Case 5c: Companies A and B

Liquidity Ratios
Current Ratio

= =

Company A Company B
17 100 11 940
= 1.7629 = 1.2542
9 700 9 520
Analysis:
Current ratio indicates a companys ability to pay its current liabilities from its
current assets. A 2:1 ratio is generally considered satisfactory. If liabilities are greater
than asset, then that makes the company not liquid. Both Company A and B is not
liquid enough to pay short term debts. In Company A, for every $1 in current liabilities,
the company has $1.7629 in current assets. On the other hand, for every $1 in current
liabilities, Company B has $1.2542 in current assets. Both dont have the capacity to pay
back their debts. But comparing the two companies through current ratio, Company
A is much better than Company B.
Liquidity (Acid Test) Ratio

( ) =

Company A Company B
17 100 8 000 11 940 4 800
= 0.9381 = 0.75
9 700 9 520
Analysis:
Acid test ratio indicates how well a company can meet its short-term obligations
with its most liquid assets (not including the inventory). The higher the acid test ratio value,
the satisfactory it becomes for the company. Both Company A and B is not liquid
enough to pay its short term debts without selling the inventory. Company A has a
quick ratio of 0.9381 while Company B has 0.75. In order for a company to be liquid, the
quick ratio should be at least 1:1 ratio.

Recommendation for Liquidity Ratios:

Both companies should sell their idle assets and control their inventory in order to
pay their short debts.
Efficiency Ratios
Proprietary Ratio

=

Company A Company B
35 080 13 840
= 0.6271 = 0.3346
55 940 41 360
Analysis:
Propriety Ratio indicates the dependency of a company upon its creditors for
working capital. Company A has a higher ratio than Company B. Therefore, Company A
has a sufficient amount of equity to support the functions of the business than
Company B. It also indicates that Company A has a higher probability to take additional
debt if necessary. A low ratio, Company B, indicates that they have higher debts and
payables rather than the equity to support their operations which may result to bankruptcy
if not solved.
Rate of earnings on total capital employed

=

Company A Company B
3 760 960
= 0.0672 6.72% = 0.0232 2.32%
55 940 41 360
Analysis:
This ratio gives the percentage return from business production for every dollar of
liabilities and capital employed. A higher rate indicates more efficient use of capital. Rate
should be higher than the companys liabilities and capital cost; otherwise it indicates that
the company is not employing its capital effectively and is not generating shareholder
value. In this case, Company A is more efficient in using its capital than Company
B.
Operating Ratio

=

Company A Company B
10 800 + 7 440 5 500 + 6 220
= 0.8291 82.91% = 0.9243 92.43%
22 000 12 680
Analysis:
This ratio shows the percentage of every dollar received from net sales which is
needed to meet the cost of production and operation. The smaller the ratio, the greater
the organization's ability to generate profit if revenues decrease. Company A has 82.91%
of its net sales are used for cost of goods sold and operating expenses while Company
B has 92.43%. Company A has smaller ratio than Company B which means it has
greater ability to generate profit than the other company.

Efficiency of Management Ratios

Turnover of Capital

=

Company A Company B
22 000 12 680
= 0.3933 39.33% = 0.3066 30.66%
55 940 41 360

Analysis:
This ratio shows what percentage is realized in net sales for every dollar available
to management in total liabilities and capital (total assets). A high turnover ratio shows
that management is being very efficient in using a companys liabilities and capital for
supporting sales. Company A has a higher turnover ratio than Company B which
means Company A is more efficient than Company B. Company B is investing in too
many liabilities and capital for supporting its sales which leads to bad debts and obsolete
inventory in the future.
Number of days sales in receivables

= ( )

Company A Company B
1 900 2 540
(365 ) = 31.5227 (365 ) = 73.1151
22 000 12 680

Analysis:
This is also called the average collection period. It shows the length that time
accounts are outstanding. A low number of days means that it takes a company fewer
days to collect its accounts receivable. A high number of days shows that a company is
selling its product to customers on credit and taking longer to collect money. The ideal
average collection period is within 1 month. Both companies are over 1 month in collecting
their receivables. Company A can collect at least 11 times per year while Company B can
collect at least 4 times a year. Company B may be very too strict with regard to its credit
policy which could affect their customers and sales as well. Company A has a better
and more efficient way in collecting the receivables.
Merchandise Turnover

=

Company A Company B
22 000 12 680
= 2.75 = 2.6417
8 000 4 800

Analysis:
This ratio indicates the number of times that the inventory is replaced during a
given period of time. A higher turnover ratio means a company has strong sales.
Company A has a higher ratio than Company B which means Company A can sell
its inventory faster and more efficient in generating its profit.

Management in the Control of Internal Operations Ratios:

Margin Percentage

=

Company A Company B
11 200 7 180
= 0.5091 50.91% = 0.5662 56.62%
22 000 12 680

Analysis:
Margin Percentage indicates how profitable a company can sell or make a profit.
Higher percentage are more favorable. Higher percentage mean the company is selling
at a higher profit percentage. In this case Company B has a higher percentage than
Company A. If the company B pays off its inventory costs, they still have 56.62% of their
sales revenue to cover their operating costs. Even if Company B has a higher percentage,
both of the companies margin percentage has still room for improvements. They are both
profitable but they can improve more by analyzing more their COGS if they can make it
lesser or cut costs.
Net Profit Ratio
( )
=

Company A Company B
2 360 320
= 0.1073 10.73% = 0.0252 2.52%
22 000 12 680

Analysis:
Net Profit Ratio shows how much sales shows up as net income after all expenses
are paid. For company A, 10.73% of its sales is net income or profit. On the other hand,
2.52% of Company Bs sales is net income or profit. A higher net profit ratio is better and
makes the company more profitable. Company A is more profitable than Company B.
Though it is more profitable, it can still improve or take corrective actions by making its
revenues constant and lowering its expenses or vice versa.