Managerial Finance

Financial Statement & Ratio Analysis

MAHMUDUR RAHMAN (R-213212) 1

1. Financial Statement: Every corporation has many and varied uses for the standardized records
and reports of its financial activities. Periodically, reports must be prepared for the regulators,
creditors, owners and the management. The guidelines used to prepare and maintain the
financial records and reports, are known as Generally Accepted Accounting Principles
(GAAP). These accounting practices and procedures are authorized by the accounting
profession’s rule-setting body, known as the Financial Accounting Standards Board (FASB).

Four key financial statements required for reporting to the shareholders are;
 Income Statement: Income Statement provides the financial summary of the firm’s
operating results during a specified period. Most commonly income statements covering a
one year period ending summary of income and expenses at a specified date, ordinarily by
the 31st December of the calendar year. Many large firms however, operate on a twelve
month financial cycle or fiscal year, which ends at a time other than December 31st. In
addition, monthly income statements are typically prepared for using by the management
and quarterly statements must be made available to the stockholders of the publicly owned
corporations.
 Balance Sheet: Balance Sheet represents a summary statement of the firm’s financial
position at a given time. The statement balances the firm’s assets what it owns against its
financing, which can be either in debt or equity. Balance Sheet shows a variety of asset,
liability and equity accounts. Here, generally a significant distinction is made between the
short term and long term assets as well as the liabilities. The current assets and current
liabilities are short-term assets and liabilities.
 Statement of Retained Earnings: Statement of Retained Earnings is an abbreviated form
of the statement of the stockholders’ equity. Unlike the statement of stockholders’ equity,
which shows all the equity account transactions, which occurred during a given year, the
statement of retained earnings reconciles the net income earned during a given year, and
any cash dividends paid, with the change in retained earnings between the start and the end
of that year.
 Statement of Cash Flows: Statement of Cash Flow is a summary of all the cash flows
over the period of concern. This statement provides an insight into the firm’s operation,
investment and financing cash flows and reconciles them with the changes in its cash and
marketable securities during the period.

MAHMUDUR RAHMAN (R-213212) 2

We can get the followings learning benefits from the financial statement and ratio analysis;
 Reviewing the Contents of the Stockholders’ Report and the Procedures for Consolidating
International Financial Statements: The annual stockholders’ report, which publicly
owned corporations must provide to stockholders, documents the firm’s financial activities
of the past year. It includes the letter to the stockholders and various subjective and factual
information. It also contains four key financial statements, which are; income statement,
balance sheet, statement of the stockholders’ equity and statement of cash flows.
 Understanding Who Uses Financial Ratios and How: Ratio analysis enables the
stockholders, lenders and the firm’s managers to evaluate the firm’s financial performance.
It can be performed on a cross sectional or a time-series basis. Benchmarking or setting a
specific standard value is a popular type of cross-sectional analysis. Users of ratios should
have to understand the cautions that are applied to their use.
 Using Ratios to Analyze a Firm’s Liquidity & Activity: Liquidity or also known as the
ability of the firm to pay off its bills as they come due, which can be measured by the
current ratio and the quick ratio. Activity ratios measure the speed, with which accounts
are converted into sales or cash inflows or outflows. The activity of the inventory can be
measured by its turnover as well as accounts receivable by the average collection period
and that of accounts payable by the average payment period. Total asset turnover measures
the efficiency, with which the firm uses its assets to generate the sales.
 Discussing the Relationship between Debt & Financial Leverage & the Ratios Used to
Analyze a Firm’s Debt: The more debt a firm uses, the greater its financial leverage, which
magnifies both the risk and return. Financial debt ratios measures both the degree of
indebtedness and ability to the debts. Common measure of indebtedness is the debt ratio.
 Using Ratios to Analyze a Firm’s Profitability & its Market Value: The common side of
the income statement, which shows each item as the percentage of sales, can be used to
determine the gross profit margin, operating profit margin and net profit margin. Other
measures of profitability includes; earnings per share, return on total assets and return on
common equity. Market ratios includes; earnings ratio and the market or book ratio.
 Using a Summary of Financial Ratios & DuPont System of Analysis to Perform a Complete
Ratio Analysis: DuPont system of analysis is a diagnostic tool used to find the key areas
responsible for the firm’s financial performance including; profit on sales, efficiency of
asset use and use of financial leverage.

