Chapter 13, Problem 6AP

1.

To determine

Complete the given tabulation

Answer to Problem 6AP

Complete the given tabulation.

	Ratio	2014	2015		2016		2017
a	Profit margin %	(18%)		8%		15%		11%
b	Gross profit ratio	36%		39%		31%		38%
c	Expenses as a % of sales excluding cost of goods sold	55%		32%		16%		27%
d	Inventory turnover	4.7		3.1		3.2		2.5
e	Days’ supply in inventory	78		118		114		146
f	Receivable turnover	6.0		4.3		4.0		3.6
g	Average days to collect	61		85		91		101

Table (1)

Explanation of Solution

Profit margin:

Profit margin ratio is used to determine the percentage of net income that is being generated per dollar of revenue or sales.

$\text{Net profit margin}\text{=}\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}$

Calculate the profit margin for the given years.

	particulars	2014	2015	2016	2017
a	Net income	(8)	5	12	11
b	Net sales revenue	44	66	80	100
c	Profit margin $\left(\text{a}\text{÷}\text{b}\right)$	(18%)	8%	15%	11%

Table (2)

Gross Profit Ratio:

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.

$\text{Gross profit ratio}=\frac{\text{Gross profit}}{\text{Net sales}}\times 100$

Calculate the gross profit ratio for the given years.

	particulars	2014	2015	2016	2017
a	Net sales revenue	44	66	80	100
b	Less: Cost of goods sold	28	40	55	62
c	Gross profit	16	26	25	38
c	Gross Profit ratio $\left(\text{c}\text{÷}\text{a}\right)\times 100$	36%	39%	31%	38%

Table (3)

Calculate the expenses as a percentage of sales excluding cost of goods sold for the given years.

	particulars	2014	2015	2016	2017
a	Net sales revenue	44	66	80	100
b	Less: Cost of goods sold	28	40	55	62
c	Less: net income	(8)	5	12	11
d	Operating expenses	8	21	13	27
e	Expense as a % of sales $\left(\text{d}\text{÷}\text{a}\right)\times 100$	55%	32%	16%	27%

Table (4)

Inventory turnover ratio:

Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold }}{\text{Average Inventory}}$

Calculate the inventory turnover ratio for the given years.

	particulars	2014	2015	2016	2017
a	Cost of goods sold	28	40	55	62
b	Beginning inventory	0	12	14	20
c	Ending inventory	12	14	20	30
d	Average inventory $\left(\text{b}\text{+}\text{c}\right)÷2$	6	13	17	25
d	Inventory turnover ratio $\left(\text{a}÷\text{d}\right)$	4.7	3.1	3.2	2.5

Table (5)

Average days in inventory:

Average days’ in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

$\text{Average days’ in inventory}\text{=}\frac{365\text{days}}{\text{Inventory turnover}}$

Calculate days’ supply in inventory for the given years.

	particulars	2014	2015	2016	2017
a	Inventory turnover ratio (refer table (5))	4.7	3.1	3.2	2.5
b	Days in a year	365	365	365	365
c	Days’ supply in inventory $\left(\text{b}÷\text{a}\right)$	78	118	114	146

Table (6)

Receivables turnover ratio:

Receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. This ratio is determined by dividing credit sales and sales return.

$\text{Receivables Turnover Ratio}\text{=}\frac{\text{Net Sales}}{\text{Average}\text{Accounts}\text{Receivables}}$

Calculate the receivables turnover ratio for the given years.

	particulars	2014	2015	2016	2017
a	Net sales revenue	44	66	80	100
b	Beginning receivables	0	11	12	18
c	Ending receivables	11	12	18	24
d	Average receivables $\left(\text{b}\text{+}\text{c}\right)÷2$	5.5	11.5	15	21
d	Receivables turnover ratio $\left(\text{a}÷\text{d}\right)$	6.0	4.3	4.0	3.6

Table (7)

Average collection period:

This ratio is used to determine the number of days a particular company takes to collect accounts receivables.

$\text{Average days’ in collection period}\text{=}\frac{365\text{days}}{\text{Inventory turnover}}$

Calculate the average collection period for the given years.

	particulars	2014	2015	2016	2017
a	receivables turnover ratio (refer table (7))	6.0	4.3	4.0	3.6
b	Days in a year	365	365	365	365
c	Average collection period $\left(\text{b}÷\text{a}\right)$	61	85	91	101

Table (8)

2.

To determine

Identify the favourable or unfavourable factors by evaluating the results of the related ratios (a) (b) and (c). Recommend the company to improve its operations.

Explanation of Solution

Identify the favourable or unfavourable factors by evaluating the results of the related ratios (a) (b) and (c).

• Sales revenue is increased progressively each year.
• Profit margin is increased, but in the last year it is decreased.
• Gross profit margin is changing every year, but it is increased in the last year.
• Expense as a % of sales are decreased more than expected.

To improve its operations, the Company should concentrate on the net income trend and workout to reduce the expenses and increase the profit margin.

3.

To determine

Identify the favourable or unfavourable factors by evaluating the results of the related ratios (d) (e) (f) and (g). Recommend the company to improve its operations.

Explanation of Solution

Identify the favourable or unfavourable factors by evaluating the results of the related ratios (d) (e) (f) and (g).

• The inventory turnover ratio reflects that the inefficiency of the management to maintain the proper inventory. There is absence of the inventory control.
• The receivables turnover ratio indicates that the company’s inefficiency to collect the accounts receivables from the customers. There is an increasing trend in the average collection period.

It is recommended that the management should revise its inventory controls and receivables collection activities. The management need to develop its own policies that will improve the Company’s inventory and receivables turnover ratios.