# Financial Ratios

1. Calculate the profitability ratios for all three years using the formulas provided in section “A. Profitability Ratios”

within Chapter 3:

1. Profit margin

2. Return on assets (a and b)

3. Return on equity ( a and b)

2. Write a one-paragraph description of any trends that appear to have taken place over the three-year time

period.

3. Examine the income statement in Figure 1 above. Note that there was an extraordinary loss of \$170,000 in

2015. This might have represented uninsured losses from a fire, a lawsuit settlement, etc. It probably does not

represent a recurring event or affect the earnings capability of the firm. For that reason, the astute financial

analyst might add back in the extraordinary loss to gauge the true operating earnings of the firm. Since it was a

tax-deductible item, we must first multiply by (1-tax rate) before adding it back in.* The tax rate was 35 percent

for the year.

\$170,000 Extraordinary loss

_____.65_ (1-tax rate)

\$110,500 After-tax addition to profits from eliminating the extraordinary loss

from net income

The more representative net income number for 2015 would now be:

Initially reported (Figure 1 above) \$200,318

Adjustment for extraordinary loss being eliminated +110,500_

Note: This adjustment was made because the \$170,000 deduction saved 35 percent of this amount in taxes. If we

eliminate the \$170,000, the tax benefit would also be eliminated. Thus, the firm would only benefit by 65 percent of

\$170,000, based on a 35 percent tax rate. The after-tax benefit of the tax adjustment for the extraordinary loss is

\$110,500.

A. Recompute the same ratios for 2015 using the adjusted net income figure of \$310,818.

4. Write a one-paragraph description of trends that appear to have taken place over the three-year time period

(Refer to question 1 above for 2013 and 2014 data and question 3 above for the adjusted net income numbers

for 2015).

5. Write a one-paragraph analysis of the company’s profitability ratios compared to the industry ratios (Figure 3

above) using the revised ratios for 2015 from question 3 above. Include asset turnover and debt to total assets

as supplemental material in your analysis.

6. Calculate the Asset Utilization ratios for 2015 using the formulas provided in section “B. Asset Utilization Ratios”

within Chapter 3:

1. Receivable turnover (Note: For the Receivables turnover ratio, only half the sales are on credit

terms.)

2. Inventory turnover

3. Fixed Asset turnover

7. Write a brief one-paragraph description of any trends that appear to have taken place. Compare Harrod’s sales

to total assets ratio to the industry in your description.

8. Write a one-paragraph conclusion that provides analysis of your answers to questions 4 and 5 above.

a. Include your opinion on whether or not Becky Harrod has a legitimate complaint about being charged

2ó percent, instead of 1 percent over prime.