Ratio Analysis\" Please respond to the following: Management of the Monteroy Inc
ID: 2592547 • Letter: R
Question
Ratio Analysis" Please respond to the following: Management of the Monteroy Inc is preparing for an important meeting with its creditors. You are hired to prepare a document supporting the view that Monteroy is a going concern with good solvency. Use at least 2 of the key ratio presented for 2016 and 2017 to make your case. Include comparison of the year to year information. Make the strongest case possible. Your choice of ratio and your interpretation of the meaning for Monteroy are the primary issues you must address this week. Be sure to note that the change is from 2016 to 2017 right to left. EXTRA CREDIT: +5 EC Prepare your discussion as above but for 2 additional ratios. Current ratio 3.1 times 2.1 times Acid-test ratio 8 times 1.4 times Asset turnover 2.8 times 2.2 times Net income Up 32% Down 8% Earnings per share $3.30 $2.50Explanation / Answer
Sovency refers to the entity’s ability to meet its financial obligations. It is an indicator of the overall financial position of the entity. It involves analysing the debt servicing ability of the firm by considering its assets. The two ratios that measure the short term solvency of an enitity are:
To measure the long term solvency of the entity, there is a Debt to total assets ratio, Interest coverage ratio, Debt servicing coverage ratio, Debt Equity ratio.
Current ratio helps in analyzing the short term solvency of the entity by comparing its current assets by its current liabilities. It indicates whether if all the current liabilities of the entity decide to take their money from the entity, the current assets of the entity are sufficient to pay them off or not? As per the industry standards, an entity having a current ratio of 2:1 is considered sufficiently solvent and is considered able to pay off its current liabilities in the event of solvency of the company.
In the given case, Monteroy has a current ratio of 3.1 and 2.1 in the preceding two years which is sufficient in terms of its solvency. The entity has improved its current ratio from the past year which is a sign of healthy growth and sound solvency of Monteroy Inc.
Asset turnover ratio discusses the sales of the entity in relation to its average total assets employed during the year. It measures the number of dollars generated by the entity by one dollar of entity’s asset. Higher the Asset turnover ratio better is the entity. The entity has improved its ratio from 2.2 to 2.8 which is a very good sign and indicates that the entity is moving in the right direction. The entity has utilized its total assets in a very efficient manner in the latest year.
Additional Analysis
Quick ratio or Acid test ratio is an improved version of Current ratio which analyses the very short term solvency of the entity. While calculating acid test ratio, Inventory of the entity is not considered for the payment to current liabilities and it takes a considerable time for inventory to convert into liquid assets. Also, prepaid expenses are not considered too because they are not to be converted into liquid assets in the future. As per industry standards, an Acid test ratio of 1:1 is considered sufficient to analyze the solvency of the entity. Monteroy has had an acid test ratio of 0.8 in the latest year which is close to industry average and is not a sign or worry and the current ratio of the entity is still very healthy. It means that the entity has invested a lot of money in its inventory which shall be repaid in the future and will definitely be beneficial to all the stakeholders of Monteroy Inc. The management is determined to further improve this ratio to further solidify the solvency of Monteroy Inc.
Earning per share means the earnings available to the shareholders of Monteroy Inc from the current year Income of the entity after paying off the annual obligations to the Debt of the company and government taxes. EPS of Monteroy Inc has improved considerably which is a further proof of sound business practices and effective performance of the management and an indicator of healthy solvency position of the entity.
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