
1.
To calculate: The following ratios for both the companies for the year ended January 31, 2013.
- a. Receivable turnover ratio.
- b. Average collection period.
- c. Inventory turnover ratio.
- d. Average days in inventory.
- e.
Current ratio . - f. Acid-test ratio.
- g. Debt to equity ratio.
1.

Explanation of Solution
Current Ratio: A part of
Acid-test Ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.
The accounts receivable turnover ratio determines the efficiency of a company to use its assets and issue the credit to the customers and collects the funds from them. The accounts receivable turnover is determined by dividing the credit sales by the average accounts receivable of that accounting period.
Average Collection Period:
The average collection period refers to the average number of days which a company takes to collect the accounts receivable. The average collection period is determined by dividing the number of days in a year by the accounts receivable turnover.
Debt to Asset Ratio: Debt to asset ratio is the ration between total asset and total liability of the company. Debt ratio reflects the finance strategy of the company. It is used to evaluate company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.
Inventory turnover ratio: Inventory turnover ratio is a financial measure that is used to evaluate as to how many times a company sells or uses its inventory during an accounting period. It can be calculated by using the following formula:
Days’ sales in inventory: Days’ sales in inventory are used to determine number of days a particular company takes to make sales of the inventory available with them. The formula to calculate the days’ sales in inventory ratio is as follows:
The ratios for both the companies for the year ended January 31, 2013 is prepared as follows:
Ratio Analysis | ||
1. Risk Ratios | Company B | Company AE |
| ||
Net Sales (A) | $1,124,007 | $3,475,802 |
Beginning Receivables (B) | $4,584 | $40,310 |
Ending Receivables (C) | $3,470 | $46,321 |
Average Receivables (D) [(B + C) ÷ 2] | $4,027 | 43,315.5 |
Receivable Turnover (A ÷ D) | 279.11 | 80.24 |
b. Average collection period | ||
Days' Sales Receivables: | ||
Days in a Year (A) | 365 | 365 |
Receivable Turnover (B) | 279.11 | 80.24 |
Days' Sales Outstanding (A ÷ B) | 1.30 | 4.54 |
Days | Days | |
c. Inventory Turnover Ratio | ||
Cost of Goods Sold (A) | $624,692 | 2,085,480 |
Beginning Inventories (B) | $104,209 | $367,514 |
Ending Inventories (C) | $103,853 | $332,452 |
Average Inventories (D) [(B + C) ÷ 2] | $104,031 | $349,983 |
Inventory Turnover (A ÷ D) | 5.99 | 5.95 |
d. Average days in inventory | ||
Days in a Year (A) | 365 | 365 |
Receivable Turnover (B) | 5.99 | 5.95 |
Days' Inventory Outstanding (A ÷ B) | 60.93 | 61.34 |
Days | Days | |
e. Current ratio | ||
Total current assets (A) | $276,873 | $1,141,800 |
Total current liabilities (B) | $128,596 | $435,902 |
Current ratio (A÷B) | 2.15 | 2.61 |
f. Acid-test ratio | ||
Cash | $117,608 | $509,119 |
Short-term investments | $26,414 | $121,873 |
Accounts receivable | $3,470 | $46,321 |
Quick assets (A) | $147,492 | $677,313 |
Total current liabilities (B) | $128,596 | $435,902 |
Acid-test ratio (A÷B) | 1.14 | 1.55 |
| ||
Total liabilities (A) | $188,325 | $534,866 |
Total | $289,649 | $1,221,187 |
Debt to equity ratio (A÷B) | 65.01% | 43.79% |
Table (1)
2.
To calculate: The Profitability ratios for both companies for the year January 31, 2013.
- a. Gross profit ratio.
- b. Return on assets ratio.
- c. Profit Margin Ratio.
- d. Asset turnover ratio.
- e. Return on equity ratio.
2.

Explanation of Solution
Profitability ratios:
In general, financial ratios are used to evaluate capabilities, profitability, and overall performance of a company.
Gross profit ratio:
Gross profit ratio is the financial ratio that shows the relationship between the gross profit and net sales. It represents gross profit as a percentage of net sales. Gross Profit is the difference between the total revenue and the cost of goods sold. It can be calculated by using the following formula:
Rate of return on the total assets is the ratio of the net income, and interest expense to the average total assets. The rate of return on total assets measures the efficiency of the business. It measures how efficiently the business is using its total assets in generating the income.
The rate of return on the total assets is calculated as follows:
Profit Margin Ratio:
Profit margin provides an indication of the earnings per dollar of sales, and it is determining the net profit as a percentage of the revenues. Use the following formula to calculate the profit margin ratio.
Asset turnover ratio:
The Asset turnover is a contrast to the profit margin ratio and it is calculated to determine the net sales and average total assets. Use the following formula to calculate the asset turnover ratio:
Return on equity ratio:
Rate of return on equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common equity that is invested in the company.
The Return on equity ratio is calculated as follows:
The Profitability ratios for both companies for the year January 31, 2013 is prepared as follows:
Ratio Analysis | ||
1. Profitability Ratios | B Company | AE Company |
a. Gross profit ratio | ||
Net sales (A) | $1,124,007 | $3,475,802 |
Gross profit (B) | $499,315 | $1,390,322 |
Gross profit ratio (B÷A) | 44.42% | 40.00% |
b. Rate of return on assets | ||
Net income (A) | $164,305 | $232,108 |
Total assets (2012) ( B ) | $531,539 | $1,950,802 |
Total assets (2013) (C) | $477,974 | $1,756,053 |
Average total assets (D) = (B+C)÷2 | $504,756.5 | $1,853,427.5 |
Rate of return on assets (A÷E) | 32.55% | 12.52% |
c. Profit Margin ratio | ||
Net income (A) | $164,305 | $232,108 |
Net sales (B) | $1,124,007 | $3,475,802 |
Profit margin ratio(A)÷(B) | 14.61% | 6.67% |
d. Asset turnover ratio | ||
Net sales (A) | $1,124,007 | $3,475,802 |
Average total assets (B) | $504,756.5 | $1,853,427.5 |
Asset turnover (A÷B) | 2.22 | 1.87 |
e. Return on equity ratio | ||
Net income (A) | $164,305 | $232,108 |
Stockholders' Equity (2012) (B) | $363,147 | $1,416,851 |
Stockholders' Equity (2013) (C ) | $289,649 | $1,221,187 |
Average common stock (D = B+C÷2) | $326,398 | $1,319,019 |
Return on equity ratio (E = A÷D) | 50.33% | 17.59% |
Table (2)
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