,000) - ($60,000+$130,000)

= $215,000 - $190,000

Share Holder's Equity = $25,000

a) Computation of Ratio's:

Particulars	ABC	XYZ
Current Ratio = Current Assets / Current Liabilities	2.5 ($20,000 / $8,000)	1.25 ($75,000 / $60,000
Debt Ratio = Total Liabilities / Total Assets*100	46% [(8,000+$20,000) / ($20,000+$40,000)*100]	88% [($60,000+$130,000) / $140,000+$75,000*100)]
Return On Sales = (Net Income/ Sales)*100	2% [($4,000 / $200,000)*100]	1.17% [($10,000 / $850,000)*100]
Asset Turnover = Net Sales / Average Total Assets	3.33 [$200,000 / ($20,000 + $40,000)]	3.95 [$850,000 / ($75,000 + $140,000)]
Return on Equity = (Net Income / Shareholder's Equity)*100	12.5% [($4,000 / $32,000)*100]	40% [($10,000 / $25,000)*100

b) Ratio analysis

Ratio Analysis is important for any organisation to analyse and interpret the information of the Company. Let us the analyse the above ratios of ABC and XYZ company of RM Industry.

Current Ratio is the ability of the firm to pay its current Liabilities with its current Assets. Current ratio of ABC is 2.5 which means the company is able to pay $2.5 for every $1 of current Liabilities. The Current Ratio of XYZ co is $1.25, which eans it is able to pay $1.5 from its current assets for every $1 of its current Liabilities. A good Current ratio reanges between 1.2 to 2. Both the companies have good Current ratio But ABC co has more ability to pay its current liabilities than XYZ co.

Debt Ratio is used to measure the portion of company's assets funded by debt. If teh company has a debt ratio of more than 50% then it is said to be leveraged company which means it has more risk. ABC co has 46% while XYZ has 88%. So, XYZ is a levveraged Co.

Return On sales is used to measure the profitability of the company without considering its non-operating expenses. Return on Sales of ABC is 2% while XYZ is 1.17%. A good return on sales is between 5 - 10%. Both the companies have low return on sales

Asset Turnover Ratio is the ability of the company to generate sales by using its total capital. If the Asset turnover ratio is 2.5 it is said to be a good ratio. Both the companies have good Asset turnover ratio, but XYZ has 3.95 which is greater than 3.33 of ABC co.

Return on Equity is used to measure the ability of the comapny to earn from each $ of the shareholder's equity. Return on Equity of XYZ is more which is 40% when compared to ABC's ratio of 12.5%

To sum up, ABC company has less risk and so less return on equity, while XYZ co has more risk and more return on equity.