1. Describe the analytical use of each of the six ratios presented above 2. For
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Question
1. Describe the analytical use of each of the six ratios presented above2. For each of the four entities described above identify two financial ratios that would be most valuable as a basis for its decision regarding Millay
3. Discuss with the financial ratios presented in the question reveal about Millay. Support your answer by citing specific ratio levels and trends as well as the interrelationships between these ratios. Exercise 24-6 (Essay) Edna Millay Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of similar size are presented below. 2014 Industny Average Millay 20122013 2014 Current ratio Quick ratio Inventory turnover Net sales to stockholders' equity Return to common stock equity Total liabilities to stockholders' equity 2.092.272.51 1.15 1.12 1.19 2.402.18 2.02 .71 2.802.99 0.14 0.15 0.17 1.41 1.37 1.44 2.24 1.22 3.50 2.85 0.11 0.95 Millay is being reviewed by several entities whose interests vary, and the company's financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Millay's financial position. Archibald MacLeish Bank. The bank is processing Millay's application for a new 5-year term note. Archibald MacLeish has been Millay's banker for several years but must reevaluate the company's financial position for each major transaction. Robert Lowell Company. Lowell is a new supplier to Millay and must decide on the appropriate credit terms to extend to the company. Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established for sale to Robert Penn Warren's clients. Working Capital Management Committee. This is a committee of Millay's management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company's working capital position, comparing actual data against budgets and recommending changes in strategy as needed
Explanation / Answer
Answer:1 The current ratio measures overall short-term liquidity and is an indicator of the short- term debt-paying ability of the firm.
The quick ratio also is a measure of short-term liquidity. However, it is a measure of more immediate liquidity than the current ratio and is an indicator of a firm’s ability to pay all of its immediate debts from cash or near-cash assets. The quick ratio is also an indicator of the degree of inventories in its current assets when compared to the current ratio.
Inventory turnover is an indicator of the number of times a firm sells its average inventory level during the year. A low inventory turnover may indicate excessive inventory accumulation or obsolete inventory.
Net sales to stockholders’ equity is an activity ratio that measures the number of times the stockholders’ equity was turned over in sales volume. This ratio could also be referred to as a net asset turnover ratio that measures net asset management. Thus, it is a measure of operational efficiency.
Net income to stockholders’ equity is a profitability ratio. It measures the return on stockholders’ investment and is used to evaluate the company’s success in generating income for the benefit of its stockholders (i.e., management effectiveness).
Total liabilities to stockholders’ equity compares the amount of resources provided by creditors to the resources provided by stockholders. Thus, it measures the extent of leverage in the company’s financial structure and is used to evaluate or judge the degree of financial risk.
Answer:2 The two ratios that each of the four entities would specifically use to examine Edna Millay Inc. are as follows:
Archibald MacLeish Bank might employ the current or quick ratio and the total liabilities to stockholders’ equity ratio.
Robert Lowell Company might employ either the current or quick ratios in conjunction with either the inventory turnover or total liabilities to stockholders’ equity ratio.
Robert Penn Warren Financial might employ net sales to stockholders’ equity and net income to stockholders’ equity.
The Working Capital Management Committee might review the current or quick ratio and the inventory turnover ratio.
Answer:3 Howser Inc. appears to have a strong current/liquidity position as evidenced by the current and quick ratios that have been improving over the three-year period. In addition, the current ratio is greater than the industry average and the quick ratio is just slightly below. However, the increase in the current ratio could be due to an increase in inventory levels. This fact is confirmed by the deteriorating inventory turnover ratio that is also below the industry average. Overstock or obsolete inventory conditions may exist.
Howser’s profitability is good as indicated by the profitability ratios that have been increasing. Both profitability ratios are greater than the industry average. The net profit margin (net income to net sales) can be derived from these two ratios (net income to stockholders’ equity and net sales to stockholders’ equity), and Millay’s margin has increased each year (2012: 5.09%; 2013: 5.36%; 2014: 5.76%) and exceeds the industry average (3.86%).
The total liabilities to stockholders’ equity ratio has increased over the three-year period and exceeds the industry average, indicating a heavy reliance on debt. This high leverage position could be dangerous if sales volume, sales margin, or income falls because interest expense is a fixed cash outlay.
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