Question

The Ferri Furniture Company: Balance Sheet as of December 31, 2016 (In Thousands)

Cash $ 277,000 Accounts Payable $ 169,000 Receivables 220,000 Notes Payable 74,000 Inventories 145,000 Other current liabilities 57,000 Total current assets $ 642,000 Total current liabilities $ 300,000 Net fixed assets 305,000 Long-term debt 66,500 Common equity 581,000 Total assets $ 947,500 Total liabilities & equity $ 947,500

The Ferri Furniture Company: Income Statement for Year Ended December 31, 2016 (In Thousands) Sales $ 3,231,000 Cost of Goods Sold Material $ 717,000 Labour 453,000 Heat, light and power 68,000 Indirect labour 113,000 Depreciation 41,500 1,838,500 Gross Profit $ 1,392,500 Selling Expenses 115,000 General and Administrative expenses 30,000 Earnings before interest and taxes (EBIT) $ 1,247,500 Interest expense 22,500 Earnings before taxes (EBT) 1,225,000 Corporate taxes (40%) 490,000 Net income $ 735,000

A – Calculate and interpret the financial ratios for 2016 corresponding to the industry norms provided as follows:

INDUSTRY NORMS Current ratio 1.5 Inventory turnover 3 Total asset turnover 1 Operating profit margin 18% Operating income return on investment 18% Debt ratio 60% Average collection period 100 days Fixed asset turnover 1.5 Return on equity 15%

B – Comment on Ferri Company’s financial position in terms of liquidity, profitability and solvency as well as its overall performance, by using the ratios that you have found and comparing them with the industry averages.

Answer 1

a)

1)

Current Ratio = Current assets / Current liablities

Current ratio = 642,000 / 300,000

Current ratio = 2.14

Current ratio is a measure of liquidity and a hiigher ratio indicates higher liquidity ( i.e., a greater ability to meet its short term obligations). The Ferri Furniture Company has better current ratio than the industry norm which has current ratio of 1.5. This means Ferri Furniture Company is able to manage short term obligations better than its competitors.

2)

Inventory Turnover = Cost of goods sold / Average inventory.

Inventory turnover = 717,000 / 145,000

Inventory turnover = 4.9

Inventory turnover is an efficiency ratio that indicates how many times a company's invetory is sold and replaced over a period of time. Therefor it indicates inventory management effectiveness of the firm. A higher turnover ration relative to industry might indicate highly effective inventory management. Inventory tunover of the industry is 3 which sates ferri company has a better inventory managemennt system which has a turover of 4.9.

Note: If opening inventory is not given, closing inventory can be taken as average inventory.

3)

Total Asset turnover = Revenue / Average total assets

Total asset turnover = 3,231,000 / 947,500

Total asset turnover = 3.41

Total asset turnover measures company's overall ability to generate revenue with a given level of assets. A ratio of 3.41 would indicate that company is generating $3.41 for every $1 of average assets. A higher ratio indicates graeter efficiency. The industry which has a total asset turnover of 1 indicates that ferri company is managing its assets more efficiently than its competitors.

4)

Operating Profit Margin = Operating income / Revenue

Operating income, EBIT =  1,247,500

Operating profit margin = 1,247,500 / 3,231,000

Operating profit margin = 0.38 or 38%'

Operating profit margin is profitability ratio which measures how much profit a company makes after paying for variable or operating costs have been paid. Feri comapny has higher operating marging than the industry norm of 18% which indicates a better profitibilty for ferri company.

5)

Operating income return on investment = Operating income / Total Operating Assets

Opreating Income =  1,247,500

Total opearting assets = Total current assets + net fixed assets

Total operating assets = 642,000 + 305,000 = 947,000

Operating income return on investment = 1247500 / 947000

Operating income return on investment = 13.1

This is a profitability measure which shows how a company's core businesses are performing, excluding financing activities, tax particulars etc. ferri company's Operating income return on investment is less than industry norm which has a measure of 18%

6)

Debt rato = Debt / Total Assets

Debt ratio =  66,500 / 947,500

Debt Ratio = 0.07 or 7%

Debt ratio is a solvency ratio that measures the extent of company's leverage. That Is, debt level of a business as a percentage of total assets. the lower the percentage, less levearge the company is using and a stronger equity position. Ferri company has a significantly lower debt ratio than the indusrty norm of 60%.

7)

Average collection period = 365 days in a year / accounts receivable turnover ratio

Accounts accounts receivable turnover ratio = Revenue / average receivable

Accounts accounts receivable turnover ratio = 3,231,000 / 220,000

Accounts accounts receivable turnover ratio =14.6

Average collection period = 365 / 14.6

Average collection period = 25

The average collection period represents the elapsed time between sale and a collection period, reflecting how fast the company collects cash from customers to whom it offers credit. Ferri company has a better collection period than the indusrty norm. Ferri company is collecting its receivables in every 25 days.

8)

Fixed asset turnover = Revenue / Average net fixet assets

Fixed asset turnover = 3,231,000 / 305,000

Fixed asset turnover =10.5

The ratio measures how efficiently the company generates revenues from its investments in fixed assets. Generally, a higher fixed asset turnover ratio indicates more efficient use of fixed aasets in generating revenue. Ferri has a highher turnover than industry norm which indicates more efficiency in the management of fixed assets.

9)

Return on equity = Net income / Average total equity

Return on equity = 735,000 / 581,000

Return on equity = 126%

Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is an important measure of profitability. Ferri company has a significantly higher return of equty that the industry norm which is 15%.

b)

Liquidity measues include current ratio for which ferri copmany has a better current ratio of 2.14 than the industry norm of 2.14. This means  Ferri Furniture Company is able to manage short term obligations better than its competitors.

Profitability measue includes Operating profit margin, operating income return on investment and return on equity.

Although operating income return on investment for ferri company is less than the industry norm, it sis doing better when we check Operating profit margin and return on equity. Therefore ferry company's profitabilty measue is better than the indusrty norm.

Solvency measures debt ratio. Ferri company has a better debt ratio than industry norm. Ferri company has a significantly lower debt ratio than the indusrty norm of 60%