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Financial ratios can be divided into five basic categories;
 Liquidity Ratio: Liquidity of a firm is measured by its ability to satisfy its short-term
obligations as they come due. Liquidity generally refers to the solvency of the firm’s
overall financial position, through which it can pay off its bills. This ratio can provide the
early signs of cash flow problems and the probable business failure. Therefore, having
enough liquidity for day to day operations is the important. If liquidity increases,
profitability falls or vice versa.
Two basic measures of the Liquidity are;
 Current Ratio: Current Ratio shows the ability to satisfy the current liabilities using
the current assets.
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
The higher the Current Ratio, the better it is good for the company.
 Acidity Test or Quick Test Ratio: Acidity Test or Quick Test Ratio Shows a firm’s
ability to meet the current liabilities with its most liquid assets.
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 − Inventory
𝐀𝐜𝐢𝐝𝐢𝐭𝐲 𝐨𝐫 𝐐𝐮𝐢𝐜𝐤 𝐓𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
The higher the Acid or Quick test, the better the firm’s liquidity position is.
[N.B: We have to comment based on the given standard value. If Ratio > Standard Value
then, the liquidity of that firm is better.]

 Activity or Asset Management Ratios: Activity Ratio is a type of the financial analysis,
which indicates how efficiently a company is leveraging the assets on its balance sheet to
generate the revenues and cash. Activity Ratio helps the analysts to determine how a
company handles the inventory management, which is the key to its operational flexibility
and the overall fiscal health. Activity Ratio is also known as the Efficiency Ratios.
Following things are calculated at the Activity Ratios;
 Inventory Turnover: How many times the inventory is produced and sold during the
period of time, is called as the Inventory Turnover.
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐆𝐨𝐨𝐝 𝐒𝐨𝐥𝐝
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲
Where;
Cost of Goods Sold = Gross Profits – Sales.
Higher Inventory Turnover Ratio is the better for the company's future.
MAHMUDUR RAHMAN (R-213212) 4
  Total Asset Turnover: Total Asset Turnover ratio represents the Total Assets create
the Revenues during the period.
𝐒𝐚𝐥𝐞𝐬
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
The higher the Total Asset Turnover Ratio, the more efficiently it uses the assets to
generate revenues or sales.
 Days Sale Outstanding (DSO) or Receivable Collection Period: Days Sale
Outstanding or Receivable Collection Period is useful in evaluating the credit and
collection policies.
𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞
𝐃𝐒𝐎 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐒𝐚𝐥𝐞𝐬 𝐩𝐞𝐫 𝐃𝐚𝐲
Where;
𝐀𝐧𝐧𝐮𝐚𝐥 𝐓𝐨𝐭𝐚𝐥 𝐒𝐚𝐥𝐞𝐬
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐒𝐚𝐥𝐞𝐬 𝐩𝐞𝐫 𝐃𝐚𝐲 =
𝟑𝟔𝟓
Lower DSO Ratio is the better for the company.
 Average Payment Period: Average Payment Period or Average Accounts Payable
period, is useful in evaluating the debit and the payment policies.
𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐏𝐚𝐲𝐚𝐛𝐥𝐞
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐏𝐚𝐲𝐦𝐞𝐧𝐭 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐏𝐮𝐫𝐜𝐡𝐚𝐬𝐞 𝐩𝐞𝐫 𝐃𝐚𝐲
Where;
𝐀𝐧𝐧𝐮𝐚𝐥 𝐓𝐨𝐭𝐚𝐥 𝐏𝐮𝐫𝐜𝐡𝐚𝐬𝐞
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐏𝐮𝐫𝐜𝐡𝐚𝐬𝐞 𝐩𝐞𝐫 𝐃𝐚𝐲 =
𝟑𝟔𝟓
Higher Accounts Payable Turnover Ratio is the better for the company.

