What do the following ratios say about the business. What do they mean in regard

Question

What do the following ratios say about the business. What do they mean in regards to the operations of the business?

-Current ratio: .85

-Inventory to Sales Conversion Period: 180 days

-Sales to Cash Conversion Period: 40 days

-Purchases to Payments Conversion Period: 7 days

The company also has a gross profit margin of 15% and a net profit margin of 3%.

Based on this additional information and the above ratio information, will this company have a good return on equity or a poor return on equity?

Explanation / Answer

Current ratio of 0.85 indicates excess of Current liability over Current assets. Hence, it will be difficult for the company to settle its dues with the liquid assets it has over its disposal as they are falling short of Current liability by 15% with respect to Liability of the company.

Inventory to sales conversion of 180 days shows that it takes 180 days for the inventory to be finally sold off as a finished good right from its purchase date. 180 days is considered too high as per standards.

Sales to Cash conversion period of 40 days indicates it takes 40 days for the company to convert its receivable to cash from debtors.

Purchases to payment conversion period indicates how much times it takes for a company to pay its creditors. 7 days is too early as per standards.

It will have a poor return on equity as all the indicators above show an abysmal situation with respect to its operations thereby indicating lower sales impacting all the way down to the Net income and resultant return on equity.

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