The Thorpe Company is a wholesale distributor of professional equipment and supplies.

The company’s sales have averaged about $900,000 annually for the three-year period 1999-2001. The firm’s total assets at the end of 2001 amounted to $850,000.

The president of the Thorpe Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past three years.

This report will be presented to the board of directors at its next meeting.

In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios that 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 three-year period 1999–2001:

Ratio 1999 2000 2001 Current ratio 2.00 2.13 2.18 Acid-test (quick) ratio 1.20 1.10 0.97 Accounts receivable turnover 9.72 8.57 7.13 Inventory turnover 5.25 4.80 3.80 Percent of total debt to total assets 44.00% 41.00% 38.00%

Percent of long-term debt to total assets 25.00% 22.00% 19.00%

Sales to fixed assets (fixed asset turnover) 1.75 1.88 1.99 Sales as a percent of 1999 sales 100.00% 103.00% 106.00%

Gross profit percentage 40.0% 33.6% 38.5%

Net income to sales 7.8% 7.8% 8.0%

Return on total assets 8.5% 8.6% 8.7%

Return on stockholders’ equity 15.1% 14.6% 14.1%

In preparing his report, the controller has decided first to examine the financial ratios independently of any other data to determine if the ratios themselves reveal any significant trends over the three-year period.

Required 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 1999–2001 period?

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

CMA Adapted