Interpreting Financial Analysis Ratios (LO5, 6)

Thorpe Company is a wholesale distributor of professional equipment and supplies. The company’s sales averaged about $900,000 annually for the three-year period, 2010-2012. Its total assets at the end of 2012 were $850,000. The president of Thorpe Company asked the controller to prepare a report summarizing the financial aspects of the company’s operations for the past three years. This report is to be presented to its Board of Directors at its next meeting. In addition to comparative financial statements, the controller decides to report a number of relevant financial ratios to assist in the identification and interpretation of trends. The controller computes the following ratios for the recent three-year period.

2012 2011 2010 GUKreMtAtiOnee erm neva ics sie cersceates ens as 2.18 PAN) 2.00 IAGIGRLES tanattlOieerewse neoc teietn,a Stpatr, ectesnsti oee 0.97 1.10 1.20 Days receivables outstanding .............. Sled) 42.60 37.60

[nVeMtonyatlinMOV.claweyemess aici sarrt pel we teecnes 3.80 4.80 E29 DebintO-CQuitvimatlaoel einaet arcoa unrar causes = 0.61 0.69 0.79 ASS CLALUSTMOCVh imeras Sora trek Ada ieee ce cleteial eas 1.99 1.88 Unths.

Sales as a percentage of 2010 sales......... 1.06 1.03 1.00 Gross protiepercentemaren erenacce ea oe as 38.50 38.60 40.00 FREWUTATKON SNES: cr cn o-a.9 ty le Cee O eerie cnet 8.0% » 7.8% 7.8%

RGtunmonpasSet Spntereraes tamrcimersa oiastist oso t 8.7% 8.6% 8.5%

Re uUnmlOnneGuilya atte cements ee, a eces eee 14.1% 14.6% 15.1%

In preparation of the report, the controller decides first to examine the financial ratios independently of any other data to determine if the ratios themselves reveal any significant trends over this three-year period.

Required Answer the following questions. Indicate in each case which ratio(s) you used to arrive at your conclusion.

a. The current ratio is increasing, whereas the acid test 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) is drawn regarding the company’s use of financial leverage during the 2010-2012 period? Explain.

c. Using the ratios provided, what conclusions are drawn regarding the company’s ability to generate sales and profits from the assets available to management?