A company has the following ratios: Current ratio - .85 Inventory to Sales Conve

Question

A company has the following ratios: 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 accountant also reports that the gross profit margin is 15% and the next profit margin is 3%. Now you are being provided with this additional information on the company. The company also has a bank line of credit that allows the company to borrow any shortfall it might have in cash. Interest on the loan is 10%. Assume the loan remained constant throughout the year. The company has $1,000,000 of equity and $120,000 in retained earnings at the end of the year. Sales in the most recent year were $2,500,000. Ignore income tax for purposes of this problem. Question: Based on all of the above information, will this company have a good return on equity or a poor return on equity? Build a balance sheet and income statement financial model to prove your answer.

Explanation / Answer

Current Ratio Current Assets/ Current Liabilities Inventory to Sales Conversion Period Inventory/Cost of Sales x 365 Sales to Cash Conversion Period Days inventory outstanding+ Days sales outstanding- Days paybles outstanding Gross Profit Margin 15% Net Profit Margin 3% Equity                                            10,00,000 Retained Earings                                              1,20,000 Sales                                            25,00,000 Sales to Cash Conversion Period 213 days Net Profit                                                  75,000 Return on Equity Net Profit/Equity*100 7.50% ROE ratio is an important measure of a company's earnings performance. The ROE tells common shareholders how effectively their money is being employed. Peer company, industry and overall market comparisons are appropriate; however, it should be recognized that there are variations in ROEs among some types of businesses. In general, financial analysts consider return on equity ratios in the 15-20% range as representing attractive levels of investment quality.

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