Question

All of Outland's sales are on credit. The company gives customers 60 days to pay accounts receivable. Industry average days to sell inventory is 50 days. Competitors to Outland typically generate a \(6 \%\) return on their assets.

Outland had the following ratio results in \(2019:\)

Gross Profit Margin - \(39 \%\)

Days to Collect Accounts Receivable \(-78\) days

Current Ratio \(-1.44\)

Days to Sell Inventory - 107 days

Quick Ratio - \(0.89\)

Return on Assets - \(7.1 \%\)

Instructions

1) Comment on the 2020 financial performance of Outland Corp. using ratios in terms of

a) Liquidity

b) Activity

c) Profitability

Hint: You should calculate 2020 ratios for those that Outland calculated in 2019 ,

and then interpret them.

2) Would you invest in this company? Why or why not?

The following are the comparative financial statements for Outland Corporation for 2020 and 2019 :

Answer 1

Step 1 Requirement 1 - Computation of Ratios & Interpretation of results

1.Comment on the 2020 financial performance of Outland corp using ratios in terms of (a) Liquidity (b) Activity (c) profitability. based on the Previous year 2019 Ratio Results:

Gross Profit Margin; Days to collect Accounts Receivable: Current Ratio: Days to sell Inventory; Quick Ratio: Return on Assets (ROA)

1. Gross Profit Margin Ratio

To find out Gross Profit Margin The following formula will be used:

Gross Profit Margin = Gross Profit/ Net sales*100

The given data for the year 2020 of Outland corp is as follows;

Gross Profit = $67500 Net Sales=$167500

G.P. Margin= 67500/167500*100 = 40.29 or 40%

A higher ratio implies that the firm is able to produce relatively at a lower cost. It is a sign of good management. compare with 2019 it is improved. so better performance.

2) Days to collect Accounts Receivable:

To calculate Days to collection period it is a must for calculating Debtors turnover ratio

The formula for calculation of Debtors Turnover Ratio= Credit sales/ Average debtors or Closing Debtors

From the given data; All sales Revenue is on Credit only = $167500

Accounts Receivables ( In the absence of Debtors) $30000+35000= 65000/2=32500

Debtors Turnover Ratio = $167500/32500=5.15

Days to collect Accounts Receivables = Days or Weeks or months in a year/ Debtors Turnover ratio

365/5.15= 70.87 days or 71 days.

The higher the ratio greater is the efficiency in the management of Debtors;

Hence compared with the previous year's performance the Days were reduced from 78 to 71. it is good and it indicates Efficiency in Managing Receivables.

 

3. Current Ratio:

Current Ratio: Current Assets/ Current liabilities = $80000/57500= 1.39

As a conventional rule, a current ratio of 2:1 is considered satisfactory. but however, it is treated as a Test od\f quantity and not quality. Compare with previous years performance it is a little bit low, but there may not be a problem.

 

4.Days to Sell Inventory: 

To determine days to sell inventory first of all calculate Average inventory and then the Cost of goods sold amount to be taken from the Income statement, so the

formula for calculation of days to sell inventory= cost of average inventory/cost of goods sold * 365 days

Average Inventory= $25000+31000/2= 28000

Cost of goods sold= $100000

so Days to sell inventory= $28000/100000*365= 102.2 days or 102 days

Compared with the previous year 2019- 107 days this one is better because the shorter the inventory period the higher the turnover rate if lower the turnover rate the more days sales that are held inventory. so performance improved. it is a sign of the prosperity of the firm.

 

5. Quick Ratio

Quick Ratio = Quick Assets/ current liabilities or quick liabilities

from the given data $4000+10000= 14000-- Quick Assets (cash+Marketable securities)

Quick liabilities= $12500+25000=37500-- Quick liabilities (Accounts payable+Notes Payable)

Quick Ratio= 14000/37500=0.37: 1

As a conventional rule Quick ratio will be 1:1 but regarding this aspect little bit care needed. compare to previous period it is low. but it indicates a problem of liquidity.

 

6. Return on Assets

Return on Assets = Net income/Average Total Assets

from the given data Net income=$15000 Average of Total assets = $210000+225000=435000/2=217500

ROA= 15000/217500=,0689*100= 6.89%

Compare with the previous year it is low, Higher the ROA number the better because companies earning more money on less investment.

 

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Step 2 Would You invest in the company

No.

Because of low liquidity ratio and RoA it is not advisable to invest in this company even if the ratios are satisfactory zone but liquidity ratio and the Roa is low.