Joyce Samantha C.
Bolivar
Activity 1-3 Problem1 Ratio Formulas and Interpretation.
Indicate for each of the following ratios the formula for calculating it and the kinds of
problems, if any, the firm may have if that ratio is too high relative to the industry
average. What if the ratio is too low relative to the industry average? Write your
answers in the empty box in the table below.
RATIO TOO HIGH
Current Ratio The value of of acceptable current
ratio varies from industry, a good
Current Assets ratio would often be between 1.5
Current Liabilities and 2.
If the current ratio is too high
(much more than 2), this may
indicate that the company may not
be using its currents assets or
short-term financing efficiently
and may pose problems in
working capital management. It
may also be a cause of holding to
many idle short term assets.
Inventory In most cases, the higher the
Turnover inventory turnover rate, the
better. However, an extremely
Cost of Goods Sold high turnover ratio does not
Average Inventories always mean better performance.
It may implies either strong sales
or ineffective buying
Times Interest
Earned
Earnings before
Interest∧Taxes
Interest
Gross Profit A higher gross profit margin
Margin indicates efficient processes in a
company. It also shows that the
company has more to cover for
BSA 3-1
TOO LOW
If the ratio is too low, the
company may not have sufficient
funds to meet its short-term
obligations.
A low inventory turnover ratio is a
signal of inefficiency. It may
implies either poor sales or
excess inventory or overstocking.
A high stock level would mean a
high storage costs and there
might be a loss of value of
inventory, spoilage and obosolete
goods.
A lower times interest earned
ratio means fewer earnings are
available to meet interest
payments. Failing to meet these
obligations could force a company
into bankruptcy. It is used by
both lenders and borrowers in
determining a company’s debt
capacity.
A lower ratio indicates your
processes may not be as efficient
as they could be. It may results in
less money being available to
Joyce Samantha C. Bolivar BSA 3-1

Gross Profits operating, financing, and other cover the operating costs of the
Sales costs. business, including marketing
expenses and administrative
salaries.
Return on Total A low ROA indicates that the
Assets company is not able to make
maximum use of its assets for
Earnings available getting more profits. The reasons
for common for low return on assets would be
stocksholders its lower asset productivity and
Total Assets wastages.

Price-Earnings The higher the P/e ratio, the
ratio higher the degree of confidence
that the investors have in the
Market price per firm’s future prospects. However,
share of too high P/e ratio could mean that
common stock ordinary shares of the company
Earnings per are overvalued in the stockmarket.
share f you invest in an overvalued
stock, you run the risk of losing
money if it doesn't meet investors'
high earnings expectation
A low P/E ratio may indicate that
the stock is undervalued. If
Investors buy undervalued stock
at a discount then when the
price of that stock climbs, they
could get profit. However,
sometimes a low P/E ratio reflects
a genuine lack of growth
potential.