Chapter 17, Problem 17SP

1.

To determine

Compute the gross margin ratio (both with and without services revenue) and profit margin ratio.

Explanation of Solution

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

$\text{Gross margin ratio}=\frac{\text{Net sales}-\text{Cost of goods sold}}{\text{Net sales}}$

Compute gross margin ratio and profit margin ratio of Company BS.

Gross profit	Without service revenue	Total revenue
Revenues (A)	$18,693	$44,000
Less: Cost of goods sold (B)	($14,052)	($14,052)
Gross margin (C) = $\left(\text{A}\right)-\left(\text{B}\right)$	$4,641	$29,948
Gross margin ratio (D) = $\left(\text{C}\right)÷\left(\text{A}\right)$	24.8%	68.1%

Table (1)

Profit margin ratio: It is one of the profitability ratios. Profit margin ratio is used to measure the percentage of net income that is being generated per dollar of revenue or sales.

  $\text{Profit margin}=\frac{\text{Net income}}{\text{Net sales}}$

Determine the profit margin ratio of Company BS.

$\begin{array}{c}\text{Profit margin}=\frac{\text{Net income}}{\text{Net sales}}\\ =\frac{\$18,833}{\$44,000}\\ =42.8\%\end{array}$

As per table (1) the gross margin ratio of Company BS without service revenue and with (total) service revenue is 24.8% and 68.1% respectively and the profit margin ratio of Company BS is 42.8%.

2.

To determine

Compute the current ratio and acid-test ratio.

Explanation of Solution

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. Current ratio is calculated by using the formula:

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

Acid test 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.

  $\text{Acid-test ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

Determine the current ratio and acid-test ratio of Company BS.

Ratios	Amount	Result
Current ratio
Current assets (A)	$95,568
Current liabilities (B)	$875
Current ratio $\left(\text{A}\right)÷\left(\text{B}\right)$		109.2:1
Acid-test ratio
Quick assets (C)	$90,924
Current liabilities (D)	$875
Acid-test ratio $\left(\text{C}\right)÷\left(\text{D}\right)$		103.9:1

Table (2)

The current ratio and acid-test ratio of Company BS is 109.2 and 103.9 respectively.

3.

To determine

Compute debt ratio and equity ratio.

Explanation of Solution

Debt ratio: The debt ratio shows the relationship between total asset and the total liability of the company. Debt ratio reflects the financial strategy of the company. It is used to measure the percentage of company’s assets that are financed by long term debts.  Debt ratio is calculated by using the formula:

$\text{Debt ratio}=\frac{\text{Total Liabilities}}{\text{Total Assets }}$

Equity ratio: The equity ratio shows the relationship between total asset and the total equity of the company. Equity ratio reflects the financial strategy of the company. It is used to measure the percentage of company’s assets that are financed by owner’s funds.  Equity ratio is calculated by using the formula:

$\text{Equity ratio}=\frac{\text{Total Equity}}{\text{Total Assets }}$

Determine the current ratio and acid-test ratio of Company BS.

Ratios	Amount	Result
Debt ratio
Total liabilities (A)	$875
Total assets (B)	$120,268
Debt ratio $\left(\text{A}\right)÷\left(\text{B}\right)$		0.7%
Equity ratio
Total equity (C)	$119,393
Total assets (D)	$120,268
Equity ratio $\left(\text{C}\right)÷\left(\text{D}\right)$		99.3%

Table (3)

The debt ratio and equity ratio of Company BS is 0.7% and 99.3% respectively.

4.

To determine

Determine the percentage of current assets and long-term assets with respect to total assets.

Explanation of Solution

Current assets: The assets which could be converted into cash within one year like accounts receivables, or marketable investments; or which could be used up within the completion of an operating cycle, like inventory, supplies and insurance, are referred to as current assets.

Long-term Assets: Long-term assets are the assets that have a useful life of more than a year that is acquired by a company to be used in its business activities, for generating revenue. Examples of long term assets are Plant, Property, Equipment, Land, and Buildings.

Determine the percentage of current asset and long-term assets with respect to total assets.

Ratios	Current Assets	Long-term Assets	Total assets
Assets	$95,568	$24,700	$120,268
$\text{Percentage =}\frac{\text{Current/Long-term Assets}}{\text{Total assets}}$	79.4%	20.5%	100%

Table (4)

The current assets and long-term assets of Company BS are 79.4% and 20.5% of the total assets respectively.