Question

5.1 SAA 1/3/2017 EARTHWEAR CLOTHIERS Ratio Analyses December 31, 2016 December 31 2012 2013 2014 2015 2016 2016 Expected Actual (Audited) (Audited) (Audited) (Audited) (unaudited) WIB Difference Industry DITETETTCE Average (from 20461 Expected 1.641.43 .1.92.... 1.80 .1.94... 2.17 . 0.23 ... 0.07 SHORT-TERM LIQUIDITY RATIOS: Current Ratio current assets / current liabilites Quick Ratio liquid assets/ current liabilities Operating Cash Flow Ratio cash fow from operations / current liabilities 0.39 0.44 0.62 0.53 0.65 0 .73 0.80 -0.07 0.69 0.42 0.810 .340. 400.40 ACTIVITY RATIOS: .. 71.18 ...77.25.74.3473.82_75.41 118.00 42.60.. .. 5.134.734.914.944.843.09. . 14.10 -11.01 Receivables Turnover... net sales / net ending receivables Days Outstanding in Accounts Receivable 365 days / receivables turnover Inventory Turnover cost of sales / inventory Days of Inventory on Hand 365 / (cost of sales / inventory) ..3.43. 4.27.4.4.4.4 4.99 ......-1.12.... . 6.20 .-2.33 106.4185.5181.4081.72_69.22. .............. ... 36.29 44.95% 44.91% 44.89% 42.51% 42.49%........43.90% . ..1.41%. ..38.80%...5.10% 4.26% 1.24% 0.96% PROFITABILITY / PERFORMANCE RATIOS: Gross Profit Percentage gross proft/ net sales Profit Margin net income / net sales Return on Assets net income / total assets Return on Equity net income / total owners' equity 2.34% 14.80% 3.61% 6.84% 3.64% 10.53% 2.37% 6.83% 3.02% 4.69% 7.40% . 3.77% 26.43% 12.86% 16.22% 11.03% 5.92% 16.70% 10.78% . 17.50% -0.80% 0.61 0.51 0.50.. .001. . COVERAGE RATIOS: Debt to Equity ..0.79...0.88.0.58 total abilities / shareholders investment Times Interest Earned 53.88 26.31 26.41 (net income + interest expense) / interest expense 23.92 10. 19 5 0.57 40.38 N/A N/A * Expected values are obtained by using the forecast function in Excel (using the row of data from 2012 and 2015 to obtain the expected value for 2016). Industry Source: Dun & Bradstreet (D8.B). The median values of the industry ratios are used for comparison purposes. For ratios not specifically included on D&B, ratios were calculated from average financial statement data provided. NA = not available or could not be calculated from financial data.

I am need of assistance with the cells in yellow.

Answer 1

Short-term liquidity ratios -

In the given details, three short-term liquidity ratios have been calculated - current ratio, quick ratio and operating cash flow. Current ratio shows an increasing trend, it increased significantly from 1.64 in 2012 to 2.17 in 2016. It has also increased compared to the industry ratio of 2.10.  

The activity ratio also shows an increasing trend and increased from 0.39 in 2012 to 0.73 in 2016. However, on comparing with industry ratio of 0.80 ii has declined marginally.

By going through all the three above ratios, we can conclude that the company is financially stable and can meet its obligations whenever they are due.

Activity ratios -

Receivables turnover indicates how many times the company is able to collect its average receivables. The periods under review shows that it has been increased year over year. From 71.18 in 2012 it increased to 118.0 in 2016. An increasing and higher ratio indicates that the company is collecting cash from debtors on time. It further shows that the cash balance of the company will be strong and can meet its obligations whenever due.

Days outstanding in accounts receivable shows the number of days it takes for the company to collect cash from its debtors. By going through the periods, we can see that the collection period has been declining. It declined to 3.09 in 2016 from 5.13 in 2012. A lower collection period means that the company is efficiently collecting cash from its debtors. However on comparing with the industry 14.10 its too low.

Inventory turnover indicates how fast the company transfers its inventories into sales. A lower ratio is not advisable as it shows slow sales and more inventory. For 2016 it was 3.87 way to below the average industry of 6.20.

Profitability ratios

Gross profit margin has declined to 43.90% in 2016 from 44.95% in 2012. However, on comparing with industry average of 38.80% it has improved significantly throughout the periods. The reason could be decline in sales volume or increase in cost of goods sold.

Return on equity measures how efficiently a company is using its assets to create profits. Return on equity should usually be compared with its peers or the industry average. The industry average was 17.50% compared to 16.70% in 2016. So we can conclude that the ratio is stable.

Coverage ratios

Debt to equity ratio shows the debt structure of the company i.e., how how much debt is financed externally and internally. A high debt to equity ratio is not advisable . The ratio should always be compared with the industry average. For 2016 the ratio was 0.50 compared to industry ratio of 0.84.

Times interest earned ratio indicates whether the company is able to pay interest on its outstanding debt with earnings before interest and tax available during the period. The company's high interest ratio of 50.57 in 2016 indicates that company is reporting high profit which is sufficient to meet interest expenses.