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Homework answers / question archive / The Ferri Furniture Company, a manufacturer and wholesaler of high-quality home furnishings, has been experiencing low profitability in recent years
The Ferri Furniture Company, a manufacturer and wholesaler of high-quality home furnishings, has been experiencing low profitability in recent years. As a result, the board of directors has replaced the president of the firm with a new president, Helen Adams, who has asked you to make an analysis of the firm’s financial position using the financial ratios. The most recent industry average ratios, and Ferri’s financial statements, are as follows:
BALANCE SHEET INCOME STATEMENT
Cash $ 400 Net Sales (all credit $ 12680
Accounts receivable 1300 Cost of goods sold 8930
Gross Profit $ 3,750
Inventories 2,100 Selling, general and
Current assets $ 3800 Administration expense 2,230
Net fixed assets 3320 Interest expense 460
Total Assets $ 7120 Profit before taxes $ 1060
Accounts payable $ 320 Taxes 390
Accruals 260 Net Profit $ 670
Short term loans 1100
Current Liabilities $ 1680
Long-term debt 2000
Shareholder’s equity 3440
Total Liabilities and
Shareholder’s Equity $ 7120
Requirements
On the basis of this information, compute and interpret the results with industry average of (i) Current Ratio, (ii) Quick Ratio (iii) Debt to total assets ratio ( iv) Average Collection Period (v) Payable Turnover in Days (vi) Gross Profit Margin
INDUSTRY AVERAGE RATIOS
Current ratio 2x Quick ratio 1.5x
Average Collection Period 45 days Debt to total assets Ratio 30%
Payable Turnover in Days 35 days Gross Profit Margin 45%
i.)current ratio = current assets / current liabilities = 3800/1680 = 2.2619
ii.)quick ratio = quick assets / current liabilities (quick assets = current assets - inventories - prepaid expenses)
= (3800-2100)/1680 = 1.012
iii.) debt to total assets ratio = total debt / total asset ratio =( long term debt + current liabilities ) / total assets
= (1680+2000)/7120 = 0.5168
iv.)average collection period = (average balance of accounts receivable / total net credit sale)*365 days
= (1300/12680)*365 = 37.42 days
** since no opening figures is given of accounts receivable to calculate average , so we shall take the given figures as the average to calculate the average collection period.
v.) payable turnover in days = 365/ payable turnover ratio
payable turnover ratio = (cost of goods sold / average accounts payable) = 27.90
& payable turnover in days = 365/payable turnover ratio
= 365/ 27.90 = 13.0824 days
vi.) gross profit margin = (gross profit / net sales )*100 = (3750/12680)*100 = 29.5741%
analysis:
1. the co. has a current ratio of 2.26 against a industry average of 2. hence the company is in a good position to meet its current financial obligations by easily converting its assets into cash.
2. the co. has a liquid ratio of 1.012 against the industry level of 1.5 which means a large chunk of funds of co. is invested in the inventory as compared to other rivals in industry which may affect its liquidity position.
3. average collection period of co. is 37.42 days against the industry average of 45 days which means co. has a stringent debt collection policy. the co. may relaxen its policy upto industry levels so as to increase sales.
4. the co has a debt to total asset ratio of 51.68% against the industry average of 30%. this means co. is highly levered and co. needs to reduce its debt so as to reduce leverage and risk associated with it. along with it , the fixed interest cost will also be reduced.
5. gross profit margin ratio of company is 29.57% against the industry average of 45%. which means the company has a low profitability and the company needs to focus upon on reducing cost of goods sold to achieve higher gross profit margin and thus higher profitability.
6. payable turnover in days of co. is 13.0824 days as compared to industry , which as 35 days period. this means the co. pays back its creditors in less no. of days than its industry peers. the co. may ask for the liberal credit policy from its creditors so that the co. has more liquidity in hands.
