Chapter 12, Problem 6PB

1.

To determine

Calculate the given risk ratios of Company TAA for 2021 & 2022.

Answer to Problem 6PB

The given risky ratios of Company TAA for 2021 as follows:

1. a. Receivables turnover ratio – 11.1 times
2. b. Inventory turnover ratio – 4.4 times
3. c. Current ratio – 15.9:1
4. d. Debt to equity ratio – 30.9%

The given risky ratios of Company TAA for 2022:

1. a. Receivables turnover ratio – 11.7 times
2. b. Inventory turnover ratio – 4.3 times
3. c. Current ratio – 14.0:1
4. d. Debt to equity ratio – 25.2%

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. It is calculated by using the following formula:

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

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.

Calculate the given risk ratios of Company TAA for 2021 & 2022 as follows:

1. a. Calculate the receivables turnover ratio of Company TAA for 2021:

$\begin{array}{c}\text{Receivables turnover ratio = }\frac{\text{Net Credit sales}}{\text{Average Accounts Receivables}}\\ =\frac{\$8,900,000}{\frac{\left(\$810,000+\$790,000\right)}{2}}\\ =\frac{\$8,900,000}{\$800,000}\\ =11.1\text{ times}\end{array}$

Calculate the receivables turnover ratio of Company TAA for 2022:

$\begin{array}{c}\text{Receivables turnover ratio = }\frac{\text{Net Credit sales}}{\text{Average Accounts Receivables}}\\ =\frac{\$10,400,000}{\frac{\left(\$790,000+\$990,000\right)}{2}}\\ =\frac{\$10,400,000}{\$890,000}\\ =11.7\text{ times}\end{array}$

1. b. Calculate the inventory turnover ratio of Company TAA for 2021:

$\begin{array}{c}\text{Inventory turnover ratio}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\ =\frac{\$5,450,000}{\frac{\left(\$1,075,000+\$1,405,000\right)}{2}}\\ =\frac{\$5,450,000}{\$1,240,000}\\ =4.4\text{times}\end{array}$

Calculate the inventory turnover ratio of Company TAA for 2022:

$\begin{array}{c}\text{Inventory turnover ratio}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\ =\frac{\$6,800,000}{\frac{\left(\$1,405,000+\$1,725,000\right)}{2}}\\ =\frac{\$6,800,000}{\$1,565,000}\\ =4.3\text{ times}\end{array}$

1. c. Calculate the current ratio of Company TAA for 2021:

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current Assets}}{\text{Current Liabilities}}\\ =\frac{\$2,469,000}{\$155,000}\\ =15.9:1\end{array}$

Calculate the current ratio of Company TAA for 2022:

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current Assets}}{\text{Current Liabilities}}\\ =\frac{\$3,070,000}{\$219,000}\\ =14.0:1\end{array}$

1. d. Calculate the debt to equity ratio of Company TAA for 2021:

$\begin{array}{c}\text{Debt to Equity Ratio}=\frac{\text{Total Liabilities }}{\text{Stockholder's Equity}}\\ =\frac{\$755,000}{\$2,444,000}\\ =30.9\%\end{array}$

Calculate the debt to equity ratio of Company TAA for 2022:

$\begin{array}{c}\text{Debt to Equity Ratio}=\frac{\text{Total Liabilities }}{\text{Stockholder's Equity}}\\ =\frac{\$719,000}{\$2,851,000}\\ =25.2\%\end{array}$

2.

To determine

Calculate the given profitability ratios of Company TAA for 2021 & 2022.

Answer to Problem 6PB

The given profitability ratios of Company TAA for 2021 are:

1. a. Gross Profit ratio – 38.8%
2. b. Return on Assets ratio – 38.9%
3. c. Profit margin – 13.8%
4. d. Assets turnover ratio – 2.8 times

The given profitability ratios of Company TAA for 2022 are:

1. a. Gross Profit ratio – 34.6%
2. b. Return on Assets ratio – 40.2%
3. c. Profit margin – 13.1%
4. d. Assets turnover ratio – 3.1 times

Explanation of Solution

Profitability ratios: In general, financial ratios are used to evaluate capabilities, profitability, and overall performance of a company.

