Financial statement analysis The following ratios describe the performance of Financial Insights Ltd for 2021 and 2022:

Ratio Value Value 2021 2022 Debt-to-equity ratio 1.36 times 1.86 times Inventory turnover 6.70 times 8.00 times Quick ratio 0.91 times 0.70 times Gross margin 63.2% 65.0%

Interest coverage 2.8 times 2.00 times Current ratio 1.89 times 1.29 times Receivables turnover 7.3 times 7.5 times Days inventory on hand 54.5 days 45.6 days Return on assets 13.24% 14.40%

Return on equity 38.43% 34.97%

1 Classify these ratios into those relating to:

a profitability b activity (turnover)

c liquidity/solvency d financial structure.

2 Based on the ratio values supplied, comment on the company’s performance in 2022 in each of the following categories:

a profitability b activity (turnover)

c liquidity/solvency d financial structure.

In addition, note the limitations of conclusions drawn from the provided information, and indicate what other information would be helpful in assessing the company’s performance.

3 Explain the following:

a Why do the return on assets and return on equity ratios differ?

b Why would the return on assets ratio be calculated if you had already calculated the return on equity ratio? (You may find it helpful to consider how these ratios are calculated.)

4 Consider the inventory turnover ratio and the days inventory on hand ratio:

a What information do these ratios provide?

b From the viewpoint of management, what are the limitations relating to these ratios?

5 During 2022, the chief financial officer (CFO) of Financial Insights Ltd employed an independent valuer to assess the current value of the land and buildings owned by the company. The valuer had advised the CFO that the value of the land and buildings had increased by $50 000 (10 per cent). Assume that this increased value is reflected in the ratios provided. Explain how this accounting policy choice would have affected each of the ratios.