Chapter 13, Problem 1CC

1.

To determine

Identify whether Company NGS was profitable in 2018 or 2017 by using gross profit percentage, return on equity and fixed assets turnover ratio.

Explanation of Solution

Gross Profit Percentage:

Gross profit 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 net sales revenue, and the cost of goods sold. It can be calculated by dividing gross profit and net sales.

Identify whether Company NGS was profitable in 2018 or 2017 by using gross profit percentage, return on equity and fixed assets turnover ratio.

$\begin{array}{c}\begin{array}{l}\text{Gross}\text{profit}\text{percentage}\\ \text{ratio (2017) }\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{sales}\text{revenue}-\\ \text{cost}\text{of}\text{goods}\text{sold}\end{array}\right)}{\text{Net}\text{sales}\text{revenue}}\text{×100}\\ \text{=}\frac{\left(\text{\$56,000}-\text{\$48,000}\right)}{\text{\$56,000}}\text{×100}\\ \text{=}\frac{\text{\$8,000}}{\text{\$56,000}}\text{×100}\\ \text{=14}\text{.29\%}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Gross}\text{profit}\text{percentage}\\ \text{ratio (2018) }\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{sales}\text{revenue}-\\ \text{cost}\text{of}\text{goods}\text{sold}\end{array}\right)}{\text{Net}\text{sales}\text{revenue}}\text{×100}\\ \text{=}\frac{\left(\text{\$80,000}-\text{\$65,000}\right)}{\text{\$80,000}}\text{×100}\\ \text{=}\frac{\text{\$15,000}}{\text{\$80,000}}\text{×100}\\ \text{=18}\text{.75\%}\end{array}$

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.

$\begin{array}{c}\begin{array}{l}\text{Return}\text{on}\text{equity}\\ \text{(2017)}\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{income}-\\ \text{preferred}\text{dividends}\end{array}\right)}{\text{Average}\text{common}\text{stockholders'}\text{equity}}\text{×100}\\ \text{=}\frac{\$2,100}{21,850(1)}\times 100\\ =\text{9}\text{.6\%}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Return}\text{on}\text{equity}\\ \text{(2018)}\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{income}-\\ \text{preferred}\text{dividends}\end{array}\right)}{\text{Average}\text{common}\text{stockholders'}\text{equity}}\text{×100}\\ \text{=}\frac{\$6,950}{\$32,025\text{ (2)}}\times 100\\ =21.70\text{\%}\end{array}$

Working note (1):

$\begin{array}{c}\begin{array}{l}\text{Average}\text{common}\\ \text{stockholders'}\text{equity}\end{array}\}=\text{Opening}+\text{closing}\\ =\frac{(\$32,100+\$11,600)}{2}\\ =\text{\$21,850}\end{array}$

Working note (2):

$\begin{array}{c}\begin{array}{l}\text{Average}\text{common}\\ \text{stockholders'}\text{equity}\end{array}\}=\text{Opening}+\text{closing}\\ =\frac{(\$31,950+\$32,100)}{2}\\ =\text{\$32,025}\end{array}$

Fixed Asset turnover:

Fixed asset turnover is a ratio that measures the productive capacity of the fixed assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

$\begin{array}{c}\text{Fixed}\text{asset}\text{trunover}\text{(2017)=}\frac{\text{Net}\text{revenue}}{\text{Average}\text{net}\text{fixed}\text{assets}}\\ \text{=}\frac{\text{\$56,000}}{\$53,000\text{ (3)}}\\ \text{=1}\text{.06}\end{array}$

$\begin{array}{c}\text{Fixed}\text{asset}\text{trunover}\text{(2018)}=\frac{\text{Net}\text{revenue}}{\text{Average}\text{net}\text{fixed}\text{assets}}\\ =\frac{\text{\$80,000}}{\$71,500(4)}\\ =\text{1}\text{.12}\end{array}$

Working note (3):

