Ex 4-6. Pg 167.

Calculate the financial ratios using the balance sheet and income
statement.
Liquidity Ratios
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 3500
1. 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 2000 = 1.75

The company owns 1.75$ in current assets for every 1$ in short-term

liabilities. Since the ratio is higher than 1, we can say that the company is
liquid.
𝑐𝑎𝑠ℎ+𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 500+2000
2. 𝐴𝑐𝑖𝑑 𝑡𝑒𝑠𝑡 𝑟𝑎𝑡𝑖𝑜 = = = 1.25
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 2000

The company has 1.25$ in cash and account receivable for every 1$ in short-
term liabilities.
𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 2000
3. 𝐷𝑎𝑦𝑠 𝑖𝑛 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒 / 365 = 8000/365 =
𝑑𝑎𝑖𝑙𝑦 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒1
91.25 𝑑𝑎𝑦𝑠
The company needs 91.25 days to collect its accounts receivable.
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 8000
4. 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 = 2000 = 4 𝑡𝑖𝑚𝑒𝑠

The company collects its accounts receivable 4 times per year.

𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 1000
5. 𝐷𝑎𝑦𝑠 𝑖𝑛 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = 𝑑𝑎𝑖𝑙𝑦 𝑐𝑜𝑠𝑡𝑠 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 = 3300/365 = 110.61

The inventory stays in our shelves for around 111 days.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 3300
6. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = = 1000 = 3.3 𝑡𝑖𝑚𝑒𝑠
𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

The inventory circulates 3.3 times per year.

Operating profitability
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 1700
1. 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑠𝑠𝑒𝑡𝑠 (𝑂𝑅𝑂𝐴) = = 8000 = 0.21
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

The company earns 21 cents (0.21$) in operating profit for every 1$ in assets.
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 1700
2. 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 (𝑂𝑃𝑀) = = 8000 = 0.21
𝑠𝑎𝑙𝑒𝑠

The company earns 21 cents (0.21$) in operating profit for every 1$ in sales.
𝑠𝑎𝑙𝑒𝑠 8000
3. 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡 = 8000 = 1

The company generates 1$ in sales for every 1$ invested in assets.

1
There are two types of sales, cash sales and credit sales. To calculate days in receivables we use only credit sales.
 𝑠𝑎𝑙𝑒𝑠 8000
4. 𝐹𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑛𝑒𝑡 𝑓𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡 = 4500 = 1.77

The company generates 1.77 $ in sales for every 1$ invested in fixed assets.

Financing Decisions
𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 2000+2000
1. 𝐷𝑒𝑏𝑡 𝑟𝑎𝑡𝑖𝑜 = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = = 0.5
8000

The company finances 50% of its assets through debt.

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 1700
2. 𝑇𝑖𝑚𝑒𝑠 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑎𝑟𝑛𝑒𝑑 = = = 4.63 𝑡𝑖𝑚𝑒𝑠
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 367

The company can cover its interest expenses using its operating income 4.63
times.

Return on Equity ratio

𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 800
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = = = 0.2
𝑡𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦 4000
The company generates 20 cents (0.20$) for every 1$ invested in equity.