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.

Calculate the given profitability ratios of Company TTA for 2021 & 2022 as follows:

1. a. Calculate the gross profit ratio of Company TAA for 2021:

$\begin{array}{c}\text{Gross Profit ratio = }\frac{\text{Gross Profit}}{\text{Net Sales}}\times 100\\ =\frac{\$3,450,000}{\$8,900,000}\times 100\\ =38.8\%\end{array}$

Calculate the gross profit ratio of Company TAA for 2022:

$\begin{array}{c}\text{Gross Profit ratio = }\frac{\text{Gross Profit}}{\text{Net Sales}}\times 100\\ =\frac{\$3,600,000}{\$10,400,000}\times 100\\ =34.6\%\end{array}$

1. b. Calculate the return on asset ratio of Company TAA for 2021:

$\begin{array}{c}\text{Return on assets ratio}=\frac{\text{Net Income}}{\text{Average total assets}}\times 100\\ =\frac{\$1,230,000}{\frac{\left(\$3,124,000+\$3,199,000\right)}{2}}\times 100\\ =\frac{\$1,230,000}{\$3,161,500}\times 100\\ =38.9\%\end{array}$

Calculate the return on asset ratio of Company TAA for 2022:

$\begin{array}{c}\text{Return on assets ratio}=\frac{\text{Net Income}}{\text{Average total assets}}\times 100\\ =\frac{\$1,360,000}{\frac{\left(\$3,199,000+\$3,570,000\right)}{2}}\times 100\\ =\frac{\$1,360,000}{\$3,384,500}\times 100\\ =40.2\%\end{array}$

1. c. Calculate the profit margin ratio of Company TAA for 2021:

$\begin{array}{c}\text{Profit Margin ratio}=\frac{\text{Net income}}{\text{Net revenue}}\\ =\frac{\$1,230,000}{\$8,900,000}\\ =13.8\%\end{array}$

Calculate the profit margin ratio of Company TAA for 2022:

$\begin{array}{c}\text{Profit Margin ratio}=\frac{\text{Net income}}{\text{Net revenue}}\\ =\frac{\$1,360,000}{\$10,400,000}\\ =13.1\%\end{array}$

1. d. Calculate the assets turnover ratio of Company TAA for 2021:

$\begin{array}{c}\text{Asset turnover }=\frac{\text{Net}\text{revenue}}{\text{Average total assets}}\\ =\frac{\$8,900,000}{\frac{\left(\$3,124,000+\$3,199,000\right)}{2}}\\ =\frac{\$8,900,000}{\$3,161,500}\\ =2.8\text{ times}\end{array}$

Calculate the assets turnover ratio of Company TAA for 2022:

$\begin{array}{c}\text{Asset turnover }=\frac{\text{Net}\text{revenue}}{\text{Average total assets}}\\ =\frac{\$10,400,000}{\frac{\left(\$3,199,000+\$3,570,000\right)}{2}/2}\\ =\frac{\$10,400,000}{\$3,384,500}\\ =3.1\text{ times}\end{array}$

3.

To determine

Describe whether the overall risk and profitability ratios are improved from 2021 to 2022.

Explanation of Solution

In this case, regarding risk the receivables turnover has been slightly improved whereas the debt to equity ratio has been declined, though both the inventory turnover ratio and current ratio indicates positive signs, both declined in 2022. 

In this case, the profitability ratios are mixed. Because in 2022, the net income has been increased by $130,000 whereas, the gross profit ratio has been declined from 38.8% to 34.6%. On the other hand, the return on assets has been increased, while the profit margin has been declined, and as result the asset turnover has been improved.