Chapter 13, Problem 3P

To determine

Compute the given ratios for the Department H

Answer to Problem 3P

Ratios of the Department H:

Return on equity	298.25%
Return on assets	19.73%
Total asset turnover	2.31
Inventory turnover	5.26
Current ratio	1.17
Quick ratio	0.34
Cash coverage ratio	12.14
Debt-to-equity ratio	29.63

Table (1)

Explanation of Solution

Return on Equity:

It is one of the profitability ratios. Return on equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common stock. Return on equity is calculated as follows:

$\text{Return on equity ratio}\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$

Return on assets:

Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets.

 $\text{Return on Assets ratio}\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}$

Total Asset Turnover ratio:

The total asset turnover ratio is used to measure the performance of the company that is the company using its assets to generate revenue. Total Asset turnover tatio is calculated as follows:

$\text{Total Assets turnover ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{Total}\text{Assets}}$

Inventory turnover ratio:

Inventory turnover ratio is one of the Assets Turnover ratios. This ratio is a financial metric used by a company to quantify the number of times inventory is used or sold during the accounting period. It is calculated as follows:

$\text{Inventory turnover ratio = }\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$

Current ratio:

Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. The ideal current ratio is 2:1. The following formula is used to calculate current ratio.

$\text{Current ratio}\text{=}\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}$

Quick 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.

$\text{Quick Ratio}\text{=}\frac{\text{Quick}\text{Assets}}{\text{Current}\text{Liabilities}}$

Cash coverage ratio:

This ratio indicates the relationship between the cash flows from operating activities and the interest payments. This ratio is calculated as follows:

$\text{Cash coverage ratio =}\frac{\text{Cash flows from operating activities }}{\text{Interest paid}}$

Debt-equity ratio:

The debt-to-equity ratio indicates that the company’s debt as a proportion of its stockholders’ equity.

$\text{Debt-equity ratio}\text{=}\frac{\text{Total}\text{Liabilities}}{\text{Total}\text{Stockholder's}\text{Equity}}$

Calculate the given ratios:

Ratio	Formula	Calculation	Result
Return on equity	$\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$	$\frac{\$8,630}{\left(\$4,333+\$1,454\right)/2}$	298.25%
Return on assets	$\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}$	$\frac{\$8,630}{\left(\$42,996+\$44,529\right)/2}$	19.73%
Total asset turnover	$\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{Total}\text{Assets}}$	$\frac{\$100,904}{\left(\$42,966+\$44,529\right)/2}$	2.31
Inventory turnover	$\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$	$\frac{\$66,548}{\left(\$12,549+\$12,748\right)/2}$	5.26
Current ratio	$\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}$	$\frac{\$18,933}{\$16,194}$	1.17
Quick ratio	$\frac{\text{Quick}\text{Assets}}{\text{Current}\text{Liabilities}}$	$\frac{\left(\$3,595+\$1,952+\$0\right)}{\$16,194}$	0.34
Cash coverage ratio	$\frac{\text{Cash flows from operating activities }}{\text{Interest paid}}$	$\frac{\$12,031}{\$991}$	12.14
Debt-to-equity ratio	$\frac{\text{Total}\text{Liabilities}}{\text{Total}\text{Stockholder's}\text{Equity}}$	$\frac{\$43,075}{\$1,454}$	29.63

Table (2)