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This term you have learned to understand a company’s financial story using the language of accounting. The recording and reporting of information is essential to decision makers and other users of financial information; numbers on the various financial statements are used to help further understand the financial condition of the business. This process is known as financial ratio analysis and allows us to analyze the company’s financial position in relation to other organizations in the industry. In this final assignment, you will apply the concepts you have learned throughout the term to perform financial statement analysis and to offer some recommendations.
Assume that you are a health care consultant hired by the Dependable DME Company. DME is Durable Medical Equipment and includes all equipment that benefits patients who have certain medical conditions. The owner of the company, David Smith, is interested in applying for a loan to expand his business; he desires to open a second location in another city. He is preparing to apply to a local bank for a loan.
The bank will base its decision on the following averages for the DME industry:
Ratio
Industry Average
Current ratio
1.50
Quick ratio
0.80
Receivables turnover ratio
18.0
Inventory turnover ratio
20.0
Debt to assets ratio
0.56
Profit margin
10.25%
The balance sheet data for Dependable DME Company follows:
December 31, 2017
December 31, 2016
Cash
$75,000
$60,000
Accounts receivable
40,000
20,000
Inventory
30,000
20,000
Prepaid insurance
5,000
5,000
Total current assets
140,000
105,000
Property and equipment
600,000
550,000
Accumulated depreciation
140,000
110,000
Total property and equipment
460,000
440,000
Total assets
$600,000
$545,000
Accounts payable
$60,000
$60,000
Other current liabilities
40,000
45,000
Total current liabilities
100,000
105,000
Bonds payable
150,000
150,000
Total liabilities
250,000
255,000
Common stock
250,000
250,000
Retained earnings
100,000
40,000
Total stockholders’ equity
350,000
290,000
Total liabilities and stockholders’ equity
$600,000
$545,000
The income statement data for Dependable DME Company follows:
Sales
$600,000
Cost of goods sold
350,000
Gross profit
$250,000
Operating expenses
100,000
Operating income
$150,000
Interest expense
25,000
Income before taxes
$125,000
Income tax expense
65,000
Net income
$60,000
Required:
Calculate the following six (6) ratios: Current Ratio, Quick Ratio, Receivables Turnover Ratio, Inventory Turnover Ratio, Profit Margin Ratio and Debt to Assets Ratio. Be sure to show the actual calculation as well as your final answer.
You are only required to calculate the ratios for 2017; however, for two of the ratios (Receivables Turnover Ratio and Inventory Turnover Ratio), you will need data from 2016 for the formula. When calculating the Quick Ratio, please note that Short-Term Investments are $0 in this scenario. (24 points; 4 points for each ratio calculation)
Below each ratio, comment on the interpretation of the ratio. In other words, what does the result tell you, specifically? (8 points)
Based upon the industry averages upon which the bank relies, should they approve the loan to Mr. Smith? Why or why not? (7 points)
In one-half page, comment on what financial aspect of Dependable DME Company looks good and where can Mr. Smith make some improvements. Specifically identify at least two recommendations to Mr. Smith that can be made to improve the financial position of his business. (8 points)
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