Written Assignment Unit 7

Case Study:
You work in the mergers and acquisitions department of a large conglomerate who is looking to invest in a retail
business. Two companies, Fashion Forward and Dream Designs, are the final two options being considered. You
have the most recent available income statements and two years of balance sheets for each company.
Compute the following ratios for each company:

 Profit Margin Ratio

For this assignment:

 Compute all required amounts and explain how the computations were performed
 Evaluate the results for each company and explain what each ratio means
 Compare and contrast the companies.
 Based on your analysis:
o recommend which company the organization should pursue
o Thoroughly support your conclusion, including what other factors should be considered
o Be specific.

Superior papers will:

 Perform all calculations correctly.

Be sure to use APA formatting in your paper. Purdue University’s Online Writing LAB (OWL) is a free website that
provides excellent information and resources for understanding and using the APA format and style. The OWL
website can be accessed here: http://owl.english.purdue.edu/owl/resource/560/01/
This paper will be assessed using the BUS 5110 Unit 7 Written Assignment rubric.

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Written Assignment Unit 7

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Written Assignment Unit 7
Trend analysis and common-size analysis provide very useful financial information, but, managers, investors,

and other stakeholders also use different ratios to evaluate the performance of the company financially. Ratio

analysis is the second main method for financial analysis. Ratios alone do not state how well or bad is the

financial status of the company. In order to provide a useful analysis, the ratios should be compared with the

industry standard or with the ratios of another competitor. (Mowen et al., 2018)

Ratios are categorized into four groups as follows:

1. Profitability ratios which focus on the income statement.

2. Short-term liquidity ratios which focus on short-term liabilities.

3. Long-term solvency ratios which focus on long-term liabilities.

4. Market valuation ratios which focus is on market value of the company. (Heisinger & Hoyle, n.d)

The table below shows the calculation of ratios followed by explanation and comparison of ratios for two

companies:

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Written Assignment Unit 7
 Profit Margin Ratio – is a profitability ratio which indicate the profit created for each dollar in net sales.

Profit margin ratio = Net income / Net sales

The ratio shows Fashion Forward produced 5.46 cents in net income for every dollar in net sales. This ratio is

slightly higher than Dream Designs’ 3.94 percent.

 Return on Assets Ratio - is a profitability ratio that used to assess how much net income was produced from

each dollar in average assets invested.

 Return on assets = Net income / Average total assets

The return on assets ratio shows Fashion Forward generated 4.92 cents in net income for every dollar in average

assets. This ratio is slightly higher than Dream Designs’ 4.81 percent.

Shareholders, creditors, and analysts often evaluate a company’s profitability. Based on the two ratios that

calculated above, Fashion Forward is slightly more profitable that Dream Design. (Heisinger & Hoyle, n.d)

 Current Ratio – is a short-term liquidity ratio which shows whether an organisation has enough current

assets to cover current liabilities.

Current ratio = Current assets / Current liabilities

The current ratio shows Fashion Forward had $1.11 in current assets for every dollar in current liabilities. This

ratio is lower than Dream Designs’ 1.40 to 1 ratio. Generally, a current ratio more than 1 to 1 is acceptable,

which shows the company has sufficient current assets to cover current liabilities.

 Quick Ratio – is a short-term liquidity ratio which shows whether a company has enough quick, or highly

liquid, assets to cover current liabilities.

Quick ratio = (Cash + Marketable securities + Short-term receivables) /Current liabilities

The quick ratio shows Fashion Forward had $0.98 in quick assets for every dollar in current liabilities. This ratio

is slightly higher than Dream Designs’ 0.87 to 1 ratio.

 Account Receivables Turnover Ratio - is a short-term liquidity ratio that shows how many times receivable

share collected in a given period.

Receivables turnover ratio = Credit sales / Average accounts receivable

The receivables turnover ratio indicates Fashion Forward collected receivables 11.43 times during 2018. This

ratio is lower than Dream Designs’ 16.46 times.

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Written Assignment Unit 7
 Average Collection Period - the receivables turnover ratio can be changed to the average collection period,

which shows how many days it takes on average to collect on credit sales, as follows:

Average collection period = 365 days / Receivables turnover ratio

The average collection period indicates Fashion Forward collected credit sales in 31.93 days, on average. The

number of days is higher than Dream Designs’ 22.17 days. Therefore, Fashion Forward is slower at collecting

accounts receivable than Dream Designs.

 Inventory Turnover Ratio - is also a short-term liquidity ratio that indicates how many times inventory is

sold and restocked in a given period.

Inventory turnover ratio = Cost of goods sold / Average inventory

The inventory turnover ratio shows Fashion Forward sold and refilled inventory 12.9 times during 2018. This

ratio is lower than Dream Designs’ 15.66 times.

 Average Sale Period - the inventory turnover ratio can be changed to the average sale period, which shows

how many days it takes on average to sell the company’s inventory, as follows:

Average sale period = 365 days / Inventory turnover ratio

The average sale period shows Fashion Forward sold its inventory in 28.29 days, on average. The number of

days is higher than Dream Designs’ 23.31 days. Therefore, Fashion Forward is slower at selling inventory than

Dream Designs. (Heisinger & Hoyle, n.d)

Suppliers and other short-term creditors often assess whether an organisation can fulfil short-term obligations.

Based on the above calculated ratios, Dream Design is slightly better in terms of meeting short-term obligations.

 Debt to Equity – is a long-term solvency ratio which measures the balance of liabilities and shareholders’

equity used to fund assets.

Debt to equity = Total liabilities / Total shareholders’ equity

The debt to equity ratio shows that Fashion Forward had $0.96 in liabilities for each dollar in shareholders’

equity. This ratio is higher than Dream Designs’ 0.77 to 1. (Heisinger & Hoyle, n.d)

Banks, bondholders, and other long-term lenders often assess whether companies can meet long-term

obligations. In conclusion, based on the ratio analysis Dream Design is recommended as the company is

performing more efficient in managing the finances just need some support to reduce the cost of sales and the

operating expenses
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Written Assignment Unit 7
References:

1. Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for

Managers. https://2012books.lardbucket.org/books/accounting-for-managers/index.html

2. Mowen, M. M., Hansen, D. R., McConomy, D. J., Heitger, D. L., Pittman, J. A., & Witt, B. D. (2018).

Cornerstones of managerial accounting. Toronto: Nelson.

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