Professor Anu Vuorikoski
Bus 173A - Intermediate Financial Management
Chapter 8: mini case
a. Why are ratios useful? What are the five major categories of ratios?
Ratios are useful to evaluate a firm’s financial statements and one can also compare their performance with other firms, or the industry average.
The five major categories for ratios are as follow:
i. Liquidity Ratios: measures the liquidity of the firm’s current assets to their current liabilities (or obligations to creditors). ii. Asset Management Ratios: measures how effectively the firm is handling and managing their assets. iii. Debt Management Ratios: measure their debt financing, or financial leverage; how much is the firm depended on debt. iv. Profitability Ratios: these ratios demonstrate the effects of liquidity, asset management, and debt combined together on operating results. v. Market Value Ratios: these are ratios that help managers know what investors think of the company’s past performance and future prospects.
b. Calculate the 2007 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity position in 2005, 2006, and as projected for 2007? We often think of ratios as being useful (1) to managers to help run the business, (2) to bankers for credit analysis, and (3) to stockholders for stock valuation. Would these different types of analysts have an equal interest in the liquidity ratios?
Current Ratio = Current Assets / Current Liabilities
Current Ratio = $2,680,112 / $1,039,800
Current Ratio = 2.58 times
Quick Asset Ratio = (Current Assets – Inventory) / Current Liabilities Quick Asset Ratio = ($2,680,112 - $1,716,480) / $1,039,800 Quick Asset Ratio = 0.93 times
The firm is has improved their in reducing their current liabilities and increasing their current asset; however, they are still below industrial avg.
| |2005 |2006 |2007E |Industrial Avg. | |Current Ratio |2.3x |1.5x |2.58x |2.7x | |Quick Acid Ratio |0.8x |0.5x |0.93x |1.0x |
Table 1 – from minicase (pg 281)
Not all type of analyst would have an equal interest in the liquidity ratios. For instance, creditors might be interested more than managers. If they are going to lend the firm some funds, they want to be sure they can be recovered their capital fast incase the firms goes bankrupt. c. Calculate the 2007 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does Computron’s utilization of assets stack up against that of other firms in its industry?
Inventory Turnover = Sales / Inventory
Inventory Turnover = $7,035,600 / $1,716,480
Inventory Turnover = 4.10 times
Industry turn over is 6.1 times while the firms inventory turnover is 4.10. The firm’s inventory is being stored longer than the industry average; hence it is taking up space, which is costing them money. They need to improve their inventory management system.
Days Sales Outstanding = Receivables / (Annual Sales/365) Days Sales Outstanding = $878,000 / ($7,035,600/365) Days Sales Outstanding = 45.55
Industry DSO is 32 days while the firm’s DSO is 45.55 days to collect money from sales (or collect money from their accounts receivable). If they have a 30 days term, they are not doing to a good job and should change or enforce new policies.
Fixed Assets Turnover = Sales / Fixed Assets
Fixed Assets Turnover = $7,035,600 / $836,840