Liquidity Ratios Essay Sample

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Of the firm’s sales, 40 percent are for cash and the remaining 60 percent are on credit. Of credit sales, 40 percent are paid in the month after sale and 30 percent are paid in the second month after the sale. Materials cost 30 percent of sales and are purchased and received each month in an amount sufficient to cover the following month’s expected sales. Materials are paid for in the month after they are received. Labor expense is 40 percent of sales and is paid for in the month of sales. Selling and administrative expense is 5 percent of sales and is also paid in the month of sales. Overhead expense is $28,000 in cash per month.| Problem 25 /Page 116

Depreciation expense is $10, 00 per month. Taxes of $8, 00 will be paid in January, and dividends of $2000 will be paid in March. Cash at the beginning of January is 80,000 and the minimum desired cash balance is $75,000|

For January, February, and March, prepares a schedule of monthly cash receipt, monthly cash payments, and complete cash budget with borrowing and repayment.

In analyzing the Profitability Ratios, we are able to note that john’s Corp shows higher profit margin than Smith by 2.10% which means good cost control, it measures of how many percent if a dollar earned, that the johns Corp get to keep as a profit. And its return on assets is higher by 6.5% and that indicates how many dollars of Johns earnings result from each dollar of assets the company controls. Return on Assets ratio gives an idea of how efficient management is at using its assets to generate profit. Smith Corporation analysis indicate higher return on equities, and less return on assets comparing to Johns Corporation, the Return on equity rate was higher for Smith and that is due for larger use of the debt, and this may not be beneficial because debt represents increased risk, a lower valuation of higher learning is possible. And also this may be result from a high return on total assets, or utilization of debt or combination of both.

Johns Corporation turns over its inventory 25 times per year comparing to Smith corporation of 13 times per year, this means that Johns Corp generate more sales per dollar of inventory than Smith Company. Johns Corp Turnover their asset 2.5 times a year, which means Johns Corp, has been able to turn a profit to good return on assets. Both Companies have been successful in maintaining more assets than liabilities thus, Both has been successful in sustaining quick ratio above 1.0 ,Thus ensuring that Cash, Cash Equivalents and account receivables are more than liabilities at the end of financial year. John’s assets turnover is more than Smith Corp, which shows the management capabilities of effectively utilizing their assets to generate revenues. For Smith Corporation the times interest earned is lower than johns, this can be caused by lower income, higher debt, or a combination of both. Times earnest earned indicates the number of times that income before tax and interest covers the interest obligation (6) times .The higher the ratio the stronger is the interest-paying ability of the firm.

Johns Corporation has a debt of Equity rate less than Smith Corporation, which means the ability for the Johns to pay down their debt, with the equity that the firm has, so the ability to sell everything, and cover their debts with the proceed of the sale, Since suppliers and short-term lenders are most concerned with liquidity ratios, Smith Corporation would get the nod as having the best ratios in this category. One could argue, however, that Smith had benefited from having its debt primarily long term rather than short term.

Nevertheless, it appears to have better liquidity ratios. Stockholders are most concerned with profitability. In this category, Jones has much better ratios than Smith. Smith does have a higher return on equity than Jones, but this is due to its much larger use of debt. Its return on equity is higher than Jones’ because it has taken more financial risk. In terms of other ratios, Jones has its interest and fixed charges well covered and in general its long-term ratios and outlook are better than Smith’s. Jones has asset utilization ratios equal to or better than Smith and its lower liquidity ratios could reflect better short-term asset management.

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