Current ratio= current assets Current liabilities
Quick ratio = cash + cash equivalent + short term investment + accounts receivable
= 878000 + 85632
The current ratio and quick ratio also referred as the acid-test are essential to a business in determining its liquidity (Tracy, n. d. p. 12). The ratios are used to determine if a company can settle its short-term liabilities with ease. The ratios help financial institutions and suppliers to determine if an enterprise is credit worth and to access the risk of doing business with the firm. The ratios also serve as an early indicator of financial distress in a company if they drop below 1.
Inventory turnover = cost of good for sale
Days Sales outstanding = Receivables
Total sales/ 365
Net asset turnover = sales
Net fixed assets
Total assets turn over = sales
The four ratios are associated with the working capital. They identify how fast activities are happening to show an organization’s efficiency. Inventory turnover indicates the effectiveness in sales of the purchased stock. Days sales outstanding ratio on the other side demonstrate the amount of time an enterprise requires to convert its receivables into cash (Wahlen, Bradshaw, Baginski & Stickney, n. d. p. 118). The net assets and total assets ratio are an indication of how good assets in the business are utilized. The ratios are used to assess the efficiency in the management of assets.
Debt –to –asset ratio = total debt
Times- interest – earned = EBIT
The ratios show the ability of the firm to manage its debt. Debt to assets ratio is a critical ratio indicating the security available to secure the debt (Tracy, n. d. p. 22). It is used by lenders to access the amount of money to give to the organization. The second ratio shows the amount of interest paid on the amount earned by the firm.
Operating margin = operating income ( EBIT)
= 492648 ×100
Profit margin = net income
= 253584 × 100
Basic earning power = EBIT
= 492642 × 100
Return on assets = net income
Return on equity = net income
The ratios indicate the profitability of a firm. They are used by investors to access the expected return on their investments (Brigham & Ehrhardt, 2014, p. 112). They are also used to compare the company’s performance with others in the industry. They are the simplest method to measure growth in the profits of business.
Price earnings ratio = price per share
Earnings per share
Market/book ratio = market price per share
Book value per share
The DuPont equation
=net income × sales × assets
Sales total assets equity (Brigham, 2016, p.118)
= 253584 × 7035600 × 3497152
7035600 3497152 1952352
0.036 × 2.011 × 1.791
XYZ has a small ROE of 0.036 compared to the other ratios in the DuPont equation. The factors leading to this situation could be minimal sales or high expenses. The company must, therefore, adjust its expenditure to improve its net income.
Daily sales = Sales/365
Daily sales = $7,035,600 /365
Daily sales = $19,275.62
Target A/R = Daily sales × Target DSO
Target A/R = $19,276 ×32
Target A/R = $616,820
Freed-up cash = old A/R–new A/R
Freed-up cash =$878,000 –$616,820
Freed-up cash = $261,180
The following would be the new balance sheet.
Accounts receivable $616.82 Debt $1,545
Other current assets 2063.18
Net fixed assets 817 Equity 1,952
Total assets $3,497 Liabilities plus equity $3,497
The change will only affect the value of the accounts receivable and the value of other current assets, particularly cash. It has no effect on the value of the total assets and liabilities plus equity. Therefore, it may not have any effects on the valuation of the company or its stock prices.
- Brigham, E. (2016). Fundamentals of Financial Management. [Place of publication not identified]: Cengage Learning.
- Brigham, E., & Ehrhardt, M. (2014). Financial Management. Mason, Ohio: South-Western.
- Tracy, A. Ratio Analysis Fundamentals.
- Wahlen, J., Bradshaw, M., Baginski, S., & Stickney, C. Financial Reporting, Financial Statement Analysis, and Valuation.