Question

I need help with problem 5.5 to solve for the 2016 ratios and to identify problems with the company and what the causes may be

250 CHAPTER 5 The Analysis of Financial Statements STUDY QUESTIONS AND PROBLEMS 5.1. Explain how the credit analyst's focus will differ from the investment analyst's focus. 5.2. What are the limitations of financial ratios? 5.3. What do liquidity ratios measure? Activity ratios? Leverage ratios? Profitability ratios? Market ratios? 5.4. How is the Du Pont System helpful to the analyst? 5.5. Eleanor's Computers is a retailer of computer products. Using the financial data pro- vided, complete the financial ratio calculations for 2016. Advise management of any ratios that indicate potential problems and provide an explanation of possible causes of the problems. Industry Averages 2016 Financial Ratios 2014 2015 2016 Current ratio Quick ratio Average collection period Inventory turnover Fixed asset turnover Total asset turnover Debt ratio Times interest earned Gross profit margin Operating profit margin Net profit margin Return on total assets Return on equity 1.71X 0.92X 60 days 4.20X 3.20X 1.40X 59.20% 4.20x 25.00% 12.50% 6.10% 8.54% 20.93% 1.65X 0.89X 60 days 3.90X 3.33X 1.35X 61.00% 3.70X 23.00% 12.70% 6.00% 8.10% 20.74% 1.70X 0.95X 65 days 4.50X 3.00X 1.37X 60.00% 4.75X 22.50% 12.50% 6.50% 8.91% 22.28% Income Statement for Year Ended 12/31/16 Balance Sheet at 12/31/16 Sales Cost of goods sold Gross profit Operating expenses Operating profit Interest expense Earnings before tax Income tax (40%) Net Income $1,500,000 1,200,000 $ 300,000 100,000 $ 200,000 72,000 128,000 51,200 $ 76,800 Cash Accounts receivable Inventory Current assets Fixed assets (net) Total Assets Accounts payable Notes payable Accrued liabilities Current liabilities Long-term debt Total liabilities Equity Total liabilities and equity $ 125,000 275,000 325,000 $ 725,000 $ 420,000 $1,145,000 $ 150,000 225,000 100,000 475,000 400,000 $ 875,000 270,000 $1,145,000

Answer 1

Current Ratio = Current Assets/Current Liabilities = 725000/475000 = 1.53X

Quick Ratio = (Current Assets- Inventory)/Current Liabilities = (725000 - 325000)/475000 = 0.84X

Avg collection period = Accounts Receivable/Sales x 365 = 275000/1500000 x 365 = 66.91 ~ 67 days

Inventory turnover = Cost of goods sold/ Average inventory = 1200000/325000 = 3.69X

Fixed Asset turnover = Sales/Fixed Assets = 1500000/420000 = 3.57X

Total Assets turnover = Sales/Total Assets = 1500000/1145000 = 1.31X

Debt Ratio = Total debt/Total Assets = (225000 + 400000)/1145000 = 54.58%

Times Interest earned = EBIT/Interest = 200000/72000 = 2.77X

Gross Profit margin = Gross Profit/Sales = 300000/1500000 = 20%

Operating Profit margin = Operating Profit/Sales = 200000/1500000 = 13.33%

Net Profit margin = Net Profit/Sales = 76800/1500000 = 5.12%

Return on total assets = Net Income/Total Assets = 76800/1145000 = 6.71%

Return on equity = Net Income/Equity = 76800/270000 = 28.44%

In the company, there has been a slight deterioration in liquidity position with the decline in current and quick ratios. Collection period has also increased and is higher than the industry averages implying that the company's credit policy for realization of receivables needs to be improved. Inventory turnover has declined and is below the industry average which implies the company needs to achieve turnaround and inventory control. Although the operating profit margins have somewhat improved on account of control over operating expenses, gross and net profit margins have declined and are below the industry average figures.