All-Things Inc. manufactures a variety of consumer products. The company\'s foun
ID: 2464126 • Letter: A
Question
All-Things Inc. manufactures a variety of consumer products. The company's founders
have managed the company for thirty years and are now interested in selling the
company and retiring. Trist Associates is looking into the acquisition of All-Things
and has requested the company's latest financial statements and selected financial
ratios in order to evaluate All-Things' financial stability and operating efficiency. The
summary information provided by All-Things is presented below.
All-Things Inc
Income Statement
For the Year Ended May 31, Year 3
(in thousands)
Sales ................................................................... $30,500
Expenses:
Cost of goods sold .......................................... 17,600
Selling and administrative expense ................ 3,050
Depreciation and amortization expense ......... 1,890
Interest expense .............................................. 900
Total expenses ................................................... 23,440
Income before taxes ........................................... 7,060
Income taxes ...................................................... 2,900
Net income ........................................................ $ 4,160
All-Things Inc.
Comparative Statement of Financial Position
As of May 31
(in thousands)
Year 3 Year 2
Cash ............................................................... $ 400 $ 500
Marketable securities ..................................... 500 200
Accounts receivable, net ................................ 3,200 2,900
Inventory ........................................................ 5,800 5,400
Total current assets ........................................ 9,900 9,000
Property, plant, and equipment, net ............... 7,100 7,000
Total assets ..................................................... $17,000 $16,000
Accounts payable ........................................... $ 3,700 $ 3,400
Income taxes payable ..................................... 900 800
Accrued expenses .......................................... 1,700 1,400
Total current liabilities ................................... 6,300 5,600
Long-term debt .............................................. 2,000 1,800
Total liabilities ............................................... 8,300 7,400
Common stock $(1 par value) ........................ 2,700 2,700
Paid-in-capital in excess of par ...................... 1,000 1,000
Retained earnings ........................................... 5,000 4,900
Total stockholders’ equity ............................. 8,700 8,600
Total liabilities and stockholders’ equity ....... $17,000 $16,000
Selected Financial Ratios
Current
All-Things Industry
Year 2 Year 1 Average
Current ratio ........................ 1.61 1.62 1.63
Acid-test ratio ...................... 0.64 0.63 0.68
Inventory turnover ............... 3.17 3.21 3.18
Times interest earned ........... 8.55 8.50 8.45
Debt-to-equity ratio ............. 0.86 1.02 1.03
Required:
a. Calculate the above ratios for fiscal year Year 3 for All-Things Inc.
b. What do these ratios tell you about the company's operations and ability to take on
additional debt?
c. Identify two limitations of ratio analysis
Explanation / Answer
Current ratio = Current assets ÷ Current liabilities = $9,900 ÷ $6,300 = 1.57
Acid-test ratio = (Cash + Marketable Securities + Net receivables) ÷
Current liabilities = ($400 + $500 + $3,200) ÷ $6,300 = 0.65
Inventory turnover = Cost of goods sold ÷ Average inventory
= $17,600 ÷ [1/2 ($5,800 + $5,400)] = 3.14
Times interest earned = Income before interest and taxes ÷ Interest expense
= ($7,060 + $900) ÷ $900 = 8.84
Debt-to-equity ratio = Total liabilities ÷ Stockholders' equity
= $8,300 ÷ $8,700 = 0.95
Current ratio.
• Measures ability to meet short-term obligations using short-term assets.
• All-Things' current ratio has declined slightly over the last three years from
1.62 to 1.57 and the level of the current ratio is a bit below the industry average. This may be cause for some concern, although the magnitudes are not large.
Acid-test ratio.
• Measures ability to meet short-term obligations using the most liquid assets.
• All-Things has improved its acid-test ratio over the last three years, but it is still below the industry average. Furthermore, an acid-test ratio below 1.0 indicates that All-Things may have difficulty meeting its short-term obligations.
Inventory turnover.
• Measures how quickly inventory is sold.
• All-Things' ratio has been steadily declining and is below the industry average.
This may indicate a decline in operating efficiency, obsolete inventory, or a poor marketing strategy.
Times interest earned.
• Measures the ability to meet interest commitments from current earnings. The higher the ratio, the more safety there is for long-term creditors.
• All-Things' ratio has been improving over the last three years and is above the industry average. This indicates that the company has additional capacity to borrow and repay funds.
Debt-to-equity ratio.
• Measures the level of protection creditors have in the case of possible insolvency. It also is used to help gauge the company's capacity to take on additional debt.
• All Things' debt-to-equity ratio has deteriorated slightly but has been below the industry average over the last three years. All-Things should be able to raise additional funds through debt and still remain below the industry average.
• Although ratios are useful as a starting point in financial analysis, they are not an end in themselves. Ratios can be used as indicators of what to pursue in a more detailed analysis.
• Different companies often use different accounting methods (e.g., FIFO versus
LIFO inventory valuation) and this can have an impact on the financial ratios that does not reflect real differences in the operations and financial health of the companies.
• Making comparisons across industries can be difficult. Companies in different industries tend to have different financial ratios.
• Since the ratios are based on accounting statements, they measure what has happened in the past and not necessarily what will happen in the future
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