FIN 2000 Lecture Notes - Lecture 4: Inventory Turnover, Asset Turnover, Quick Ratio

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yellowcattle191

22 Jun 2017

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Ratio analysis involves analyzing financial statements to help appraise a firm"s financial position and strength. The current and quick ratios both help us measure a firm"s liquidity. The current ratio measures the relationship of the firm"s current assets to its current liabilities, while the quick ratio measures the firm"s ability to pay off short-term obligations without relying on the sale of inventories. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use estimates of a firm"s liquidity position. High current and quick ratios always indicate that the firm is managing its liquidity position well. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would increase.

Related Questions

QUESTION 1

Determine the cost of sales for a firm with the following financial ratios and data:

Current ratio = 3.0; Quick ratio = 2.0; Current liabilities $1,000,000; Inventory turnover 6 times

	a.	$6,000,000
	b.	$3,000,000
	c.	$2,000,000
	d.	$1,000,000

8.3 points

QUESTION 2

What would be the times interest earned of a company, if its total interest charges are $20,000, sales are $220,000, and its net profit margin is 6 percent? Assume a tax rate of 40 percent.

	a.	2.65
	b.	2.1
	c.	1.1
	d.	1.2

8.3 points

QUESTION 3

A firm's current ratio is 1.5 and its quick ratio is 1.0. If its current liabilities are $10,000, what are its inventories?

	a.	$20,000
	b.	$ 5,000
	c.	$10,000
	d.	$15,000

8.3 points

QUESTION 4

If a firm wishes to retain the same return on equity when its net profit margin and total asset turnover has declined, it must

	a.	increase its equity multiplier
	b.	increase sales and increase assets
	c.	decrease its equity multiplier
	d.	reduce sales and increase assets

8.3 points

QUESTION 5

The sales-to-inventory ratio:

	a.	is technically inferior to other commonly used ratios.
	b.	is superior to the inventory turnover ratio.
	c.	as a determination of financial performance, is good comparison tool.
	d.	was developed by the Dupont Corporation and is satisfactory when used to make comparisons between the firm and the industry as a whole.

8.5 points

QUESTION 6

Primary sources of comparative financial data include

	a.	Dun and Bradstreet
	b.	Richard Moore, Inc.
	c.	Framingham Financial Library
	d.	New York Times

8.3 points

QUESTION 7

____ indicate the ability of the firm to meet its short-term financial obligations

	a.	Leverage ratios
	b.	Profitability ratios
	c.	Activity ratios
	d.	Liquidity ratios

8.3 points

QUESTION 8

If a firmâs common size income statement shows that the earnings after tax percentage is too low, the firm may have spent too much money:

	a.	on total assets as a percentage of long-term liabilities.
	b.	on cost of goods sold as a percentage of sales.
	c.	on taxes paid as a percentage of stockholdersâ equity.
	d.	on expenses as a percentage of current assets.

8.3 points

QUESTION 9

The ____ ratio indicates the percentage of a firm's earnings that are distributed as dividends.

	a.	payout
	b.	earnings
	c.	return on earnings
	d.	dividend yield

8.3 points

QUESTION 10

The work of the external independent auditor includes a letter that states that the financial information represents fairly the financial position of the company and that these statements were:

	a.	based on the company's accounting information system (AIS)
	b.	constructed in conformity with generally accepted accounting principles
	c.	developed using management's choice of accounting enhancement techniques
	d.	an accurate picture of the company's market position

8.3 points

QUESTION 11

The greater the amount of financial leverage used by a firm, the greater its ____, all other things being equal.

	a.	liquidity
	b.	profitability
	c.	size
	d.	risk

8.3 points

QUESTION 12

The type of ratio that indicates the firmâs ability to provide adequate returns in the form of dividends and share price appreciation is:

	a.	Profitability ratios
	b.	Asset management ratios
	c.	Financial leverage management ratios
	d.	Liquidity ratios

8.5 points

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redant965

Data for Barry Computer Co. and its industry averages follow.

Barry Computer Company:
Balance Sheet as of December 31, 2014 (In Thousands)

Cash	$139,080	Accounts payable	$139,080
Receivables	382,470	Other current liabilities	115,900
Inventories	231,800	Notes payable	127,490
Total current assets	$753,350	Total current liabilities	$382,470
		Long-term debt	$266,570
Net fixed assets	405,650	Common equity	509,960
Total assets	$1,159,000	Total liabilities and equity	$1,159,000

Barry Computer Company: Income Statement for Year Ended December 31, 2014 (In Thousands)

Sales		$1,900,000
Cost of goods sold
Materials	$779,000
Labor	418,000
Heat, light, and power	95,000
Indirect labor	190,000
Depreciation	57,000	$1,539,000

Gross profit		$361,000
Selling expenses		228,000
General and administrative expenses		19,000
Earnings before interest and taxes (EBIT)		$114,000
Interest expense		26,657
Earnings before taxes (EBT)		87,343
Federal and state income taxes (40%)		34,937
Net income		$52,406

1. Calculate the indicated ratios for Barry. Round your answers to two decimal places.

Ratio	Barry	Industry Average
Current	x	1.99x
Quick	x	1.35x
Days sales outstanding^a	days	34.99days
Inventory turnover	x	8.44x
Total assets turnover	x	1.91x
Profit margin	%	2.63%
ROA	%	5.02%
ROE	%	10.93%
ROIC	%	7.90%
TIE	x	3.20x
Debt/Total capital	%	47.00%

^aCalculation is based on a 365-day year.

