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current ratio, inventory turnover, etc. In addition, note if the ratio is a Liquidity, Efficiency/Asset Utilization, Leverage or Profitability ratio. Finally, please, specify whether a company should…
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Assignment 7 Questions Please identify the following ratios which we have discussed in e.g. current ratio, inventory turnover, etc. In addition, note if the ratio is a Liquidity, Efficiency/Asset Utilization, Leverage or Profitability ratio. Finally, please, specify whether a company should try to have a higher or lower value for the ratio and why.
a) This ratio specifies how quickly the company turning its assets into sales: total asset turnover. It is an efficiency/asset utilization ratio. A company should have higher value for the ratio to be more efficient in using its assets.
b) The amount of profit generated by the company per dollar of sales: Net profit margin. It is profitability ratio. A company should have higher value for the ratio because it indicates high profitability.
c) This ratio gives a measure of the number of days it takes a company to collect on sales that it sells on credit: Days sales outstanding. Efficiency/Asset Utilization ratio. A lower value for the ratio is favourable as a company collects cash faster from customers, it has good collection procedures.
d) This ratio is used to determine how easily a company can pay interest expenses on outstanding debt: Times interest earned. It is a leverage ratio. A higher value for the ratio is favourable; the company has more cover for finance costs hence low business risk.
e) This ratio specifies the number of days it takes for the company’s inventory to be converted to sales, either as cash or accounts receivable: Days in inventory. Efficiency/Asset Utilization ratio. A lower value for the ratio is more favourable as the company is converting its inventories into cash faster; hence the inventory is more liquid.
f) This ratio indicates how profitable a company is over on accounting period (typically 12 months) without regard to how it is financed: Return on assets. Profitability ratio. A higher value for the ratio is required because it indicates that the company is more profitable.
g) A ratio that further refines the liquidity by measuring the amount of the most liquid current assets there are to cover current liabilities: Acid test ratio. It is a liquidity ratio. A company should have higher value for the ratio to be able to meet its short term obligations with lots of ease.
h) This ratio compares the amount of interest-bearing debt in a company’s capital structure to its total assets: Debt-to-total asset ratio (leverage ratio). A lower value for the ratio is required because it indicates less leverage and less risk.
i) This ratio is a measure of the number of days it takes a company to pay its suppliers: Accounts payable days (Efficiency/Asset utilization ratio). A higher value for the ratio is required because it makes the company to have more cash in hand which is vital for free cash flow and working capital.
j) The smallest this ratio can be is 1. At that level, the company would be entirely financed with equity: Equity ratio (leverage ratio). A higher value for the ratio is required as it indicates that the company is less risky and more sustainable.
k) This ratio tells us how many times a year the company’s inventory is converted to sales (via cost of goods): Inventory turnover (Efficiency/asset utilization ratio. A higher value for the ratio is required because it implies strong sales.
l) The concept behind this ratio is to ascertain a company’s short-term assets (cash, cash equivalents, marketable securities, receivables and inventory) are readily available to pay off its short-term liabilities (Sales payable, current portion of term debt, payables, accrued expenses and taxes): Current ratio. It is a liquidity ratio. A company should have higher value for the ratio to be able to meet its short term obligations with lots of ease
m) This ratio measures the interest-bearing debt component of a company’s capital structure to its total capital: Debt-to-capital ratio (leverage ratio). A lower value for the ratio is required because it indicates that equity holders are making less use of debt thus making the overall business less risky.
n) This ratio indicates how profitable a company is over an accounting period (typically 12 months for its shareholders): Return on equity. Profitability ratio. A higher ratio is required, implying higher returns to shareholders.
2) Try to match the five following type of companies with their corresponding balance sheets and financial ratios as shown below. Please, briefly indicate why you believe your match to be accurate, i.e. what specific characteristics led to your match:
a) Electric utility (B). Electric utility industries have lower use of debt.
b) Japanese automobile manufacturer (A) It uses more debts and covers their interest payments with a factor of 3 and has huge investments in Property, plant and equipment
c) Discount general merchandise retailer (D). Has a lower receivable day because the discount lures customers to pay promptly. Has a current ratio of greater than 1.
d) Automated test equipment/systems company (E). Relies on more research and development hence lower debt-to-asset ratio. Also, it incurs losses due to large sunk cost.
e) Upscale apparel retailer (C). Has a large supplier from suppliers hence have higher accounts payable. Read More
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