Purpose of Assignment
This activity helps students recognize the significant role accounting plays in providing financial information to management for decision making through the evaluation of financial statements. This experiential assignment requires students to use ratios to evaluate and analyze a company’s liquidity, solvency, and profitability.
Two-Rivers Inc. (TRI) manufactures a variety of consumer products. The company’s founders have run the company for thirty years and are now interested in retiring. Consequently, they are seeking a purchaser, and a group of investors is looking into the acquisition of TRI. To evaluate its financial stability, TRI was requested to provide its latest financial statements and selected financial ratios. Summary information provided by TRI is presented below. Required: a. Calculate the select financial ratios for the fiscal year Year 2. (use MS word or excel but excel is more recommended)
Current ratio is a measure of how much short term assets are available to meet the short term liabilities of the company
=current assets/current liabilities
A current ratio between 1.5 and 3 is ideal showing the company’s ability to address short term obligaions.
Acid test ratio is the measure of how much fluid cash is available for the short-term liabilities of the company
= (cash + short-term investment + accounts receivable)/current liabilities
(500 + 400+ 3200)/6300
A higher acid test ratio number shows the organization has a better amount of quick assets to its current liabilities. In this case the liabilities are higher than the assets.
Time interest earned is the measure of how many times income has to be multiplied to cover the interest
=income before interest and income taxes/ interest expense
= income before taxes = 7060 income taxes = 900 = 7060 + 900 = 7960
Times interest earned = 7960/900
Organizations with a time interest earned ratio higher than 2.5 are considered acceptable risk. The high value of the organization is therefore acceptable.
Debt to equity is used in determining the financial leverage of a company
(short term debt + long term debt + fixed payments)/ shareholder’s equity)
Ideal debt to equity ratio falls between 1 and 1.5 showing the organization is operating at sub-optimal levels.
Inventory turnover is a ratio on the number of times an organization has sold and replaced inventory in a given time.
=cost of goods sold /average inventory
The ideal inventory turn-over ratio is between 4 to 6 thus the ratio is bad for operating efficiency and financial stability of the organization
b. Interpret what each of these financial ratios means in terms of TRI’s financial stability and operating efficiency.