 Debt Ratio: Debt position of a firm indicates the amount of other people’s money being
used to generate the profits.
Debt Ratio can be calculated by the followings;
 Debt to Assets Ratio: Debt to Assets Ratio measures the proportion of the total assets
financed by the firm’s creditors. The higher this ratio, the greater the amount of other
people’s money being used to generate profits.
𝐓𝐨𝐭𝐚𝐥 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
𝐃𝐞𝐛𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
When this ratio is greater than 1 it means that, the portion of the assets is funded by the
debt. Higher ratio (Greater than 1) also indicates that, a company may put itself at risk
of defaulting on its loans, if the interest rates suddenly rise.
MAHMUDUR RAHMAN (R-213212) 5
  Debt to Equity Ratio: Debt to Equity Ratio measures the proportion of total assets
financed by the firm’s owner from their owned equities. The higher this ratio, the
greater the amount of the owners money being used to generate the profits.
𝐓𝐨𝐭𝐚𝐥 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
𝐃𝐞𝐛𝐭 𝐄𝐪𝐮𝐢𝐭𝐲 𝐑𝐚𝐭𝐢𝐨 =
𝐓𝐨𝐭𝐚𝐥 𝐄𝐪𝐮𝐢𝐭𝐲

When this ratio is greater than 1 it means that, the portion of the assets is funded by the
owners’ equity directly.

[N.B: Debt to Assets Ratio + Debt to Equity Ratio = 100%]

 Profitability Ratio: Profitability Ratio enables the analysts to evaluate the firm’s profits
with respect to a given level of sales, a certain level of assets or the owners’ investment.
Without profits, a firm could not attract the investors for the outside capital. Owners,
creditors and management pays a close attention to boosts the profits because of the great
importance of it on the market places for earnings.
Profitability Ratio can be calculated by the followings;
 Earnings Per Share (EPS): The firm’s Earnings Per Share (EPS) is generally of the
interests to present or prospective stockholders and management. It represents the
number of money earned during the period against of each outstanding share of the
common stock.
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐭𝐡𝐞 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬
𝐄𝐏𝐒 =
𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐬𝐡𝐚𝐫𝐞𝐬 𝐨𝐟 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤 𝐨𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠

Higher EPS Ratio is the better for the company.

 Return on Assets (RoA): Return on Assets (ROA) measures the overall effectiveness
of the management in generating profits with its available assets.
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬
𝐑𝐎𝐀 =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
Higher RoA Ratio is better for the firms.
 Return on Equity (RoE): Return on Equity (RoE) measures the amount of the returns
earned on the common stockholders’ investment in the firm.
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬
𝐑𝐎𝐄 =
𝐓𝐨𝐭𝐚𝐥 𝐄𝐪𝐮𝐢𝐭𝐲

Higher RoE Ratio is better for the firms.

MAHMUDUR RAHMAN (R-213212) 6

  Gross Profit Margin: Gross Profit Margin measures the percentage of each sales
revenue remaining after the firm has paid for its goods.
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭𝐬
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 =
𝐓𝐨𝐭𝐚𝐥 𝐒𝐚𝐥𝐞𝐬
Where;
Gross Profit = Sales - Cost of Goods Sold.
The higher the Gross Profit Margin, the better it is.
 Operating Profit Margin: Operating Profit Margin measures the percentage of each
sales profits remaining after all costs and expenses deducted except interest, taxes and
preferred stock dividends.
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭𝐬
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 =
𝐓𝐨𝐭𝐚𝐥 𝐒𝐚𝐥𝐞𝐬
The higher the Operating Profit Margin, the better it is.
 Net Profit Margin: Net Profit Margin measures the percentage of each sales revenue
remaining after all the costs and expenses, including; interest, taxes and preferred stock
dividends have been deducted.
𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 =
𝐓𝐨𝐭𝐚𝐥 𝐒𝐚𝐥𝐞𝐬
The higher the firm’s net profit margin, the better.

 Market or Book Ratio: Market Ratio relates the firm’s market value as measured by its
current share price relates to certain accounting values. These ratios give an insight into
how investors in the marketplace feels the firm is doing in terms of risk and return. They
normally reflects the common stockholders’ assessment of all aspects of the firm’s past
and expected future performance.
Market Ratio can be calculated by the followings;
 Price / Earnings (P/E) Ratio: Price / Earnings (P/E) ratio is commonly used to assess
the owners’ appraisal of share value. It measures the amount that investors wants to
pay for each dollar of a firm’s earnings. This ratio indicates the degree of confidence,
which investors have on the firm’s future performance.
𝐌𝐚𝐫𝐤𝐞𝐭 𝐩𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞 𝐨𝐟 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤
𝐏𝐄 𝐑𝐚𝐭𝐢𝐨 =
𝐄𝐏𝐒
Higher P/E ratio is good for the company and shows the greater the investor confidence.

