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

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