Accounting for Managers: Financial Ratio Analysis and Interpretation

This assignment solution focuses on financial ratio analysis, a crucial aspect of accounting for managers. It begins by calculating and interpreting various financial ratios, including current, quick, average collection period, inventory turnover, debt, interest coverage, operating profit margin, total and fixed asset turnover, return on assets, and return on equity. The analysis compares the company's performance with industry standards, highlighting strengths and weaknesses in liquidity, profitability, asset management, and capital structure. The solution also computes earnings per share, price-earnings ratio, and market-to-book value ratio, providing a comprehensive financial evaluation. Finally, it includes a discussion on the importance of understanding accounting principles, referencing Warren Buffett's insights on financial statement analysis and its role in investment decisions. The assignment emphasizes the significance of financial planning and the impact of debt and liquidity on a company's financial health.

ACCOUNTING FOR MANAGERS

Answer a.
Current ratio
Particulars 2015 2014
Current asset 80600 63125
Current liabilities 89700 34375
Current ratio 0.90 1.84
Quick ratio
Particulars 2015 2014
Current asset 80600 63125
Inventories 59150 36250
Current liabilities 89700 34375
Quick ratio 0.24 0.78
Average collection period
Particulars 2015 2014
Days 365 365
Account receivables 20800 15625
Credit sales 400000 187500
Average collection
period
18.
98
30.
42
Inventory turnover ratio
Particulars 2015 2014
Sales
40000
0
18750
0
Average inventory 59150 36250
Inventory turnover ratio 6.76 5.17
Debt ratio
Particulars 2015 2014
Debt 119535 70313
Total assets 195000 140625
Debt ratio 61% 50%
Interest coverage ratio
Particulars 2015 2014
EBIT 42000 18000
Interest expense 9094 5719

Interest coverage ratio
4.
62
3.
15
Operating profit margin
Particulars 2015 2014
Operating profit
16000
0 75000
Sales
40000
0
18750
0
Operating profit margin
ratio 40% 40%
Total asset turnover ratio
Particulars 2015 2014
Sales 400000 187500
Total asset 195000 140625
Total asset turnover
ratio
2.
05
1.
33
Fixed asset turnover ratio
Particulars 2015 2014
Sales 400000 187500
Fixed asset 114400 77500
Fixed asset turnover
ratio
3.
50
2.
42
Return on asset
Particulars 2015 2014
Net income 22884 8597
Total assets 195000 140625
Return on asset 12% 6%
Return on equity
Particulars 2015 2014
Net income 22884 8597
Total shareholders
equity 75465 70312
Return on equity
30
%
12
%

Table showing comparison of ratios between the company and the industry.
Particulars
Industr
y 2015 2014
Current ratio 2 0.9 1.84
Quick ratio 0.8 0.24 0.78
Average collection
period 37 days
19
days
30
days
Inventory turnover 2.5 6.76 5.17
Debt ratio 58% 61% 50%
Interest coverage
ratio 3.8 4.62 3.15
Operating profit
margin 10% 40% 40%
Total asset turnover 1.14 2.05 1.33
Fixed asset turnover
1.
40 3.50 2.42
Return on asset 11.40% 12% 6%
Return on equity 9.50% 30% 12%
Answer 2.
Let us now examine the financial position for the year 2014 of the company based on the
above calculations:
The liquidity position of the company can be evaluated with the help of current ratios and the
quick ratio. The current ratio of the company can be defined as the ability of the company to
meet its short term obligations with the help of current asset. The favourable current ratio is
usually 2. The current ratio of the industry is 2 that shows that the industry overall has a good
liquidity position (Loughran, 2011). In the year 2014, the gelato industries are 1.84 which is
not bad but it will be good if it rises in future. Another measure of liquidity is quick ratio, this
ratio is more reliable than the current ratio as it excludes the amount of inventories because
inventories cannot be easily converted into cash. The quick ratio in the year of 2014 was
almost equal to the ratio of industry standards which is good. The quick ratio of the company
is 0.78 in the year 2014 whereas of the industry is 0.8.
Profit earning is the primary aim of running a business (Harrison, Horngren & Thomas, n.d.).
A profitability ratio includes the operating margin ratio, return on asset ratio as well as return
on equity ratio. Normally, as per the industry standards the profitability is 10% but Gelato
industries earn a profit of 40% which shows its efficiency and excellent financial
performance. The return on asset ratio is calculated by dividing the net income by the total
assets (Libby, Libby & Hodge, n.d.). This ratio is calculated in order to determine the ratio of
net income that has been earned on investing in the assets of the company. The return on
asset ratio of the industry is 11.4% but on comparing we see that the ratio of the company is