MAHMUDUR RAHMAN (R-213212) 7

 DuPont Equation Analysis: DuPont analysis is used to understand the firm’s financial
statements and to assess its financial condition. It merges the income statement and balance
sheet into two measures of profitability, which are; Return on Assets (RoA) and Return on
Equity (RoE).
DuPont equation can be calculated by the followings;
 RoA Extension:
𝐑𝐨𝐀 = 𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 × 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫
or;
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐒𝐚𝐥𝐞𝐬
𝐑𝐨𝐀 = ×
𝐒𝐚𝐥𝐞𝐬 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
 RoE Extension:
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐜𝐨𝐦𝐦𝐨𝐧 𝐬𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
𝐑𝐨𝐄 = ×
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐂𝐨𝐦𝐦𝐨𝐧 𝐒𝐭𝐨𝐜𝐤 𝐄𝐪𝐮𝐢𝐭𝐢𝐞𝐬

MAHMUDUR RAHMAN (R-213212) 8

 Mathematical Example
Problem 01: Complete the 2012 balance sheet for O’Keefe Industries using the information
that follows it;

The following financial data for 2012 are also available:

 Sales totaled $1,800,000.
 Gross profit margin was 25%.
 Inventory turnover was 6.0.
 There are 365 days in the year.
 Average collection period or DSO was 40 days.
 Current ratio was 1.60.
 Total asset turnover ratio was 1.20.
 Debt ratio was 60%.

Solution:
Here given;
Total Asset Turnover ratio = 1.20 Sales = $1,800,000

We know;
Sales
Total Assets Turnover =
Total Assets
Sales
or, = 1.20
Total Assets
$1,800,000
or, Total Assets =
1.2
∴ Total Assets = $15,00,000.

MAHMUDUR RAHMAN (R-213212) 9

As the Total Assets is $15,00,000 therefore, the Total Liability amount will also be $15,00,000.

At the Assets part:

For Accounts Receivable;

We know;
Accounts Receivable
DSO =
Average Sales per Day

Given;

DSO = 40 Sales = $1,800,000

Therefore;
Accounts Receivable
DSO =
Average Sales per Day
or, Accounts Receivable = DSO × Average Sales per Day
Total Sales
= 40 ×
365
$1,800,000
= 40 ×
365
∴ 𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞 = $𝟏, 𝟗𝟕, 𝟐𝟔𝟎.

For Inventories;
We know;
Cost of Good Sold
Inventory Turnover =
Inventory
Here;
Inventory Turnover = 6 &
Gross Profit Margin = 25% = 0.25
Gross Profit
𝑜𝑟, = 0.25
Sales

or, Gross Profit = Sales × 0.25

or, Sales – COGS = $1,800,000 × 0.25
or, $1,800,000 – COGS = $4,50,000
∴ COGS = $13,50,000.

MAHMUDUR RAHMAN (R-213212) 10

Therefore;
Cost of Good Sold
Inventory Turnover =
Inventory
$13,50,000
𝑜𝑟, =6
Inventory
$13,50,000
or, Inventory =
6
∴ 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 = $𝟐, 𝟐𝟓, 𝟎𝟎𝟎.

Finally;
Current Assets = Cash + Marketable Securities + Accounts Receivable + Inventories
= $ (32,720 + 25,000 + 1,97,260 + 2,25,000)
∴ 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 = $4,79,980.

And;
Fixed Assets = Total Assets – Current Assets
= $ (15,00,000 – 4,79,980)
∴ 𝐅𝐢𝐱𝐞𝐝 𝐀𝐬𝐬𝐞𝐭𝐬 = $10,200,020.

So therefore;
We finally get Total Assets = $ (4,79,980 + 10,200,020) = $15,00,000.

