Question

Income statement and balance sheet data for The Sports Shack are provided below.

The Sports Shack Income Statements For the years ended December 31
	2019	2018
Sales revenue	$8,200,000	$6,600,000
Cost of goods sold	6,100,000	4,700,000
Gross profit	2,100,000	1,900,000
Expenses:
Operating expenses	1,450,000	1,400,000
Depreciation expense	90,000	100,000
Interest expense	25,000	50,000
Income tax expense	95,000	80,000
Total expenses	1,660,000	1,630,000
Net income	$440,000	$270,000

The Sports Shack Balance Sheets December 31
Assets	2019		2018	2017
Current assets:
Cash	$290,000		$218,000	$196,000
Accounts receivable	1,050,000		680,000	880,000
Inventory	919,000		1,250,000	1,100,000
Supplies	80,000		90,000	65,000
Long-term assets:
Equipment	1,100,000		1,200,000	900,000
Accumulated depreciation	(440,000)		(350,000)	(250,000)
Total assets	$2,999,000		$3,088,000	$2,891,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$50,000	$65,000		$55,000
Interest payable	2,000	4,000		6,000
Income tax payable	38,000	40,000		30,000
Long-term liabilities:
Notes payable	200,000	400,000		300,000
Stockholders’ equity:
Common stock	900,000	900,000		900,000
Retained earnings	1,809,000	1,679,000		1,600,000
Total liabilities and equity	$2,999,000	$3,088,000		$2,891,000

Required:

a. Calculate the following risk ratios for 2018 and 2019.

Receivables turnover ratio	Current ratio
Inventory turnover ratio	Debt to equity ratio

b. Calculate the following profitability ratios for 2018 and 2019.

Gross profit ratio	Profit margin
Return on assets	Asset turnover

c. Based on the ratios calculated, determine whether overall risk and profitability improved from 2018 to 2019.

Answer 1

a) Receivables Turnover Ratio = Sales / Average Receivables

For 2018:Average Receivables = opening receivables +closing receivables /2 = $880000+$680000/2= $780000

Receivables turnover ratio = $6600000/780000= 8.46 times

For 2019: Average Receivables = $1050000/$680000/2 = $865000

Receivables Turnover ratio= $8200000/865000=9.47 times

Current Ratiio = Current Assets/ Current Liabilities

For 2018: Current Assets= $218000+$680000+$1250000+$90000= $2238000

Current Liabilities = $65000+$4000+$40000= $109000

Current Ratio= $2238000/109000= 20.53

For 2019: Current Assets = $290000+$1050000+$919000+$80000= $2339000

Current Liabilities = $50000+$2000+$38000= $90000

Current Ratio= $2339000/90000= 25.98

Inventory Turnover Ratio = Cost of the goods sold/ Average Inventory

For 2018: Average inventory = opening inventory + closing inventory/2 = 1100000+1250000/2= $1175000

Inventory Turnover ratio = $4700000/1175000= 4 times

For 2019: Average Inventory = $1250000+$919000/2= $1084500

Inventory Turnover Ratio = $6100000/1084500= 5.62 times

Debt to Equity ratio = Debt / Equity

For 2018: 400000/ 900000+1679000= $400000/2579000= 0.15

For 2019: 200000/ 900000+1809000= $200000/ 2709000= 0.07

b) Gross Profit Ratio : Gross Profit /. sales

For 2018: 1900000/6600000= 28.78%

For 2019: 2100000/8200000= 25.60%

Profit Margin = Net income/ sales

For 2018: $270000/6600000= 4.09%

For 2019: $440000/8200000 = 5.36%

Reurn on Assets = Net income/ Average assets

For 2018: Average assets = Opening assets +closing assets /2 = $3088000+$2891000/2 = $2989500

Return on assets = $270000/ 2989500= 0.9%

For 2019: Average assets = $2999000+$3088000/2= $3043500

Return on assets = $440000/3043500= 14.45%

Asset Turnover ratio= Sales / Average assets

For 2018: $6600000/2989500= 2.2

For 2019: $8200000/3043500= 2.69

C) Overall risk measure :

Situation has improved in 2019 based on the risk ratios calculated. Receivables turnover ratio, current ratio and inventory turnover ratios have increased/improved which means firm is taking less time in collecting its receivables, has more current assets than current liabilities and inventory position is also improved. Also, Debt equity ratio is improved which means it has lesser debt obligations.

Overall profitability measure:

We can see that only Gross profit ratio declined in 2019. All other ratios have improved from 2018 to 2019 which means income and profitability has improved. Gross profit ratio decline will be covered by improvement in other profitability ratios. So, overall profitability has increased/improved.