only 6% which shows the inefficiency of the company to use its assets. The company is
unable to make maximum utilisation of its resources (Weygandt, Kieso & Kimmel, n.d.). The
total asset turnover ratio was better when compared to the industry standards. However, it
also increased from 2014 and 2015.
The capital structure of a company usually comprises of debt and equity. A company with
high debt ratio is considered to be in a great risk as there lies a risk of insolvency. The debt
ratio according to the industry standards was 58% but in the year 2014 it was low as 51% but
it increased drastically in the year 2015 to 60% which is considered very bad for the financial
position of the company. A company is in a very dangerous situation as there lies doubt of its
survival (Ittelson, 2009).
The efficiency of the management in using its assets is called the asset management
efficiency ratio (Warren., 2015). In this question we have computed some ratios of this
category namely, asset turnover ratio, inventory turnover ratio and fixed asset turnover ratio.
Higher the ratio better it is. Therefore, on comparing it is seen that the fixed turnover ratio is
increasing over the years and it is also higher when compared to the industry standards. The
inventory turnover ratio is a kind of efficiency ratio which shows the efficiency in managing
the inventories on comparing the cost of goods sold over a period with the average
inventory .
Answer c.
Earnings per share
Net income 22884
Number of shares
outstanding 5000
Earnings per share
4
.58
Note: it has been observed that there was no dividend distribution to the shareholders.
Price earnings ratio
Market value per share 15
Earnings per share
4.5
8
Price earnings ratio
3.2
8
Market to book value ratio
Market value 75000
Book value 75465
Market to book value
ratio
0.
99

Note: Market value= Number of shares outstanding* Market value of each share.
Book value of 2015= Total asset – Total liabilities.
Note: The number of shares outstanding which is 5000 and the market value of $ 15 is
mentioned in the questions.
Answer d.
From the above computation of ratios and properly analysing them, it has been found out the
company has an excellent financial performance over the year and it has been able to use all
its resources in an optimum and best possible manner. This can be examined with the help of
various efficiency ratios. The financial position of the company is based on the capital
structure is not very good because of the presence of high proportion of debt in the capital
structure (Piper, 2015). The company is also not being able to maintain a proper liquidity
position. Therefore, it has become difficult for the company to pay off its short term
obligations. This may be caused due to some flaws in the financial planning of the company.
The company is meeting up standards of the industry the only areas where it is left behind is
the debt ratio and the liquidity position. If the company makes required changes in these two
areas, then the company will have a bright future with growing profits and market (Hart,
Wilson & Keers, 2001).
Answer e.
These words “Accounting is a language of business and you have to learn it like a
language...to be successful in business, you have to understand the underlying financial
values of the business” was spoken by Warren buffet who is considered as one of the greatest
investors (Berry & Jarvis, 2007).
He made the world understand the significance of the accounting procedure and how it can be
used before taking an investment decision. He spread a message that great companies exists
to make great investments. He taught people how to identify the great companies present in
the market and developed the sense of reading financial statements. An investor can take
correct decisions when he knows how to analyse and compare the financial values that are
mentioned in the income statement, balance sheet and cash flow statement of a company.
An investor before taking an investment decision is keen to know the degree of risk that he
has to take. Therefore, it is important for us to know and analyse that whether the company is
capable enough of paying off its debt or not (Izhar & Hontoir, 2001).
In short, Warren buffet has taught people to take their investment decisions wisely and in a
logical manner as there lies risk if we invest in any random company without the knowledge
of its financial performance and financial position.