(Analysis of Given Ratios) Picasso Company is a wholesale distributor of professional equipment and supplies. The company’s sales have averaged about $900,000 annually for the 3-year period 2003–2005. The firm’s total assets at the end of 2005 amounted to $850,000.

The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past 3 years. This report will be presented to the board of directors at their next meeting.

In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the 3-year period 2003–2005.

In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.
Instructions

(a) The current ratio is increasing while the acid-test (quick) ratio is decreasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend.

(b) In terms of the ratios provided, what conclusion(s) can be drawn regarding the company’s use of financial leverage during the 2003–2005 period?

(c) Using the ratios provided, what conclusion(s) can be drawn regarding the company’s net investment in plant and equipment?

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2003 2004 2005 Current ratio Acid-test (quick) ratio Accounts receivable turnover 1.80 1.89 1.96 1.04 0.99 0.87 8.75 7.71 6.42 Inventory turnover 4.91 4.32 3.42 Percent of total debt to total assets 51 46 41 Percent of long-term debt to total assets 31 27 24 Sales to fixed assets (fixed asset turnover) 1.58 1.69 1.79 Sales as a percent of 2003 sales 1.00 1.03 1.07 Gross margin percentage 36.0 35.1 34.6 Net income to sales 6.9% 7.0% 7.2% Return on total assets 7.7% 7.7% 7.8% Return on stockholders' equity 13.6% 13.1% 12.7%