Ratios of Tulip Trading Company - Essay Example

INTERMEDIATE ACCOUNTING I – FINAL EXAM and Section # of QUESTION NO Ratios of Tulip Trading Company Ltd are stated below, which include Average Collection and Payment period, Inventory turnover, Earning per share, Gross Profit margin etc. Figures in 000 AVERAGE COLLECTION PERIOD Average Collection period = (Acc. Receivable/Annual Credit Sales) X 365 Average Collection period = (125/11,200) X 365 = 4.07 days The low Average Collection period means that the company is able to collect its receivables within a reasonable time. (Investopedia, 2009) here, its in the benefit of the company to collect receivables in due time. AVERAGE PAYMENT PERIOD Average Payment Period = (Acc. Payable/Cost of Sales) X 365 Average Payment Period = (222/6513) X 365 = 12.44 days The average payment period is much greater than the average payment period, which signifies that it is a good sign for the company. (Bized, 2009) INVENTORY TURNOVER Inventory Turnover = Sales/Inventory Inventory Turnover = 11,200/125 = 89.6 times It shows a high inventory turnover ratio which signifies good sales but lesser rate of return. (Investopedia, 2009) OPERATING RETURN ON ASSETS Operating Return on Assets = Net Operating Income/Total Assets Operating Return on Assets = 1,266/5665 = 22.35% It represents that the profitability of the company is good in relation to its Net Assets. (Investopedia, 2009) which is presumed to be a good sign for the company and the company is using its assets effectively. RETURN ON CAPITAL EMPLOYED ROCE = Earnings before Interest and Tax/Capital Employed ROCE = 1,266/4,809 = 32.58% It is an indication of the high profits and efficiency of the company with respect to its capital investments. (Investopedia, 2009) EARNINGS PER SHARE Earnings per share = (Earnings after Tax – Dividends)/No. of Ordinary Shares Earnings per share = (991 – 63)/3,125 = $ 0.297 It means a good earning per share value as compared to the value of the shares and is a good sign for the company. (Bized, 2009) PRICE-EARNING RATIO It is the comparison between the companys Market Value per share with the Earnings per Share. (Investopedia, 2009) Its calculation is given below: Price-Earning Ratio = Share Price / Earnings per Share Price-Earning Ratio = 1.20/0.297 = $ 4.04 GROSS PROFIT MARGIN Gross Profit Margin = Gross Profit/Net Sales Gross Profit Margin = 4,637/11,200 = 41.40 % It signifies a very healthy gross profit margin. (Bized, 2009) It shows the high profitability of the company as compared to others. QUESTION NO. 2 (a) Following are the two ratios which are used to measure a companys ability to pay Current Liabilities, namely Quick ratio and Current ratio. QUICK RATIO It represents the companys ability to discharge its short term liabilities. (Investopedia, 2009) It can be calculated by the following formula: Quick Ratio = (Current Assets-Inventories)/Current Liabilities CURRENT RATIO It indicates the strength of a company to attend its short term obligations. (Investorwords, 2009) Its formula is given below: Current Ratio = Current Assets/Current Liabilities QUESTION NO. 2 (b) Treatment of increment in days-sales-in-receivable ratio and response to it TREATMENT OF INCREASE IN RATIO The increase in days-sales-in-receivable should be taken as a bad sign for the Sony Company as the increase represents that some customers are taking a longer period of time to pay off their debts. (Abrema, 2009) MEASURES TO REDUCE THE RATIO A Re-assessment of the Companys policies to ensure collection on time can help reduce this ratio. This can be done by offering discounts on payment within a certain period. QUESTION NO. 2 (c) Identification and the affect on the decision of a party to whom gearing ratio is important GEARING RATIO The change in gearing ratio will affect the decisions of the shareholders of the ABC company. It decisions will be affected in the following ways: The dividend may start reducing and later on become zero In years, earning less income, interest will have to be paid with lesser capital The long term liability holders will gain the power to override the decisions of the shareholders, in the general meeting (Bized, 2009) QUESTION