8/10/2019 Ratio Analysis and Interpretation

1/8

RATIO ANALYSIS & INTERPRETATION

Question 1

1. Quick Ratio indicates the ability of a firm to pay debt instantly.

2. The ratio determined by dividing total current assets by total current liabilities is the Current

Ratio or Work ing Capital Ratio.

3. The ratio of the quick assets to current liabilities, which indicates the instant debt -paying

ability of a firm, is the Acid-Test Ratio or Quick Ratio.

4. A measure useful in evaluating efficiency in the management of inventories is the Inventory

Turnover.

5. Comparisons of data within a company are an example of I ntr acompany Basis Analysis.

6. In vertical analysis, each item is expressed as a percentage of the base amount.

7. The debt to total assets ratio measures the percentage of total assets provided by creditor .

8. Earnings per share is used for measur ing of the net income earned on each share of common

stock.

9. The asset turnover ratio is used for measur ing how effi cientl y a company uses its assets to

generate sales.

10. Horizontal analysisevaluates a series of financial statement data over a period of time.

8/10/2019 Ratio Analysis and Interpretation

2/8

Question 2

The comparative financial statements of Optical Solutions Inc. are as follows:

The market price of Optical Solutions Inc. common stock was $60.00 on December 31, 2010.

Optical Solutions Inc.

Comparative Retained Earnings Statement

For the Years Ended December 31, 2010 and 2009

2010 2009

Retained earnings, January 1st $ 604,000 $ 306,000

Add net income for year 428,000 314,000

Total 1,032,000 620,000

Deduct dividendsOn Preferred stockOn Common stock

4,00012,000

4,00012,000

Total 16,000 16,000

Retained earnings December 31st 1,016,000 604,000

Optical Solutions Inc.

Comparative Income Statement

For the Years Ended December 31, 2010 and 2009

2010 2009

Sales $ 1,608,000 $ 1,481,000

Sales returns and allowances 5,920 6,000Net sales 1,602,080 1,475,600

Cost of goods sold 480,200 499,200

Gross profit 1,121,880 976,400

Selling expenses 324,000 352,000

Administrative expenses 234,000 211,200

Total operating expenses 558,000 563,200

Income from operations 563,880 413,200

Other income 24,000 19,200

Other expense (interest) 110,720 80,000

Income before income tax 477,160 352,400

Income tax expense 49,160 38,400Net income 428,000 314,000

8/10/2019 Ratio Analysis and Interpretation

3/8

8/10/2019 Ratio Analysis and Interpretation

4/8

14.

SOLUTION

Determine the following measures for 2010:

1. Working Capital

Formula:

It means that the optical solutions Inc. is able to pay off its short-term liabilities and it can

also be a signal that the company might be able to expand its operations.

2. Current Ratio

Formula:

Due to current ratio calculated is more than 1, so it means that the company is capable to

pay its own debts over the next business cycle, usually 12 months or a year. For every $1

of current debts, the firm has $3.10 of current assets as back up.

3. Quick Ratio

Formula:

8/10/2019 Ratio Analysis and Interpretation

5/8

This indicates that the company has enough current assets to cover its current debts

without selling its inventories. For every $1 of current debts, the firm has $2.52 of current

assets to be paid back

4. Account Receivable Turnover

Formula:

times

It means that the company is able to collect its receivables from the customers on average

6.8 times during 2010.

5. Number of days sales in receivables

Formula:

This means that receivables are collected on average every 53.68 days during 2010.

6. Inventory Turnover

Formula:

8/10/2019 Ratio Analysis and Interpretation

6/8

times

It indicates that during 2010 the company is able to sell inventory 3.5 times.

7. Number of days sales in inventory

Formula:

This indicates that the company takes 104.24 days to turn its inventory into sales.

8. Profit Margin

Formula:

This shows that the company is able to generate $0.027 of net profit from every dollar of

sales.

9. Ratio of net sales to assets (Asset Turnover)

Formula:

The result shows that the company is able to generate $0.66 of net sale from every dollar

of assets.

8/10/2019 Ratio Analysis and Interpretation

7/8

10. Rate earned on total assets (Return on Assets)

Formula:

It means that $0.18 of net profit results from $1 of assets that the company controls.

11. Rate earned on common stockholders equity

Formula:

Rate earned on common stockholders equity

This indicates that for each dollar invested by the owners, the company is able to earn

$2.12 of net income.

12. Earnings per share on common stock

Formula:

Earnings per share on common stock

The result shows that for each share of common stock, the company is able to earn $10.6

of net income.

13. Price-earnings ratio

Formula:

8/10/2019 Ratio Analysis and Interpretation

8/8

times

This indicates the investors are ready to pay 5.66 times earnings for a share if the market

price of common stock is $60 and earnings per share is $10.6.

Note!!!!

To find Dividend

Net Income/Net Profits = Dividend + Retained Earnings

To find total averageTotal average = (Year 1 + Year 2)/2

To find net sale

Net (credit) Sales = Sales - Sales Returns and Allowance

To find Earnings Before Interest and Tax Expenses (EBIT)

EBIT/Income from operation = Net Income + Interest expense + Tax expense