Financial Ratios Example I-A



Q46. Example I-A
Using the information presented below, calculate the profitability and activity ratios.

[Financial information]

Cash = $120,000
Accounts receivable = $260,000
Inventory = $350,000
Current assets = $730,000
Property, plant and equipment = $1,520,000
Total assets = $2,250,000

Accounts payable = $210,000
Short-term borrowings = $260,000
Current liabilities = $470,000
Long-term liabilities = $580,000
Total liabilities = $1,050,000

Total stockholders’ equity = $1,200,000
Total liabilities and stockholders’ equity = $2,250,000

Average accounts receivable = $250,000
Average inventory = $300,000
Average total assets = $2,000,000

Average accounts payable = $200,000
Average stockholders’ equity = $1,250,000

Cash sales = $750,000
Credit sales = $1,750,000
Sales = $2,500,000
Cost of goods sold = $1,500,000
Credit purchases = $1,350,000
Gross profit = $1,000,000

Earnings before interest and taxes (EBIT) = $525,000
Interest expense = $100,000
Tax expense = $125,000
Net income = $300,000

[Financial ratios to be calculated]

(1) Profitability ratios
a. Profit margin ratio
b. Gross profit ratio
c. Return on assets (ROA)
d. Return on equity (ROE)

(2) Activity ratios
a. Assets turnover ratio
b. Inventory turnover ratio
c. Accounts receivable turnover ratio
d. Accounts payable turnover ratio

A46.
(1) Profitability ratios
a. Profit margin ratio = 12.0%
b. Gross profit ratio = 40.0%
c. Return on assets (ROA) = 15.0%
d. Return on equity (ROE) = 24.0%

(2) Activity ratios
a. Assets turnover ratio = 1.25
b. Inventory turnover ratio = 5.0
c. Accounts receivable turnover ratio = 7.0
d. Accounts payable turnover ratio = 6.75

[Note]
(1) Profitability ratios

a. Profit margin ratio
= Net income / Sales
= $300,000 / $2,500,000 = 12.0%

b. Gross profit ratio
= Gross profit / Sales
= (Sales – Cost of goods sold) / Sales
= ($2,500,000 – $1,500,000) / $2,500,000
= $1,000,000 / $2,500,000 = 40.0%

c. Return on assets (ROA)
= Net income / Average total assets
= $300,000 / $2,000,000 = 15.0%

d. Return on equity (ROE)
= Net income / Average stockholders’ equity
= $300,000 / $1,250,000 = 24.0%

(2) Activity ratios

a. Assets turnover ratio
= Sales / Average total assets
= $2,500,000 / $2,000,000 = 1.25

b. Inventory turnover ratio
= Cost of goods sold / Average inventory
= $1,500,000 / $300,000 = 5.0

c. Accounts receivable turnover ratio
= Credit sales / Average accounts receivable
= $1,750,000 / $250,000 = 7.0

d. Accounts payable turnover ratio
= Credit purchases / Average accounts payable
= $1,350,000 / $200,000 = 6.75