RATIO ANALYSIS & INTERPRETATION

Question 1
1. Quick Ratio indicates the ability of a firm to pay debt instantly.
2. The ratio determined by dividing total current assets by total current liabilities is the Current
Ratio or Working Capital Ratio.
3. The ratio of the quick assets to current liabilities, which indicates the instant debt-paying
ability of a firm, is the Acid-Test Ratio or Quick Ratio.
4. A measure useful in evaluating efficiency in the management of inventories is the Inventory
Turnover.
5. Comparisons of data within a company are an example of Intracompany Basis Analysis.
6. In vertical analysis, each item is expressed as a percentage of the base amount.
7. The debt to total assets ratio measures the percentage of total assets provided by creditor.
8. Earnings per share is used for measuring of the net income earned on each share of common
stock.
9. The asset turnover ratio is used for measuring how efficiently a company uses its assets to
generate sales.
10. Horizontal analysis evaluates a series of financial statement data over a period of time.

Question 2
The comparative financial statements of Optical Solutions Inc. are as follows:
The market price of Optical Solutions Inc. common stock was $60.00 on December 31, 2010.
Optical Solutions Inc.
Comparative Retained Earnings Statement
For the Years Ended December 31, 2010 and 2009
Retained earnings, January 1st
Add net income for year
Total
Deduct dividends
On Preferred stock
On Common stock
Total
Retained earnings December 31st

2010
$ 604,000
428,000
1,032,000

2009
$ 306,000
314,000
620,000

4,000
12,000

4,000
12,000

16,000
1,016,000

16,000
604,000

Optical Solutions Inc.

Comparative Income Statement
For the Years Ended December 31, 2010 and 2009
Sales
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Other income
Other expense (interest)
Income before income tax
Income tax expense
Net income

2010
$ 1,608,000
5,920
1,602,080
480,200
1,121,880
324,000
234,000
558,000
563,880
24,000
110,720
477,160
49,160
428,000

2009
$ 1,481,000
6,000
1,475,600
499,200
976,400
352,000
211,200
563,200
413,200
19,200
80,000
352,400
38,400
314,000

Optical Solutions Inc.

Comparative Balance Sheet
For the Years Ended December 31, 2010 and 2009
Assets:
Current assets
Cash
Temporary investments
Account receivable (net)
Inventories
Prepaid expenses
Total current assets
Long-term investments
Property, Plant, and Equipment (net)
Total assets
Liabilities
Current liabilities
Long-term liabilities
Mortgage note payable, 8%, due 2015
Bonds payable, 10%, due 2019
Total long-term liabilities
Total liabilities
Stockholders Equity
Preferred $2.00 stock, $50 par
Common stock, $5 par
Retained earnings
Total stockholders equity
Total liabilities and stockholders equity
Instructions: Determine the following measures for 2010:
1. Working Capital
2. Current Ratio
3. Quick Ratio (Acid-Test Ratio)
4. Account Receivable Turnover
5. Number of days sales on receivables
6. Inventory Turnover
7. Number of days sales in inventory
8. Profit Margin
9. Ratio of net sales to assets (Asset Turnover)
10. Return on total assets
11. Return on common stock
12. Earnings per share on common stock
13. Price-earnings ratio

2010

2009

240,000
364,000
260,000
208,000
44,000
1,116,000
204,800
1,539,200
2,860,000

162,400
328,800
211,200
66,400
23,200
792,000
256,000
976,000
2,024,000

360,000

320,000

384,000
800,000
1,184,000
1,544,000

0
800,000
800,000
1,120,000

100,000
200,000
1,016,000
1,316,000
2,860,000

100,000
200,000
604,000
904,000
2,024,000

14.

SOLUTION
Determine the following measures for 2010:
1. Working Capital
Formula:

It means that the optical solutions Inc. is able to pay off its short-term liabilities and it can
also be a signal that the company might be able to expand its operations.
2. Current Ratio
Formula:

Due to current ratio calculated is more than 1, so it means that the company is capable to
pay its own debts over the next business cycle, usually 12 months or a year. For every $1
of current debts, the firm has $3.10 of current assets as back up.
3. Quick Ratio
Formula:

 This indicates that the company has enough current assets to cover its current debts
without selling its inventories. For every $1 of current debts, the firm has $2.52 of current
assets to be paid back
4. Account Receivable Turnover
Formula:

times
It means that the company is able to collect its receivables from the customers on average
6.8 times during 2010.

5. Number of days sales in receivables

Formula:

This means that receivables are collected on average every 53.68 days during 2010.
6. Inventory Turnover
Formula:

times
It indicates that during 2010 the company is able to sell inventory 3.5 times.
7. Number of days sales in inventory
Formula:

This indicates that the company takes 104.24 days to turn its inventory into sales.
8. Profit Margin
Formula:

This shows that the company is able to generate $0.027 of net profit from every dollar of
sales.
9. Ratio of net sales to assets (Asset Turnover)
Formula:

The result shows that the company is able to generate $0.66 of net sale from every dollar
of assets.

10. Rate earned on total assets (Return on Assets)

Formula:

It means that $0.18 of net profit results from $1 of assets that the company controls.
11. Rate earned on common stockholders equity
Formula:
Rate earned on common stockholders equity

This indicates that for each dollar invested by the owners, the company is able to earn
$2.12 of net income.
12. Earnings per share on common stock
Formula:

Earnings per share on common stock

The result shows that for each share of common stock, the company is able to earn $10.6
of net income.
13. Price-earnings ratio
Formula:

times
This indicates the investors are ready to pay 5.66 times earnings for a share if the market
price of common stock is $60 and earnings per share is $10.6.

Note!!!!
To find Dividend
Net Income/Net Profits = Dividend + Retained Earnings
To find total average
Total average = (Year 1 + Year 2)/2
To find net sale
Net (credit) Sales = Sales - Sales Returns and Allowance
To find Earnings Before Interest and Tax Expenses (EBIT)
EBIT/Income from operation = Net Income + Interest expense + Tax expense