Performing ratio analysis The following financial statements were prepared for t
ID: 2334985 • Letter: P
Question
Performing ratio analysis
The following financial statements were prepared for the management of MNM Ltd. The statements contain some information that will be disclosed in note form in the general purpose financial statements to be issued.
Identify and calculate the ratios that a financial analyst might calculate to give some indication of the following:
a. the entity’s earning ability;
b. the extent to which internal sources have been used to finance asset acquisitions;
c. the rapidity with which accounts receivable are collected;
d. the ability of the entity to meet unexpected demands for working capital;
e. the ability of the entity’s earning to cover its interest commitments;
f. the length of time taken by the entity to sell its inventories.
Explanation / Answer
a. The entity's earning ability:-
Net Profit Ratio = Net Profit/Sales * 100
= 75000/462500 * 100
= 16.22%
b. the extent to which internal sources have been used to finance asset acquisitions
Retained earnings to Total Asset Ratio = Retained Earnings/Total Assets * 100
= 81935/ 420675 * 100
= 19.48%
c. the rapidity with which accounts receivable are collected;
Accounts receivable turnover Ratio = Sales/Average Accounts Receivable
462500/141750 (143325+140175)/2)
= 3.26 times
Number of days = 365/3.26
= 111.96 days.
So, Accounts Receivable are collected at every 111.96 days.
d. the ability of the entity to meet unexpected demands for working capital;
Current Ratio = Current Assets/Current Liabilities
= 285075/156240
= 1.82 times
e. the ability of the entity’s earning to cover its interest commitments;
Interest coverage ratio = EBIT/Interest Expenses
= Profit + Interest + Tax / Interest Expense
= 75000 + 3150 + 31500 / 3150
= 34.81 times
f. the length of time taken by the entity to sell its inventories
Inventory Turnover Ratio = COGS/Average Inventory
= 307500/118125 (110250 + 126000)/2)
= 2.60 times
So, number of days = 365/2.60
= 140.38 days.