Define the term “liquidity” within a financial statement analysis context. What

Question

Define the term “liquidity” within a financial statement analysis context. What are the current and quick ratios? Assess the firm’s liquidity position.

What are the inventory turnover, days sales outstanding, fixed asset turnover, and total asset turnover? How do the firm’s asset utilization ratios stack up against the industry averages?

What are the debt, times-interest-earned, and fixed charge coverage ratios? How does it compare with the industry with respect to financial leverage?

Calculate the profitability ratios, that is, its profit margin, return on assets (ROA), return on equity (ROE).

What is common size analysis? Briefly describe how it an be applied to income statements and balance sheets. Does common size analysis replace ratio analysis, or should it be used to supplement ratio analysis?

2016 Balance Sheets Cash Accounts receivable Inventory 2017 S 57,600 351,200 715.200 S1,124,000 S 491,000 Less: Accumulated Depreciation 146,200 S 344,800 $1468 800 S 52,000 402,000 836.000 S1,290,000 S 527,000 166,200 S 360,800 Total current assets Gross Fixed assets Net fixed assets Total assets S 145,600 200,000 136,000 S 481,600 323,432 460,000 203,768 S663,768 175,200 225,000 140,000 S 540,200 424,612 460,000 225,988 S 685,988 Accounts Payable Notes Payable Accruals Total current liabilities Long-term debt Common stock Retained earnings Total equity Total claims Income Statement Sales Cost of goods sold Other expenses Depreciation S3.432,000 2,864,000 340,000 18,900 S 209,100 62.500 S 146,600 58.640 $3,850,000 3,250,000 430,300 20,000 S 149,700 76,000 S 73,700 29.480 EBIT Interest expense EBIT Taxes (40%) Net income Other data December 31 stock price Number of share outstanding Dividend per share Annual $8.50 100,000 S0.22 S40,000 $6.00 100,000 S0.22 S40,000 lease payment

Explanation / Answer

Liquidity position of the firm indicates the firm's ability tomeet its short term obligation and also assesses the firm's capability to sell assest quickly to raise cash. Liquidity position of a company can be assesses through some of the company's liquidity ratios like current and quick ratio.

Current ratio determines the ability of the company to pay off its current liabilities
Current ratio = Current Asset/Current Liabilities
For Fy2016
Current Ratio = 1124,000/481600
      = 2.33
For Fy2017
Current Ratio = 1290000/540200
   =2.39

For FY2016
Quick Ratio = (Current Assets- Inventory)/Current Liabilities
      = (1124000-715200)/481600
      = 0.85
For Fy2017
Quick Ratio =(1290000-836000)/540200
      = 0.84

The company's current ratios for both the years is more than 1.0 which means it can meet its short term obigation. However, the current ratio is less than the industry average which indicates the company is less liquid in terms of its peers. Also, if we see the quick ratio of the firm it is less than 1 which indicates that the company will have to sell its inventory, which at times is difficult,to meet short term obligations.

2. Inventory turnover = COst of goods sold/ average inventory
      = 3250000/[(715200+836000)/2]
      = 4.2x
Day sales outstanding = accounts receivable / (annual sales / 365 days)
For Fy2016    DSO =351200/(3432000/365)
   = 37.3 days

For Fy2017 DSO = 38.1 days


Fixed Asset turnover = Net Sales/ net fixed Asset
For FY2016    = 3432000/344800
= 9.95x
For FY2017 = 3850000/360800
      =10.7x


Total Asset Turnover for Fy2017= Net Sales/Average Total Assets
      = 3850000/[(1468800+1650800)/2]
=2.5x

The firm's asset utilization is less than the industry average in terms of inventory turnover and total asset turnover. Though fixed asset turnover for 2017 is at par with repscet to industry average yet the firm needs to pay attention to the proper asset utilization of both its inventory and long term assets.

3. Financial Leverage for FY2017
Debt Ratio = Total Debt/Total Asset
   = (Total current liabilities+Long term debt)/Total Asset
     =(540200+424612)/1650800
   =58.4%
TImes earned interest = EBIT/Interest payable.
  =149700/76000
      =2.0x

Fixed Charge coverage ratio = EBIT+Fixed charges before tax/Fixed charges before tax+Interest
=(149700+40000)/(40000+76000)
   =1.6x

Fixed charge here is the annual lease payment of $40000

Financial leverage ratios are weaker than the industry average and the firm has higher debt in its accounts whose repayment ratio is also weaker which indicates the company should lower its total debt and pay attention on its repayment.

4. Profitability ratio
Profit margin = Net Income/Net sales
   =44220/3850000
      = 1.1%
ROA = Net Income/Average Total Asset
=44220/(1650800+1468800)/2
= 2.8%
ROE = 44220/685988
= 6.4%

Common size analysis is a tool to analyse financial statement. It evaluates each line items of the financial statements by expressing them as a percentage of the base amount for that period. it helps to understand the impact of each line item in the statement.

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.