At the Liability part:

For Current Liabilities;
We know;
Current Assets
Current Ratio =
Current Liabilities
Here;
Current Ratio = 1.6.
Therefore;
Current Assets
Current Ratio =
Current Liabilities
$4,79,980
or, 1.6 =
Current Liabilities
∴ 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬 = $𝟐, 𝟗𝟗, 𝟗𝟖𝟖.

MAHMUDUR RAHMAN (R-213212) 11

Now;
Current Liabilities = Accounts Payable + Note Payable + Accrual
or, Note Payable = Current Liabilities – Accrual – Accounts Payable
= $2,99,988 - $20,000 - $1,20,000
∴ 𝐍𝐨𝐭𝐞𝐬 𝐏𝐚𝐲𝐚𝐛𝐥𝐞 = $𝟏, 𝟓𝟗, 𝟗𝟖𝟖.
And;
Total Liabilities = Current Liabilities + Long term Debt + Stockholders Equity
or, Long term Debt = Total Liabilities – Current Liabilities – Stockholders Equity
= $ (15,00,000 – 2,99,988 – 6,00,000)
∴ 𝐋𝐨𝐧𝐠 𝐭𝐞𝐫𝐦 𝐃𝐞𝐛𝐭 = $𝟔, 𝟎𝟎, 𝟎𝟏𝟐.
So therefore;
We finally get Total Liabilities = $ (2,99,988 + 6,00,012 + 6,00,000) = $15,00,000.

Therefore;
Completed Balance Sheet for O’Keefe Industries is;
O’Keefe Industries Balance Sheet
December 31, 2012
Assets Amount ($) Liabilities Amount ($)
Cash 32,720 Accounts Payable 1,20,000
Marketable Securities 25,000 Notes Payable 1,59,988
Accounts Receivable 1,97,260 Accrual 20,000
Inventories 2,25,000 Total Current Liabilities 2,99,988
Total Current Assets 4,79,980 Total Long term Debt 6,00,012
Total Fixed Assets 10,200,020 Stockholders’ Equity 6,00,000
Total Assets 15,00,000 Total Liabilities 15,00,000

MAHMUDUR RAHMAN (R-213212) 12

Problem 02: Using the financial statements for Fox Manufacturing Company for the year
ended December 31, 2012 along with the industry average ratios below, prepare and interpret
a complete ratio analysis of the firm’s 2012 operations and summarize your findings and make
the recommendations.
Income Statement Balance Sheet

Industry Average

MAHMUDUR RAHMAN (R-213212) 13

Solution:
Current Ratio:
We know;
Current Assets
Current Ratio =
Current Liabilities
Given;
Current Assets = $1,38,300
Current Liabilities = $75,000
Therefore;

Current Assets
Current Ratio =
Current Liabilities

$1,38,300
=
$75,000

∴ 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝟏. 𝟖𝟒.

Quick Test Ratio:

We know;
Current Assets − Inventory
Quick Test Ratio =
Current Liabilities
Given;
Current Assets = $1,38,300
Current Liabilities = $75,000
Inventory = $82,000
Therefore;
Current Assets − Inventory
Quick Test Ratio =
Current Liabilities
$1,38,300 − $82,000
=
$75,000
∴ 𝐐𝐮𝐢𝐜𝐤 𝐓𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝟎. 𝟕𝟓

MAHMUDUR RAHMAN (R-213212) 14

Inventory Turnover:
We know;
Cost of Goods Sold
Inventory Turnover =
Inventories
Given;
Inventories = $82,000
Sales = $6,00,000
Gross Profits = $1,40,000
So;
Cost of Goods Sold = Sales – Gross Profits
= $6,00,000 - $1,40,000
∴ COGS = $4,60,000
Therefore;
Cost of Goods Sold
Inventory Turnover =
Inventories
$4,60,000
=
$82,000
∴ 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 = 𝟓. 𝟔𝟏

Average Collection Period:

We know;
Accounts Receivable
DSO =
Average Sales per Day
Given;
Accounts Receivable = $34,100
Total Sales = $6,00,000
Therefore;
Accounts Receivable
DSO =
Average Sales per Day
Accounts Receivable
=
Total Sales
365
$34,100
=
$6,00,000
365
∴ 𝐃𝐒𝐎 = 𝟐𝟎. 𝟕𝟒 ~ 𝟐𝟏 𝐝𝐚𝐲𝐬.

