# FINANCIAL RATIOS ANALYSIS

FINANCIAL RATIOS ANALYSIS 5

ARROW AND PLUME FINANCIAL RATIOANALYSIS FOR THE YEAR END 31st DECEMBER 2011

 PLUME COMPANY ARROW COMPANY RETURN ON EQUITY= net income/ sales =887000/ 4472500 =0.2 Return on equity ( ROE)= =598810/3675260 =0.02 RETURN ON ASSETS= net income/ total assets =887000/ 4477500 =0.2 Return on assets =598810/ 9829079 =0.06 Gross profit margin= gross profit/ sales =2,117,000/4,705,000 =0.45 Gross profit margin= gross profit/ sales Gross profit= sales- cost of sales =2948603/ 21390264 =0.14 Debt to asset ratio= total liabilities/ total assets =1790500/ 4477500 =0.4 Debt to asset ratio =6153819/ 9829079 =0.6 Debt to equity ratio= total liabilities/ shareholders’ equity =1790500/ 4472500 =0.4 Debt to equity ratio = 6153819/ 3675260 =1.7 Current ratio = current assets / current liabilities = 1940500 / 1375000 = 1.4 Current ratio = 7024591 / 3958927 = 1.8 Acid ratio = current assets – inventory / current liabilities =1940500 – 595000 / 137500 = 0.98 Acid ratio = 7024591 – 1963910 / 3958927 = 1.23

Returnon equity (ROE) measures the rate yield on shareholders’ investmentin a company. A higher return on equity is recommended since theshareholders are interested in wealth maximization. Plume Company isin a better position because it has a higher return on equitycompared to Arrow Company. Return on assets (ROA) is theprofitability of an asset in a company it measures the return onboth fixed and current assets. Plume company assets were wellutilized to generate more profit.

Thegross profit margin ratio measures profit earned by the companybefore factoring in any indirect cost incurred by the company. Anincreasing gross profit margin is recommended because it shows thatthe company’s performance is improving. In the ratio analysisabove, Plume Company is in a better financial performance as comparedto the Arrow Company.

Inventoryturnover measures the number of times inventory can be converted tosales in a year that is an average of 365 days. The shorter theconversion times, the better the position of a company to earnrevenue. Therefore Plume Company has a shorter inventory turnoverratio compared to Arrow Company.

Collectionperiod is the average time in which the company takes to collect cashfrom debtor from the date of delivery of goods or services. Thecompany is recommended to take the least days to collect debts thiswill save the company from liquidity problem. Plume Company has ashorter collection period of 45 days as compared to Arrow Companywith a collection period of 76 days. Fixed assets turnover measuresefficiency of the company to generate one dollar per day. Fixedassets of Plume Company are efficient to generate each dollar.

Debtto asset ratio measures the ability of the company’s assets tofinance debt. Therefore from the above analysis, plume company assetshave more ability to finance the company’s debt. Another leverageratio is debt to equity ratio which compares initial capital to debt.A lower ratio is best for the company since it shows that the companyis a going concern entity.

Thecompany’s liquidity position is indicated by current ratio andacid ratio. The current ratio shows the company’s ability to meetits short term financial obligation as and when it fall due. ArrowCompany has the ability to meet its short term financialobligationthan the plume company. Acid ratio measures the ability ofthe company to use the most liquid assets to meet its short termdebts.

PlumeCompany is a better company for an investor, the returns oninvestment is high and the financial leverage ratio shows that thecompany is going to operate in the foreseeable future. In additionthe company’s assets are able to generate profit and finance longterm debts. Plume inventory can be easily converted into sales.

References

Ehrhardt,M., &amp Brigham, E. (2008).&nbspCorporate Finance: A FocusedApproach&nbsp(3rd ed.). p. 131

Fabozzi,Frank J., Pamela P. Drake, &amp Ralph S. Polimeni. (2007).&nbspTheComplete CFO

Handbook:From Accounting to Accountability. Hoboken, NJ: John Wiley &ampSons.