How to analyse the performance of a business

Solve the problem below, calculate the ratios, interpret the results against the industry average, and fill in the table on the worksheet. Then, provide an analysis of how those results can be used by the business to improve its performance.

Balance Sheet as of December 31, 2010

Gary and Company

Cash

$45

Accounts payables

$45

Receivables

66

Notes payables

45

Inventory

159

Other current liabilities

21

Marketable securities

33

Total current liabilities

$111

Total current assets

$303

Net fixed assets

147

Long Term Liabilities

Total Assets

$450

Long-term debt

24

Total Liabilities

$135

Owners Equity

Common stock

$114

Retained earnings

201

Total stockholders’ equity

315

Total liabilities and equity

$450

Income Statement Year 2010

Net sales

$795

Cost of goods sold 

660

Gross profit  

135

Selling expenses  

73.5

Depreciation

12

EBIT

49.5

Interest expense  

4.5

EBT

45

Taxes (40%)  

18

Net income

27

1. Calculate the following ratios AND interpret the result against the industry average:

Ratio

Your Answer

Industry Average

Your Interpretation(Good-Fair-Low-Poor)

Profit margin on sales

 3.4%

3%

 Good

Return on assets

 6%

9%

 Fair

Receivable turnover

 0

16X

 Good

Inventory turnover

 4.2X

10X

 Fair

Fixed asset turnover

 5.9

2X

 Good

Total asset turnover

 1.8

3X

 Low

Current ratio

 2.7

2X

 Good

Quick ratio

 1.3

1.5X

 Fair

Times interest earned

 10

7X

 Good

2. Analysis:

Give your interpretation of what the ratios calculations show and how the business can use this information to improve its performance. Justify all answers.

Gary and company has a high profit margin ratio as compared to the average ratio of the industry this indicates that for each dollar sold by the firm $.034 is profit which is higher by $ 0.004 to average ratio of the industry.

Return on asset ratio indicates how assets are efficiently utilized to generate profit. In this case, Gary and Company generates $ 0.06 to its asset when a sale of $ 1 is made. However, this lower as compared to the average industry ROA by $.003 but it is fair.

Receivable turnover ratio indicates how well a firm is able to manage its credit sales. Gary and Company has a zero times that mean it is able to collect its credit sales within a short time or rather credit sales are paid within a day. This is a good rating bearing in mind the receivable turnover in this industry is 10X.

Inventory turnover indicates the number of times a firm’s inventory was sold in a given year. On that note, Gary and Company was able to turn its inventory 4.2 times which is lower to the average industry rating of 10 times.

Fixed Asset turnover ratio indicate the level of efficiency in utilizing fixed assets, the higher the ratio the better for a firm. That being the case, Gray and Company is able to make a sale worth 5.2 times its fixed assets which is higher as compared to the industry rate which is 2 times.

Total asset turnover indicates the efficiency of a firm in generating sales by exploiting its asset base. The higher the rates the better, on that note, Gray and Company had a rating of 1.8 times which means in the financial year 2010, Gray and Company had sales worth 1.8 times of total asset. This is lower as compared to that of the industry which is 3 times.

Current ratio indicates the capability of a firm to repay its obligation within a given a financial year. On that note, Gray and Company has higher current asset than current liabilities in the year 2010 by 2.7 times.

Quick acid ratio indicates the ability of a firm to pay its obligation within a given year using current assets that are easily convertible into cash. The firm has quick acid ratio of 1.3 which is fair but it is lower to that of the industry which is 1.5 times.

Times earned interest indicates the capability of a firm to repay its interest expense. That being the case, Gray and Company has net income which is ten times its interest expense which is a good rating because the average times earned interest 7 times.