Chapter 12, Problem 2AP

1.

To determine

Calculate the given risk ratios of Company AE for the year ended February 3, 2018.

Answer to Problem 2AP

Calculate the given risk ratios of Company AE for the year ended February 3, 2018 are:

1. a. Receivables turnover ratio – 46.0 times
2. b. Average Collection period – 7.9 days
3. c. Inventory turnover ratio – 6.4 times
4. d. Average days in inventory – 57 days
5. e. Current ratio – 2.0:1
6. f. Acid-test ratio – 1.0:1
7. g. Debt to equity ratio – 45.7%

Explanation of Solution

Risk Ratios: Risk ratios are the metrics used to evaluate the liquidity, capabilities, profitability, and overall performance of a company. The following are the ratios that evaluate the risk of a company:

Receivables turnover ratio: This is the ratio which analyzes the number of times accounts receivables is collected and converted into cash during the period. This ratio gauges the efficacy of collecting receivables. Larger the ratio, more efficient in collecting receivables. This ratio is determined by dividing credit sales and average accounts receivable. It is calculated by using the following formula:

$\text{Receivables turnover ratio = }\frac{\text{Net Credit sales}}{\text{Average Accounts Receivables}}\times 100$

Average days to collect accounts receivable (average collection period): This ratio measures the number of times receivables are collected in the period. This ratio analyzes the period receivables are outstanding. So, this ratio also gauges the efficacy of collecting receivables. Lower the ratio, more efficient the collection of receivables.

Average days to sell inventory (average days in inventory): This ratio analyzes the period from the time inventory is acquired, to the period it is sold, in the period. This ratio measures the period inventory is held with the company. So, this ratio also gauges the efficacy of inventory management. Lower the ratio, more efficient the inventory management

Inventory turnover: This is the ratio which analyzes the number of times inventory is sold during the period. This ratio gauges the efficacy of inventory management. Larger the ratio, more efficient the inventory management.

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Acid-test ratio: The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio. Quick assets are cash, marketable securities, and accounts receivables. This ratio assesses the short-term liquidity of a company.

Calculate the given risk ratios of Company AE for the year ended February 3, 2018 are as follows:

1. a. Calculate the receivables turnover ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Receivables turnover ratio = }\frac{\text{Net Credit sales}}{\text{Average Accounts Receivables}}\\ =\frac{\$3,795,549}{\frac{\left(\$78,304+\$86,634\right)}{2}}\\ =\frac{\$3,795,549}{\$82,469}\\ =46.02\text{times}\end{array}$

1. b. Calculate the average collection period of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Average collection period}=\frac{\text{365 Days}}{\text{Receivables turnover ratio}}\\ =\frac{\text{365 Days}}{46.0\text{times}}\\ =7.93\text{days}\end{array}$

1. c. Calculate the inventory turnover ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Inventory turnover ratio}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\ =\frac{\text{\$2,425,044}}{\frac{\left(\text{\$398,213}+\text{\$358,446}\right)}{\text{2}}}\\ =\frac{\$\text{2,425,044}}{\$378,330}\\ =6.40\text{ times}\end{array}$

1. d. Calculate the average days in inventory of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Average days in inventory = }\frac{\text{365 days}}{\text{Inventory turnover ratio}}\\ =\frac{\text{365 days}}{6.4}\\ =57.0\text{ days}\end{array}$

1. e. Calculate the current ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current Assets}}{\text{Current Liabilities}}\\ =\frac{\$968,530}{\$485,221}\\ =2:1\end{array}$

1. f. Calculate the acid test ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Acid test}\text{Ratio}=\frac{\text{Cash + Current Investments + Accounts Receivables}}{\text{Current Liabilities}}\\ =\frac{\$413,613+\$0+\$78,304}{\$485,221}\\ =\frac{\$491,917}{\$485,221}\\ =1.01:1\end{array}$

1. g. Calculate the debt to equity ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Debt to Equity Ratio}=\frac{\text{Total Liabilities }}{\text{Stockholder's Equity}}\times 100\\ =\frac{\$569,522}{\$1,246,791}\times 100\\ =45.7\%\end{array}$

2.

To determine

Calculate the given profitability ratios of Company AE for the year ended February 3, 2018.

Answer to Problem 2AP

The given profitability ratios for Company AE for 2018 are:

1. a. Gross Profit ratio – 36.1%
2. b. Return on Assets ratio – 11.3%
3. c. Profit margin – 5.4%
4. d. Assets turnover ratio – 2.1 times
5. e. Return on Equity ratio –16.7%

Explanation of Solution

Return on Assets (ROA): This financial ratio evaluates a company’s efficiency in operating the assets to generate net income. So, ROA is a tool used to measure the performance of a company.

Profit margin: The percentage of net income generated by every dollar of net sales is referred to as profit margin. This ratio measures the profitability of a company by quantifying the amount of income earned from sales revenue generated after the expenses are paid. The higher the ratio, the more ability to cover operating expenses.

Asset turnover: This ratio analyzes number of times sales or revenue generated from the available assets.

Return on equity (ROE): This financial ratio evaluates a company’s efficiency in using stockholders’ equity to generate net income. So, ROE is a tool used to measure the performance of a company.

The given profitability ratios for Company AE for 2018 are as follows:

1. a. Calculate the gross profit ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Gross Profit ratio = }\frac{\text{Gross Profit}}{\text{Net Sales}}\times 100\\ =\frac{\text{\$1,370,505}}{\text{\$3,795,549}}\times 100\\ =36.1\%\end{array}$

1. b. Calculate the return on asset ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Return on assets ratio}=\frac{\text{Net Income}}{\text{Average total assets}}\times 100\\ =\frac{\text{\$204,163}}{\frac{\text{(\$1,816,313}+\text{1,782,660)}}{\text{2}}}\text{×100}\\ =\frac{\$\text{204,163}}{\$1,799,486.5}\times 100\\ =11.3\%\end{array}$

1. c. Calculate the profit margin ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Profit Margin ratio}=\frac{\text{Net income}}{\text{Net revenue}}\\ =\frac{\$\text{204,163}}{\$3,795,549}\\ =5.37\%\end{array}$

1. d. Calculate the assets turnover ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Asset turnover }=\frac{\text{Net}\text{revenue}}{\text{Average total assets}}\\ =\frac{\$3,795,549}{\frac{\left(\$1,816,313+\$1,782,660\right)}{2}}\\ =\frac{\$3,795,549}{\$1,799,486.5}\\ =2.1\text{ times}\end{array}$

1. e. Calculate the return on equity ratio of Company AE for the year ended February 3, 2018:

$\begin{array}{c}\text{Return on equity ratio}=\frac{\text{Net Income}}{\text{Average stockholder's equity}}\times 100\\ =\frac{\$204,163}{\frac{(\$1,246,791+\$1,204,569)}{2}}\times 100\\ =\frac{\$204,163}{\$1,225,680}\times 100\\ =16.65\%\end{array}$