Chapter 13, Problem 13.1CC

1.

To determine

To Identify: whether Company NGS was profitable in 2016 or 2015 by using gross profit percentage, return on equity and fixed assets turnover ratio.

Explanation of Solution

Gross Profit Percentage:

Gross profit is the financial ratio that shows the relationship between the gross profit and net sales. It represents gross profit as a percentage of net sales. Gross Profit is the difference between the net sales revenue, and the cost of goods sold. It can be calculated by dividing gross profit and net sales.

Identifywhether Company NGS was profitable in 2016 or 2015 by using gross profit percentage, return on equity and fixed assets turnover ratio.

$\begin{array}{c}\begin{array}{l}\text{Gross}\text{profit}\text{percentage}\\ \text{ratio (2015) }\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{sales}\text{revenue-}\\ \text{cost}\text{of}\text{goods}\text{sold}\end{array}\right)}{\text{Net}\text{sales}\text{revenue}}\text{×100}\\ \text{=}\frac{\left(\text{\$56,000-\$48,000}\right)}{\text{\$56,000}}\text{×100}\\ \text{=}\frac{\text{\$8,000}}{\text{\$56,000}}\text{×100}\\ \text{=14}\text{.29\%}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Gross}\text{profit}\text{percentage}\\ \text{ratio (2016) }\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{sales}\text{revenue-}\\ \text{cost}\text{of}\text{goods}\text{sold}\end{array}\right)}{\text{Net}\text{sales}\text{revenue}}\text{×100}\\ \text{=}\frac{\left(\text{\$80,000-\$65,000}\right)}{\text{\$80,000}}\text{×100}\\ \text{=}\frac{\text{\$15,000}}{\text{\$80,000}}\text{×100}\\ \text{=18}\text{.75\%}\end{array}$

Return on equity ratio:

Rate of return on equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common equity that is invested in the company.

$\begin{array}{c}\begin{array}{l}\text{Return}\text{on}\text{equity}\\ \text{(2015)}\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{income-}\\ \text{preferred}\text{dividends}\end{array}\right)}{\text{Average}\text{common}\text{stockholders'}\text{equity}}\text{×100}\\ \text{=}\frac{\$2,100}{\frac{(\$32,100+\$11,600)}{2}}\times 100\\ =\text{9}\text{.6\%}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Return}\text{on}\text{equity}\\ \text{(2016)}\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Net}\text{income-}\\ \text{preferred}\text{dividends}\end{array}\right)}{\text{Average}\text{common}\text{stockholders'}\text{equity}}\text{×100}\\ \text{=}\frac{\$6,950}{\frac{(\$31,950+\$32,100)}{2}}\times 100\\ =21.70\text{\%}\end{array}$

Fixed Asset turnover:

Fixed asset turnover is a ratio that measures the productive capacity of the fixed assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

$\begin{array}{c}\text{Fixed}\text{asset}\text{trunover}\text{(2015)=}\frac{\text{Net}\text{revenue}}{\text{Average}\text{net}\text{fixed}\text{assets}}\\ \text{=}\frac{\text{\$56,000}}{\frac{(\$79,000+\$27,000}{2}}\\ \text{=1}\text{.06}\end{array}$

$\begin{array}{c}\text{Fixed}\text{asset}\text{trunover}\text{(2016)=}\frac{\text{Net}\text{revenue}}{\text{Average}\text{net}\text{fixed}\text{assets}}\\ \text{=}\frac{\text{\$80,000}}{\frac{(\$64,000+\$79,000}{2}}\\ \text{=1}\text{.12}\end{array}$

By comparing the gross profit percentage, return on equity and fixed assets turnover ratio for 2015 an d 2016 of Company NGS. Company NGS has high gross profit percentage in 2016 for each sales dollar for the balance cover cost except cost of goods sold on 2016. NGS also has high profit percentage in 2016 than 2015 for return on equity and fixed assets turnover. Increase in the return on equity during 2016 reports that company is able to retain its business better than during the year 2015. Increase in the fixed asset turnover during  2016 reports that NGS is well organised to use its assets to generate its sales.

2.

To determine

To Identify: whether Company NGS was liquid in 2016 or 2015 by using current ratio.

Explanation of Solution

Current ratio:

Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.

Identify whether Company NGS was liquid in 2016 or 2015 by using current ratio.

$\begin{array}{c}\text{Current}\text{ratio (2015) =}\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}\\ \text{=}\frac{\text{\$11,100}}{\text{\$8,000}}\\ \text{=1}\text{.39}\end{array}$

$\begin{array}{c}\text{Current}\text{ratio (2016) =}\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}\\ \text{=}\frac{\text{\$10,950}}{\text{\$8,000}}\\ \text{=1}\text{.37}\end{array}$

It is difficult to determine whether Company NGS has more liquidity during 2016 or 2015 because company has in both the years’ sufficient current assets to meet out their current liabilities for every year.

3.

To determine

To Identify: whether Company NGS was liquid in 2016 or 2015 by using debt-to-assets and times interest earned ratio.

Explanation of Solution

Debt to Asset Ratio:

Debt to asset ratio is the ratio between total asset and total liability of the company. Debt ratio reflects the finance strategy of the company. It is used to evaluate company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.

Identify whether Company NGS was liquid in 2016 or 2015 by using debt-to-assets and times interest earned ratio.

$\begin{array}{c}\text{Debt-to-asset}\text{ratio (2015)=}\frac{\text{Total}\text{liabilities}}{\text{Total}\text{assets}}\\ \text{=}\frac{\text{\$58,000}}{\text{\$90,100}}\\ \text{=0}\text{.64}\end{array}$

$\begin{array}{c}\text{Debt-to-asset}\text{ratio (2016)=}\frac{\text{Total}\text{liabilities}}{\text{Total}\text{assets}}\\ \text{=}\frac{\text{\$43,000}}{\text{\$74,560}}\\ \text{=0}\text{.57}\end{array}$

Times interest earned ratio:

Times interest earnedratio quantifies the number of times the earnings before interest and taxes can pay the interest expense.

$\begin{array}{c}\text{Times Interest Earned (2015) = }\frac{\text{Net Income }+\text{ Interest Expense + Income tax expense}}{\text{Interest Expense}}\\ =\frac{\$2,100+\$3,100+\$800}{\$3,100}\\ =1.94\end{array}$

$\begin{array}{c}\text{Times Interest Earned (2016) = }\frac{\text{Net Income }+\text{ Interest Expense + Income tax expense}}{\text{Interest Expense}}\\ =\frac{\$6,950+\$1,000+\$3,050}{\$1,000}\\ =11.00\end{array}$

Company NGS has more solvency during the year 2016 than 2015 because increase in the times interest earned ratio during 2016 shows that company has sufficient profit during the year 2016 to cover its interest. Decrease in the debt-to-assets ratio during 2016 than 2015 shows that company has reduced its financial risk level in the year 2016.