MAHMUDUR RAHMAN (R-213212) 15

Total Assets Turnover:
We know;
Total Sales
Total Assets Turnover =
Total Assets
Given;
Total Sales = $6,00,000
Total Assets = $4,08,300
Therefore;
Total Sales
Total Assets Turnover =
Total Assets
$6,00,000
=
$4,08,300
∴ 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 = 𝟏. 𝟒𝟕.

Debt Ratio:
We know;
Total Liabilities
Debt Ratio =
Total Assets
Here;
Total Assets = $4,08,300
Total Liabilities = $4,08,300
Therefore;
Total Liabilities
Debt Ratio =
Total Assets
$4,08,300
=
$4,08,300
∴ 𝐃𝐞𝐛𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝟏.

Gross Profit Margin:

We know;
Gross Profits Therefore;
Gross Profits Margin =
Total Sales Gross Profits
Given; Gross Profits Margin =
Total Sales
Gross Profits = $1,40,000 $1,40,000
=
Total Sales = $6,00,000 $6,00,000
∴ 𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭𝐬 𝐌𝐚𝐫𝐠𝐢𝐧 = 𝟎. 𝟐𝟑𝟑.

MAHMUDUR RAHMAN (R-213212) 16

Operating Profits Margin:
We know;
Operating Profits
Operating Profit Margin =
Total Sales
Given;
Operating Profits = $80,000
Total Sales = $6,00,000
Therefore;
Operating Profits
Operating Profit Margin =
Total Sales
$80,000
=
$6,00,000
∴ 𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭𝐬 𝐌𝐚𝐫𝐠𝐢𝐧 = 𝟎. 𝟏𝟑𝟑.

Net Profits Margin:

We know;
Earning available for common stockholders
Net Profit Margin =
Total Sales
Given;
Total Sales = $6,00,000
Earnings available for common stockholders = $42,900
Therefore;
Earning available for common stockholders
Net Profit Margin =
Total Sales
$42,900
=
$6,00,000
∴ 𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭𝐬 𝐌𝐚𝐫𝐠𝐢𝐧 = 𝟎. 𝟎𝟕𝟐.

Return on Assets (RoA):

We know;
Earnings available for common stockholders Therefore;
RoA =
Total Assets $42,900
Given; ROA =
$4,08,300
Earnings available for common stockholders = $42,900 ∴ 𝐑𝐨𝐀 = 𝟎. 𝟏𝟎𝟓.
Total Assets = $4,08,300

MAHMUDUR RAHMAN (R-213212) 17

Return on Equities (RoE):
We know;
Earnings available for common stockholders
RoE =
Total Equities
Given;
Earnings available for common stockholders = $42,900
Total Equities = $1,83,300
Therefore;
Earnings available for common stockholders
RoE =
Total Equities
$42,900
=
$1,83,300
∴ 𝐑𝐨𝐄 = 𝟎. 𝟐𝟑𝟒.

Earning Per Share (EPS):

We know;
Earnings available for the common stockholders
EPS =
Number of shares of common stock outstanding
Given;
Earnings available for common stockholders = $42,900
Number of shares of common stock outstanding = $20,000
Therefore;
Earnings available for the common stockholders
EPS =
Number of shares of common stock outstanding
$42,900
=
$20,000
∴ 𝐄𝐏𝐒 = 𝟐. 𝟏𝟒.

MAHMUDUR RAHMAN (R-213212) 18

Interpretation of Findings on the basis of Industrial Average;
Comments
Financial Ratios Values from Findings Industry Average
Good Poor
Current Ratio 1.84 2.35 - ✔
Quick Ratio 0.75 0.87 - ✔
Inventory Turnover 5.61 4.55 ✔ -
Average Collection Period 21 Days 35.8 Days ✔ -
Total Asset Turnover 1.47 1.09 ✔ -
Debt Ratio 1 0.30 ✔ -
Gross Profit Margin 0.233 0.202 ✔ -
Operating Profit Margin 0.133 0.135 - ✔
Net Profit Margin 0.072 0.091 - ✔
RoA 0.105 0.099 ✔ -
RoE 0.234 0.167 ✔ -
EPS $2.14 $3.10 - ✔

MAHMUDUR RAHMAN (R-213212) 19