Financial Ratios Example II-A



Q48. Example II-A
Using the information presented below, calculate the profitability and liquidity ratios.

[Financial information]

Cash = $370,000
Accounts receivable = $780,000
Inventory = $970,000
Current assets = $2,120,000
Property, plant and equipment = $4,380,000
Total assets = $6,500,000

Accounts payable = $650,000
Short-term borrowings = $830,000
Current liabilities = $1,480,000
Long-term liabilities = $1,620,000
Total liabilities = $3,100,000

Total stockholders’ equity = $3,400,000
Total liabilities and stockholders’ equity = $6,500,000

Average accounts receivable = $740,000
Average inventory = $960,000
Average total assets = $6,250,000

Average accounts payable = $625,000
Average stockholders’ equity = $3,260,000

Cash sales = $1,150,000
Credit sales = $6,400,000
Sales = $7,550,000
Cost of goods sold = $4,830,000
Credit purchases = $4,720,000
Gross profit = $2,720,000

Earnings before interest and taxes (EBIT) = $1,550,000
Interest expense = $250,000
Tax expense = $410,000
Net income = $890,000

[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) Liquidity ratios
a. Current ratio
b. Quick ratio
c. Working capital ratio

A48.
(1) Profitability ratios
a. Profit margin ratio = 11.8%
b. Gross profit ratio = 36.0%
c. Return on assets (ROA) = 14.2%
d. Return on equity (ROE) = 27.3%

(2) Liquidity ratios
a. Current ratio = 1.43
b. Quick ratio = 0.78
c. Working capital ratio = 0.10

[Note]
(1) Profitability ratios

a. Profit margin ratio
= Net income / Sales
= $890,000 / $7,550,000 = 11.8%

b. Gross profit ratio
= Gross profit / Sales
= (Sales – Cost of goods sold) / Sales
= ($7,550,000 – $4,830,000) / $7,550,000
= $2,720,000 / $7,550,000 = 36.0%

c. Return on assets (ROA)
= Net income / Average total assets
= $890,000 / $6,250,000 = 14.2%

d. Return on equity (ROE)
= Net income / Average stockholders’ equity
= $890,000 / $3,260,000 = 27.3%

(2) Liquidity ratios

a. Current ratio
= Current assets / Current liabilities
= $2,120,000 / $1,480,000 = 1.43

b. Quick ratio
= Quick assets / Current liabilities
= (Cash + Accounts receivable) / Current liabilities
= ($370,000 + $780,000) / $1,480,000
= $1,150,000 / $1,480,000 = 0.78

c. Working capital ratio
= Working capital / Total assets
= (Current assets – Current liabilities) / Total assets
= ($2,120,000 – $1,480,000) / $6,500,000
= $640,000 / $6,500,000 = 0.10