$\begin{array}{c}\begin{array}{l}\text{Average net fixed}\\ \text{assets for 2017}\end{array}\}=\frac{\left[\begin{array}{l}\text{opening balance of fixed asset}\\ +\text{opening balance of fixed asset}\end{array}\right]}{2}\\ =\frac{\$79,000+\$27,000}{2}\\ =\$53,000\end{array}$

Working note (4):

$\begin{array}{c}\begin{array}{l}\text{Average net fixed}\\ \text{assets for 2018}\end{array}\}=\frac{\left[\begin{array}{l}\text{opening balance of fixed asset}\\ +\text{opening balance of fixed asset}\end{array}\right]}{2}\\ =\frac{\$64,000+\$79,000}{2}\\ =\$71,500\end{array}$

By comparing the gross profit percentage, return on equity and fixed assets turnover ratio for 2017 and 2018, Company NGS has high gross profit percentage in 2018 for each sales dollar for the balance cover cost except cost of goods sold on 2018. NGS also has high profit percentage in 2018 than 2017 for return on equity and fixed assets turnover. Increase in the return on equity during 2018 reports that company is able to retain its business better than during the year 2017. Increase in the fixed asset turnover during  2018 reports that NGS is well organised to use its assets to generate its sales.

2.

To determine

Identify whether Company NGS was liquid in 2018 or 2017 by using current ratio.

Explanation of Solution

Current ratio:

Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.

Identify whether Company NGS was liquid in 2018 or 2017 by using current ratio.

$\begin{array}{c}\text{Current}\text{ratio (2017) =}\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}\\ \text{=}\frac{\text{\$11,100}}{\text{\$8,000}}\\ \text{=1}\text{.39}\end{array}$

$\begin{array}{c}\text{Current}\text{ratio (2018) =}\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}\\ \text{=}\frac{\text{\$10,950}}{\text{\$8,000}}\\ \text{=1}\text{.37}\end{array}$

It is difficult to determine whether Company NGS has more liquidity during 2018 or 2017 because company has sufficient current assets to meet out their current liabilities for every year.

3.

To determine

Identify whether Company NGS was liquid in 2018 or 2017 by using debt-to-assets and times interest earned ratio.

Explanation of Solution

Debt to Asset Ratio:

Debt to asset ratio is the ratio 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.

Identify whether Company NGS was liquid in 2018 or 2017 by using debt-to-assets and times interest earned ratio.

$\begin{array}{c}\text{Debt-to-asset}\text{ratio (2017)}=\frac{\text{Total}\text{liabilities}}{\text{Total}\text{assets}}\\ \text{=}\frac{\text{\$58,000}}{\text{\$90,100}}\\ \text{=0}\text{.64}\end{array}$

$\begin{array}{c}\text{Debt-to-asset}\text{ratio (2018)}=\frac{\text{Total}\text{liabilities}}{\text{Total}\text{assets}}\\ \text{=}\frac{\text{\$43,000}}{\text{\$74,560}}\\ \text{=0}\text{.57}\end{array}$

Times interest earned ratio:

Times interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense.

$\begin{array}{c}\text{Times Interest Earned (2017) = }\frac{\text{Net Income }+\text{ Interest Expense + Income tax expense}}{\text{Interest Expense}}\\ =\frac{\$2,100+\$3,100+\$800}{\$3,100}\\ =1.94\end{array}$

$\begin{array}{c}\text{Times Interest Earned (2018) = }\frac{\text{Net Income }+\text{ Interest Expense + Income tax expense}}{\text{Interest Expense}}\\ =\frac{\$6,950+\$1,000+\$3,050}{\$1,000}\\ =11.00\end{array}$

Company NGS has more solvency during the year 2018 than 2017. Because increase in the times interest earned ratio during 2018, shows that the company has sufficient profit during the year 2018 to cover its interest. Decrease in the debt-to-assets ratio during 2018 than 2017, shows that company has reduced its financial risk level in the year 2018.