2. Construct the Du Pont equation for both Barry and the industry. Round your answers to two decimal places.

	FIRM	INDUSTRY
Profit margin	%	2.63%
Total assets turnover	x	1.91x
Equity multiplier

3. Outline Barry's strengths and weaknesses as revealed by your analysis. Select One below

a. The firm's days sales outstanding is less than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is lower than the industry average, its other profitability ratios are high compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.

b. The firm's days sales outstanding is more than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well above the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an above average liquidity position and financial leverage is similar to others in the industry.

c. The firm's days sales outstanding is comparable to the industry average, indicating that the firm should neither tighten credit nor enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in a below average liquidity position and financial leverage is similar to others in the industry.

d. The firm's days sales outstanding ratio is more than twice as long as the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.

e. The firm's days sales outstanding is more than twice as long as the industry average, indicating that the firm should loosen credit or apply a less stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.

4. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2014. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.)

Select one below

a. If 2014 represents a period of normal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2014 ratios will be misled, and a return to supernormal conditions in 2013 could hurt the firm's stock price.

b. If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2014 ratios will be well informed, and a return to normal conditions in 2013 could hurt the firm's stock price.

c. If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2014 ratios will be misled, and a return to normal conditions in 2013 could hurt the firm's stock price.

d. If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors need only look at 2014 ratios to be well informed, and a return to normal conditions in 2013 could help the firm's stock price.

e. If 2014 represents a period of normal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2014 ratios will be misled, and a continuation of normal conditions in 2013 could hurt the firm's stock price.

taupehornet862

Problem 4-23
Ratio Analysis

Data for Barry Computer Co. and its industry averages follow.

Barry Computer Company:
Balance Sheet as of December 31, 2014 (In Thousands)

Cash	$153,615	Accounts payable	$167,580
Receivables	516,705	Other current liabilities	139,650
Inventories	391,020	Notes payable	83,790
Total current assets	$1,061,340	Total current liabilities	$391,020
		Long-term debt	$349,125
Net fixed assets	335,160	Common equity	656,355
Total assets	$1,396,500	Total liabilities and equity	$1,396,500

Barry Computer Company: Income Statement for Year Ended December 31, 2014 (In Thousands)

Sales		$2,450,000
Cost of goods sold
Materials	$1,102,500
Labor	661,500
Heat, light, and power	73,500
Indirect labor	196,000
Depreciation	98,000	$2,131,500

Gross profit		$318,500
Selling expenses		171,500
General and administrative expenses		24,500
Earnings before interest and taxes (EBIT)		$122,500
Interest expense		38,404
Earnings before taxes (EBT)		84,096
Federal and state income taxes (40%)		33,638
Net income		$50,458

aCalculation is based on a 365-day year.

Construct the Du Pont equation for both Barry and the industry. Round your answers to two decimal places.

1)	FIRM	INDUSTRY
Profit margin	?%	1.92%
Total assets turnover	?x	1.98x
Equity multiplier	?

2) Outline Barry's strengths and weaknesses as revealed by your analysis.
Select the true statement

a)The firm's days sales outstanding is more than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well above the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an above average liquidity position and financial leverage is similar to others in the industry.

b)The firm's days sales outstanding is comparable to the industry average, indicating that the firm should neither tighten credit nor enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in a below average liquidity position and financial leverage is similar to others in the industry.

c)The firm's days sales outstanding ratio is more than twice as long as the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.

d)The firm's days sales outstanding is more than twice as long as the industry average, indicating that the firm should loosen credit or apply a less stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.

e)The firm's days sales outstanding is less than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is lower than the industry average, its other profitability ratios are high compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.

3) Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2014. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.)

Select true statement

a) If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors need only look at 2014 ratios to be well informed, and a return to normal conditions in 2013 could help the firm's stock price.

b) If 2014 represents a period of normal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2014 ratios will be misled, and a continuation of normal conditions in 2013 could hurt the firm's stock price.

c) If 2014 represents a period of normal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2014 ratios will be misled, and a return to supernormal conditions in 2013 could hurt the firm's stock price.

d) If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2014 ratios will be well informed, and a return to normal conditions in 2013 could hurt the firm's stock price.

e) If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2014 ratios will be misled, and a return to normal conditions in 2013 could hurt the firm's stock price.

FIN 2000 Lecture Notes - Lecture 4: Inventory Turnover, Asset Turnover, Quick Ratio

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