NO. 2 (d) Analysis and Comparison of Company A and B, being grocery stores and Construction companies respectively CURRENT RATIO Company B, a Construction Company, is likely to have a high current ratio because of it being a cyclical industry. This is because of the availability of funds during downturns. (Netmba, 2007) INVENTORY TURNOVER Company A, a grocery store, is more probable to have a high Inventory turnover because of the sales of perishable goods which require quick sales to avoid wastage. (Money Central, 2009) RATE OF RETURN ON SALES Company B is more likely to have a high Rate of Return on Sales because of lesser competition and regulations etc. (Financial Dictionary, 2009) QUESTION NO. 3 Determination of a stock valuation method as a contemporary manager DETERMINATION OF STOCK VALUATION MODEL There are many methods which are preferred by the Accounting Standards for the valuation of the stock, e.g. Specific Identification, FIFO, LIFO, Weighted Average etc. In order to assess the stock valuation model to be adopted by the company, following points would be considered: Specific Identification method is the most favorable and an ideal method to be used. Here, the actual cost of the Inventory can be identified but there are some limitations as it can be used in large and easily traceable good manufacturing industries such as Vehicles and Furniture. (Money Central, 2009) In FIFO (First In First Out) method, it is assumed that the goods that were bought first were also sold first. As a result, during a rising trend in prices FIFO will give a better assessment of the cost of ending Inventory. (CBA, 1998) LIFO (Last In First Out) method assumes that the goods bought in at the end are being sold first. Therefore, the ending inventory will be valued at a lower price during a rising trend in prices and vice versa. (CBA, 1998) but one of the advantages of using LIFO is that it reduces the amount of taxes during rising trend of prices. In Weighted Average, an average of the whole rate is determined and that rate is applied to the Ending Inventory. It is easy to calculate but it doesn’t show the exact effect of Inflation on prices. (CBA, 1998) Example An analysis of three months is given below PARTICULARS UNIT COST QUANTITY TOTAL COST JAN 10 100 1000 FEB 12 100 1200 MAR 15 100 1500 SALE 18 250 4500 The Ending Inventory of 50 units will be valued at: FIFO = 50 X $15 = $750 LIFO = 50 X $10 = $500 Weighted Average = 50 X $12.33 = $617 CONCLUSION Hence, regard shall be given to the positive and negative affects of all the valuation methods and a most favorable method should be determined in accordance with the kind of industry. BIBLIOGRAPHY (1998). Retrieved from CBA: http://web.cba.neu.edu/~sbruns/invmeth.htm (2007). Retrieved from Netmba: http://www.netmba.com/finance/financial/ratios/ (2009). Retrieved from Investopedia: http://www.investopedia.com/terms/i/inventoryturnover.asp (2009). Retrieved from Investopedia: http://www.investopedia.com/terms/r/returnonassets.asp (2009). Retrieved from Investopedia: http://www.investopedia.com/terms/r/roce.asp (2009). Retrieved from Investopedia: http://www.investopedia.com/terms/p/price-earningsratio.asp (2009). Retrieved from Investopedia: http://www.investopedia.com/terms/q/quickratio.asp (2009). Retrieved from Investorwords: http://www.investorwords.com/1258/current_ratio.html (2009). Retrieved from Abrema: http://www.abrema.net/abrema/days_sales_rec_g.html (2009). Retrieved from Bized: http://www.bized.co.uk/compfact/ratios/gearing3.htm (2009). Retrieved from Money Central: http://moneycentral.msn.com/investor/alerts/glossary.asp?TermID=45 (2009). Retrieved from Financial Dictionary: http://financial-dictionary.thefreedictionary.com/Return+on+Sales (2009). Retrieved from Money Central: http://moneycentral.msn.com/taxes/glossary/glossary.asp?TermID=313 (2009). Retrieved from Investopedia: http://www.investopedia.com/terms/a/average_collection_period.asp (2009). Retrieved from Bized: http://www.bized.co.uk/compfact/ratios/sdc8.htm (2009). Retrieved from Bized: http://www.bized.co.uk/compfact/ratios/investor4.htm (2009). Retrieved from Bized: http://www.bized.co.uk/compfact/ratios/profit3.htm Read More