Question

Background:

Anne Schippel, business banker, is analyzing Dry Supply's financial statements. When calclating ratios, many commercial lenders use a ratio summary. Figure 8.5 summarizes the key ratios as they might appear on her spreadsheet.

In reviewing the Ratio Summary and Comparative Data for Dry Supply for 12/31/20xx through 12/31/20xz, Anne Schippel has developed some questions and observations regarding the ratios. It is now your turn to do the same.

Figure 8.5 Ratio Summary: Dry Supply	12/31/20xx	12/31/20xy	12/31/20xz
Liquidity Current Ratio Quick Ratio Working Capital	1.3x 0.8x $47,000	1.5x 1.0x $66,000	1.5x 1.0x $92,000
Leverage Debt to net worth Tangible leverage Tangible effective leverage	3.3x 3.3x 1.3x	2.7x 2.7x 1.0x	1.9x 1.9x 0.7x
Profitability Gross profit margin Operating profit margin Pretax profit margin Net Profit margin Return-on-assets Return-on-equity	27.9% 2.3% 2.2% 1.0% 8.2% 35.1%	28.8% 3.0% 2.8% 1.5% 10.0% 36.6%	31.3% 5.0% 4.4% 2.5% 14.8% 42.6%
Efficiency Accounts receivable turnover Inventory turnover Accounts payable turnover Sales to total assets	44.5d 41.3d 17.9d 3.4x	44.0d 39.4d 17.9d 3.4x	44.5d 38.8d 17.9d 3.4x
Coverage Tradition cash flow coverage Interest Coverage Fixed charge coverage Dividend payout ratio	n/a 4.3x 4.5x 0.0%	n/a 4.7x 4.7x 0.0%	n/a 4.6x 4.3x 0.0%

Figure 8.6 Wholesale Dry-Cleaning Equipment Industry Quartiles 20xz
Ration	Higher	Median		Lower
Current Quick Tangible Leverage Pretax profit margin Return-on-assets Interest coverage	2.4x 1.2x 0.9x n/a 10.7x 5.5x	1.5x 0.8x 2.5x 2.1x 3.2x 2.1x		1.2x 0.5x 5.1x n/a (0.3x) 1.0x

Part 1

For each of the ratios listed below, perform your own ratio analysis by stating your observation and develop any necessary questions you would ask Dry Supply to complete your analysis.

A. Liquidity Ratios

B. Financial Leverage Ratios

C. Profitability Ratios

D. Efficiency Ratios

E. Coverage Ratios

Part 2

Using the commercial lending decision tree, Schippel deteremined that Dry Supply, as a wholesaler, would likely show certain financial characteristics when she began to analyze the financial statements. What are some examples of these characteristics within the ratios for 20xx through 20 xz?

Answer 1

A. Liquidity ratios have improved from 20xx to 20xy which means Dry Supply had increased Current Assets¹ (mainly cash and receivables) as can be seen in the Quick ratio² improvement. This means that either the current liabilities decreased or current assets increased. Since working capital has increased it is safe to say that current assets increased. But ratios remained same in 20xz which indicate that current liabilities also increased.

¹Current Assets = cash, bank, stock, investments, sundry debtors (net), bills receivable and prepaid exps

²Quick ratio = {Current assets - (Stock and prepaid exps)} / Current Liabilities. Basically liquid assets are those which can be converted to cash immediately.

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B. Leverage ratios assess how much capital is derived from debts of the business. for example; A healthy debt ratio is 2:1 which means the business capital comprises of $200 of debt and $100 of equity.

Dry supply leverage ratios have reduced over the 3 years indicating debt has reduced and equity increased in their capital structure.

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C. Profitability ratios simply indicate the how well the business is earning in terms of profits. Here it can be easily determined that Net profit and gross profits have increased implying the business revenue increased and/or costs reduced.

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D. Efficiency ratios indicate how well the debtors and creditors are being managed. If debt collection is good and fast then the days will decrease and vice versa for payables where ideally business hould aim to pay out as late as possible without adversely affecting relations or paying interest. Here all ratios have been the same except for Inventory turnover.

Here the ratio indicates that average inventory was sold every 38.8 days in 20xz which is a slight improvement from 41.3 days in 20xx.