Chapter 17, Problem 7QS

To determine

Introduction:

Ratio Analysis

• Ratio analysis is a study of several key metrics of a company based on the data presented in its’ financial statements with an objective to evaluate the financial health of a company.

• It is essential for investors, stakeholders, government bodies etc. to evaluate the key metrics of an entity in order to ensure that the company fulfills the going concern principle and displays financial stability.

The key metrics mentioned above include the following:

• Current Ratio – It is a measure of the relation between the current assets and current liabilities and seeks to measure the ability of the business to fulfill its short term obligations.

• Current assets are assets that are convertible to cash within a period of one year or less. Current liabilities are liabilities that need to be discharged within a period of one year or less.

$\text{Current Ratio = Current Assets / Current Liabilities}$

• Acid Test Ratio – Also known as quick ratio, it seeks to measure the liquidity position of the Business.

• It seeks to measure the short term liquidity position of the business by comparing the liquid assets i.e. current assets that are readily convertible to cash / liquid instruments and current liabilities.

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

• Accounts receivable turnover – A measure of the relation between the turnover and accounts receivable measured in number of times.

• It seeks to measure the relation of the credit sales in proportion to the total turnover and is an indicator of how much of the receivables are blocked due to credit sales.

$\text{Accounts Receivable Turnover Ratio = Turnover / Accounts Receivable}$

• Merchandise inventory turnover – A measure of the relation between the turnover and inventory measured in number of times.

• It seeks to measure the relation of the inventory rolled over in proportion to the total turnover and is an indicator of how much of the inventory is fast moving in relation to the total turnover.

$\text{Merchandise Inventory Turnover Ratio = Turnover / Merchandise Inventory}$

• Working capital Ratio – A measure of the correlation between the working capital deployed and the total turnover evaluating the effectiveness of the working capital utilized by the business.

To Prepare:

Report comparing Morgan and Parker companies highlighting their ability to meet current obligations and use current assets efficiently