Financial Ratios Example II-B



Q49. Example II-B
Using the information presented below, calculate the solvency and activity 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) Solvency ratios
a. Debt to equity ratio
b. Debt to assets ratio
c. Long-term debt to assets ratio
d. Times interest earned ratio
e. Assets to equity ratio

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

A49.
(1) Solvency ratios
a. Debt to equity ratio = 0.91
b. Debt to assets ratio = 0.48
c. Long-term debt to assets ratio = 0.25
d. Times interest earned ratio = 6.20
e. Assets to equity ratio = 1.92

(2) Activity ratios
a. Assets turnover ratio = 1.21
b. Inventory turnover ratio = 5.03
c. Accounts receivable turnover ratio = 8.65
d. Accounts payable turnover ratio = 7.55

[Note]
(1) Solvency ratios

a. Debt to equity ratio
= Total liabilities / Total stockholders’ equity
= $3,100,000 / $3,400,000 = 0.91

b. Debt to assets ratio
= Total liabilities / Total assets
= $3,100,000 / $6,500,000 = 0.48

c. Long-term debt to assets ratio
= Long-term liabilities / Total assets
= $1,620,000 / $6,500,000 = 0.25

d. Times interest earned ratio
= Earnings before interest and taxes (EBIT) / Interest expense
= (Net income + Interest expense + Tax expense) / Interest expense
= ($890,000 + $250,000 + $410,000) / $250,000
= $1,550,000 / $250,000 = 6.20

e. Assets to equity ratio
= Average total assets / Average stockholders’ equity
= $6,250,000 / $3,260,000 = 1.92

(2) Activity ratios

a. Assets turnover ratio
= Sales / Average total assets
= $7,550,000 / $6,250,000 = 1.21

b. Inventory turnover ratio
= Cost of goods sold / Average inventory
= $4,830,000 / $960,000 = 5.03

c. Accounts receivable turnover ratio
= Credit sales / Average accounts receivable
= $6,400,000 / $740,000 = 8.65

d. Accounts payable turnover ratio
= Credit purchases / Average accounts payable
= $4,720,000 / $625,000 = 7.55