Income statement Sales 205,000 cost of goods sold -97,000 salaries expense -24,000 depreciation expense -16,000 interest expense -2,400 loss on equipment disposal -2,500 net income 63,100 Statement of Retained Earnings Beginning Balance - Retained Earnings 6,000 Plus - Net Income 63,100 Less - Dividends (41,500) Ending Balance - Retained Earnings 27,600 Balance sheets 2018 2019 change Assets: Cash 13,000 64,600 51,600 Accounts Receivable 25,000 19,000 (6,000) Inventory 19,000 13,000 (6,000) prepaid expenses 0 0 0 Equipment 60,000 41,000 (19,000) Accum. Depr - Equipment (22,000) (26,000) (4,000) total assets 95,000 111,600 Liabilities: Accounts Payable 11,000 9,000 (2,000) accrued Liabilities 13,000 10,000 (3,000) Bonds Payable 40,000 40,000 0 total liabilities 64,000 59,000 Shareholders’ Equity: Common Stock 25,000 25,000 0 Retained Earnings 6,000 27,600 21,600 total equity 31,000 52,600 total liabilities and shareholder equity 95,000 111,600 Based on the above financial statements, calculate the following ratios for 2019: A. Current Ratio B. Gross Profit Percentage C. Debt Ratio D. Debt to Equity Ratio

Calculation of Ratios for 2019:

A. Current Ratio = Current Assets/Current Liabilities

Current Assets = Cash + Accounts Receivable + Inventory + Prepaid Expenses

Current Assets = 64,600 + 19,000 + 13,000 + 0 = $96,600

Current Liabilities = Accounts Payable + Accrued Liabilities

Current Liabilities = 9,000 + 10,000 = $19,000

Therefore, Current Ratio = 96,600/19,000 = 5.08

The implication is that current assets are 5.08 times of  current liabilities.  This is an indication is that working capital (cash) is not being efficiently managed.  There is excess cash in 2019 especially that should be reinvested to earn some income, instead of being idle.

However, it is not enough to use only one year's ratio to make judgements.  Current ratios over the years and those of the industry should be compared to obtain a comparative result.

B. Gross Profit Percentage = Gross Profit/Sales x 100 = $108,000/$205,000 x 100 = 52.7% approximately.

Gross profit equals sales minus cost of goods sold, i.e. $108,000 $(205,000 - 97,000)

The Gross profit percentage signals the ability of the company to generate revenue over the cost incurred in generating the revenue.

C. Debt Ratio = Total Debt/Total Assets x 100

Debt Ratio = 59,000/111,600 x 100 = 53% approximately

The implication is that debts are 53% of assets.

D. Debt to Equity Ratio = Total Debt/Total Equity

Debt to Equity Ratio = 111,600/52,600 = 2.12 or 2

The implication of this ratio alone is that debts are two times of equity.   In financing the company's operations, more outside funds are being used instead of the entity's own funds.

Explanation:

A. Current Ratio is a liquidity ratio that compares current assets to current liabilities.  It measures the company's ability to pay off short-term debts from short-term resources.  It is also known as the working capital ratio.

Current Assets are economic resources of a firm that can change within a year.  Current Liabilities are obligations that must be settled with resources within a year.

B. Gross Profit Percentage:  This is the margin of income expressed as a percentage of the revenue earned, which indicates the profitability or otherwise of the products and services of a firm.

C. Debt Ratio: This is a financial ratio which indicates the proportion of the company's assets that are financed by debts.  It shows the leverage being applied in the company.  If there are more debts than assets, it means more leverage is being maintained, and vice versa.

D. Debt to Equity Ratio is one of the gearing ratios that compares the outside funds and owners' funds used in financing operations.

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