ACCOUNTING ANALYSIS

Fundamentals of Accounting

Fundamentals of Accounting

Introduction

Compare the ratios, and answer the following questions

Ratio

Year 1

Year 2

Current ratio

3.12:1

2.96:1

Quick ratio

1.34:1

1.02:1

Receivables turnover

9.7 times

10.2 times

Inventory turnover

2.4 times

2.3 times

Profit margin

11.4%

12.6%

Asset turnover

1.21 times

1.22 times

Return on assets

13.7%

15.4%

Return on equity

28.5%

29.3%

Price-earnings ratio

10.4 times

12.4 times

Debt ratio

50.2%

45.3%

Times interest earned

9.6 times

13.0 times

What does the calculation of each ratio represent?

How does year one compare with year two, and what trend can be seen when you compare the two years?

Is the trend from year one to year two positive or negative?

What are the possible reasons for the trend?

What recommendations do you have for turning a negative trend to a positive trend?

Discussion

What does the calculation of each ratio represent?

Current Ratio

Current Ratio tells us how much worth of current assets does a company holds for $1 of current liabilities. Whereas, Quick Ratio tells us how much work of highly liquid assets (this generally excludes trading inventory from the total current assets) does a company hold for $1 of current liability (Groppelli, 2000). These ratios mainly provide information about the liquidity position of the company.

Turnover Ratio

Receivables turnover ratio of the company tells us how many times in a year normally, the organization manages to converts its trade receivables (credit sales) in to cash sales (Kieso, 2007). Whereas, Inventory turnover provides information about the number of times the organization is able to convert its trading inventory or stock in trade in to sales during a year. These ratios normally reflect on the management performance and effectiveness, and are called Activity Ratio. Higher the ratios better the performance of the management.

Profitability Ratio

Profit Margin represents the net profit for a particular year as a percentage of the sales revenue of the company. Asset turnover ratio, on the other hand, shows how much sales revenue a company makes by investing 1$ of asset in the business (Houston, 2009). Return on assets is similar to asset turnover, but this mainly reflects the performance of the company with respect to net profitability. This ratio shows how much of the net profit, a company can make by investing $1 of assets in the business, whereas, return on equity shows the net profit related to stockholder. These ratios are called profitability ratios as they provide information about the profitability position of the company and are calculated in percentage terms (Myers, 1984).

Leverage/Debt Ratio

Debt ratio shows the total amount of debt available in the overall capital financing of the organization, whereas Times Interest Earned shows how many times the company can meet its interest cost for a particular year. These ratios are generally called leverage ratios (Williams, 2008).

Price to Earnings Ratio

Price to Earnings Ratio is a valuation ratio, which looks into the relationship of Market Price per Share and Earnings per share of the company (Weston, 1990).

How does year one compare with year two, and what trend can be seen when you compare the two years?

Liquidity Position

Liquidity Position of the company has deteriorated from year 1 to Year 2. The current ratio has declined from 3.12 times in year 1 to ...