By Vince Ferrito


This ratio explains a company’s ability to pay current liabilities with current assets.
 The rule of thumb is that it should be about 2:1.
 Division A and C are at 2.85 while Division B is at
3.54. This is a bit too high and indicates that the company is not making enough sales. It is not prudent to tie up a lot of money in current assets because they yield little return.

 This is a more sever test to see if a company can pay off liabilities.
 The rule of thumb for this ratio is that it should be about
1:1.
 Once again the numbers for Division A, B, and C (1.67,
2.14, and 1.67, respectively) are a bit too high indicating that too much funds are being tied up in current assets.
However, it is clear that all divisions of the company can easily pay off their current liabilities.

 Obviously, one wants this ratio to be kept minimal. However, borrowed funds are important in allowing companies to expand.
 As long as return on assets is greater than the cost of borrowing then a company is making good use of debt.
 In the chart on the following slide is easy to see that return on equity is higher than return on assets so it is clear that although the debt to asset ratio for Divisions A and C is 39.32% they are making excellent use of borrowed funds.

Ratio Comparisons
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
Return on
Sales (Profit
Margin)
Return on
Assets
Return on
Equity
Division A
Division B
Division C

Return on Sales (Profit Margin)
Return on Assets
Return on Equity
Division A Division B Division C
6.63%
14.75%
22.01%
9.46%
18.26%
22.35%
6.63%
14.75%
22.01%
The above ratios indicate the profitability of the company.
From the above numbers (illustrated in the chart on the previous slide) it is clear that all three divisions of this company are doing very well with Division B leading the way.

 The return on sales ratio is very industry specific.
In this case, these numbers appear solid since widgets aren’t significantly marked up, so profit margins of about 6% and 9% are healthy. There is a high volume of sales that ensure profit.
 Return on assets also seem to be healthy.
Divisions A and C could be a bit higher, but 15% is still a strong ratio.

 The return on equity for these three companies is really superb. All three divisions have about a
22% return on investment.
 Compared to about a 3% return on a savings account and about an 8% return on a mutual fund,
22% return on equity is an amazing investment.
This will ensure that the company will always have sufficient funds available to borrow and expand as long as this ratio remains high.

 This ratio should be in alignment with the company’s credit policy. 30 days is a common policy to have.
 The averages for all three divisions is about 40-45 days. If a 45 day payment period is company policy than this ratio is an indication that the company is doing well in enforcing it’s policy. If the policy is less than this, however, this ratio indicates that the divisions might never get paid, or run into debt since they are not getting the funds they are owed on time.

 This number is also very industry specific.
 All three divisions have an average of about 60 days. This may be too high. There are tremendous hidden costs (such as paying for warehouse space and security) in inventory so it would be to the company’s advantage to attempt to lower these averages. This will only lead to greater profitability.