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Algenio, Gillian Clarisse A.

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Business Ratios
• Measure financial and operational aspects of a company’s
performance
• Interpret ratios by comparing them with those of similar businesses in
the same industry and by asking the following questions:
1. Is there a significant difference in my company’s ratio and the
industry average?
2. If so, is this a meaningful difference?
3. Is the difference good or bad?
4. What are the possible causes of this difference? What is the most
likely cause?
5. Does this cause require that I take action?
6. What action should I take to correct the problem?
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I. Liquidity Ratios
• Indicate whether a business will be able to meet its maturing
obligations as they come due
A. Current Ratio (Working Capital Ratio)
Sam's Appliance Shop Industry Median Variance
1.87:1 1.60:1 16.70%
• The shop has $1.87 in current assets for every $1 of current liabilities.
• The ratio falls short of the rule of thumb of 2:1 but is above the industry median.

B. Quick Ratio (Acid Test Ratio)

Sam's Appliance Shop Industry Median Variance
0.63:1 0.50:1 25.9%
• The shop has 0.63 cents in quick assets for every $1 of current liabilities.
• The ratio is below the rule of thumb of 1:1 but is acceptable when measured against
industry standards.
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II. Leverage Ratios
• Measure financing supplied by a company’s owners against that
supplied by its creditors

A. Debt Ratio
Sam's Appliance Shop Industry Median Variance
0.68:1 0.62:1 10.4%
• The creditors have claims of 68 cents against every $1 of assets that the shop owns.
• Although the company does not appear to be overburdened with debt, Sam’s might have
difficulty borrowing, especially from conservative lenders.
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II. Leverage Ratios
B. Debt to Net Worth Ratio
Sam's Appliance Shop Industry Median Variance
2.20:1 2.30:1 -4.5%
• Sam’s Appliance Shop owes creditors $2.20 for every $1 of equity that Sam owns.
• Though the ratio is slightly below the industry median, borrowing capacity is somewhat
limited because creditors’ claims against the business are more than twice those of the
owners.

C. Times Interest Earned Ratio

Sam's Appliance Shop Industry Median Variance
2.52:1 2.10:1 20.1%
• Sam’s Appliance Shop’s earnings are 2.5 times greater than its interest expenses.
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III. Operating Ratios
• Evaluate the company’s overall performance and show how effectively it is
putting its resources to work
A. Average Inventory Turnover Ratio
Sam's Appliance Shop Industry Median Variance
2.05 times/year 4.4 times/year -53.5%
• Sam’s Appliance Shop turns its inventory about two times a year, or once every 178
days.
• Inventory is moving through Sam’s at a very slow pace, half that of the industry median.
B. Average Collection Period Ratio
Sam's Appliance Shop Industry Median Variance
50.0 days 10.5 days 376.3%
• Sam’s Appliance Shop collects the average accounts receivable after 50 days.
• This indicates a problem in the shop’s collection of payment.
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C. Average Payable Period Ratio

Sam's Appliance Shop Industry Median Variance
59.3 days 23.0 days 158.1%
• Sam’s Appliance Shop takes an average of about 59 days to pay its accounts with
vendors and suppliers.
• Sam’s payables are nearly significantly slower than those of the typical firm in the
industry.

D. Net Sales to Total Assets Ratio

Sam's Appliance Shop Industry Median Variance
2.21:1 3.4:1 -35.1%
• Sam’s Appliance Shop generates $2.21 in sales for every dollar of assets.
• Sam’s Appliance Shop is not generating enough sales, given the size of its asset base.
 IV. Profitability Ratios 8

• Measure how efficiently a firm is operating

A. Net Profit to Sales Ratio
Sam's Appliance Shop Industry Median Variance
3.24% 4.3% -24.6%
• Sam’s Appliance Shop keeps 3.24 cents in profit out of every dollar of sales it generates.
• The operating expenses should be reviewed.

B. Net Profit to Assets Ratio

Sam's Appliance Shop Industry Median Variance
7.15% 4.0% 78.8%
• Sam’s Appliance shop earns a return of 7.15 percent on its asset base.
• The shop has an above-average return but is due to its thinner asset base.
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IV. Profitability Ratios
C. Net Profit to Equity Ratio
Sam's Appliance Shop Industry Median Variance
22.65% 16.0% 41.6%

• Sam’s Appliance Shop’s owners are earning 22.65 percent on the money they have
invested in the business.
• The ratio is above the industry median but is due to the owner’s relatively low
investment in the business.
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Break-Even Analysis
• Level of operation (sales dollars or production quantity) at
which it neither earns a profit nor incurs a loss
• Sales > Break-even point = Profit
• Sales < Break-even point = Net loss
• Fixed expenses: do not vary with changes in the volume of
sales or production
• Variable expenses: vary directly with changes in the volume
of sales or production
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Steps in Calculating the Break-Even Point
1. Determine the expenses the business can expect to incur.
Net sales $950,000.00
Cost of goods sold $646,000.00
Total expenses (including COGS) $882,500.00

2. Categorize the expenses estimated.

Total expenses (including COGS)
$882,500.00

Variable expenses Fixed expenses $177,375.00

COGS $646,000.00
Other variable expenses $59,125.00
Total $705,125.00
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3. Calculate the ratio of variable expenses to net sales.

𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬 $𝟕𝟎𝟓, 𝟏𝟐𝟓. 𝟎𝟎

= = 𝟕𝟒%
𝐍𝐞𝐭 𝐬𝐚𝐥𝐞𝐬 $𝟗𝟓𝟎, 𝟎𝟎𝟎. 𝟎𝟎

1.00 – 0.74 = 0.26

∴ The shop uses 74 cents out of every sales ∴ The remaining 26 cents ($1.00 - 0.74 =
dollar to cover variable expenses. 0.26) is the contribution margin to cover
fixed costs and make a profit.
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4. Compute break-even point

𝐓𝐨𝐭𝐚𝐥 𝐟𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭 $𝟏𝟕𝟕, 𝟑𝟕𝟓. 𝟎𝟎

𝐁𝐫𝐞𝐚𝐤 − 𝐞𝐯𝐞𝐧 𝐬𝐚𝐥𝐞𝐬 $ = = = $𝟔𝟖𝟐, 𝟐𝟏𝟐. 𝟎𝟎
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐞𝐱𝐩𝐫𝐞𝐬𝐬𝐞𝐝 𝐚𝐬 𝟎. 𝟐𝟔
𝐚 𝐩𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬

∴ The shop will break even with sales of $682,212.00/year or

$682.212/312 days = $2,187.00/day.

Sales at break−even point $682,212.00

- Variable expenses (74% of sales) -504,837.00
Contribution margin 177,375.00
- Fixed expenses -177,375.00
Net income (or net loss) $ 0.00
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*Adding a Profit
- Desired net income = $80,000.00

𝐓𝐨𝐭𝐚𝐥 𝐟𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭 + 𝐝𝐞𝐬𝐢𝐫𝐞𝐝 𝐧𝐞𝐭 𝐢𝐧𝐜𝐨𝐦𝐞 $𝟏𝟕𝟕, 𝟑𝟕𝟓. 𝟎𝟎 + $𝟖𝟎, 𝟎𝟎𝟎. 𝟎𝟎
𝐒𝐚𝐥𝐞𝐬 $ = = = $𝟗𝟖𝟗, 𝟗𝟎𝟒. 𝟎𝟎
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐞𝐱𝐩𝐫𝐞𝐬𝐬𝐞𝐝 𝐚𝐬 𝟎. 𝟐𝟔
𝐚 𝐩𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬

∴ To achieve a net profit of $80,000.00 (before taxes), the shop must generate net sales of
$989,904.00/year or $989,904/312 days = $3,173.00/day
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*Break-Even Point in Units
𝐓𝐨𝐭𝐚𝐥 𝐟𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭𝐬
𝐁𝐫𝐞𝐚𝐤 − 𝐞𝐯𝐞𝐧 𝐯𝐨𝐥𝐮𝐦𝐞 =
𝐒𝐚𝐥𝐞𝐬 𝐩𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭 − 𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐜𝐨𝐬𝐭 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭
Given:
Fixed costs $390,000.00
Variables costs $12.10 per unit
Selling price $17.50 per unit

− Compute per unit contribution margin

𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 = 𝐏𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭 − 𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐜𝐨𝐬𝐭 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭 = $𝟏𝟕. 𝟓𝟎 − $𝟏𝟐. 𝟏𝟎 = $𝟓. 𝟒𝟎/𝐮𝐧𝐢𝐭

$𝟑𝟗𝟎, 𝟎𝟎𝟎. 𝟎𝟎
𝐁𝐫𝐞𝐚𝐤 − 𝐞𝐯𝐞𝐧 𝐯𝐨𝐥𝐮𝐦𝐞 𝐮𝐧𝐢𝐭𝐬 = = 𝟕𝟐, 𝟐𝟐𝟐 𝐮𝐧𝐢𝐭𝐬
$𝟓. 𝟒𝟎
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*Convert Break-Even Point in Units to Break-Even Sales

𝐁𝐫𝐞𝐚𝐤 − 𝐞𝐯𝐞𝐧 𝐬𝐚𝐥𝐞𝐬 = 𝐁𝐫𝐞𝐚𝐤 − 𝐞𝐯𝐞𝐧 𝐩𝐨𝐢𝐧𝐭 𝐢𝐧 𝐮𝐧𝐢𝐭𝐬 𝐒𝐞𝐥𝐥𝐢𝐧𝐠 𝐩𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭
= (72,222 units)($17.50) = $1,263,889.00

*Adding a Profit
- Desired net income = $60,000.00
𝐓𝐨𝐭𝐚𝐥 𝐟𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭 + 𝐝𝐞𝐬𝐢𝐫𝐞𝐝 𝐧𝐞𝐭 𝐢𝐧𝐜𝐨𝐦𝐞 $𝟑𝟗𝟎, 𝟎𝟎𝟎. 𝟎𝟎 + $𝟔𝟎, 𝟎𝟎𝟎. 𝟎𝟎
𝐒𝐚𝐥𝐞𝐬 $ = = = 𝟖𝟑, 𝟑𝟑𝟑 𝐮𝐧𝐢𝐭𝐬
𝐏𝐞𝐫 𝐮𝐧𝐢𝐭 𝐜𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 $𝟓. 𝟒𝟎

∴ To achieve a net profit of $60,000.00 (before taxes), the shop must generate net sales of
83,333 units/year or 83,333/312 days = 267 units/day