WRITTEN ASSIGNMENT 7 

: FIANANCIAL RATIOS BUS 5110

Ratio analysis is a widely used technique for evaluating the financial performance of

companies for purposes of making investment decisions. It aids investors in making

comparisons of one accounting period with another for the same business entity or to compare

one business entity with another. Numerade.com(n.d). A single ratio is not sufficient to

adequately judge the financial situation of the company. Several ratios must be analyzed

together and compared with prior-year ratios, or even with other companies in the same

industry. This comparative aspect of the analysis is extremely important in financial analysis.

Dheeraj Vaidya, CFA, FRM (n.d). Different ratios are used to measure different metrics

effectiveness. For the purpose of our work, we will discuss financial analysis of two

companies, the Fashion Forward and Dream Designs. Therefore, ratios will be used to

compare the two companies to see which company potential investors should invest in. Our

work will consist in computing the following ratios for each company:

 Profit Margin Ratio

 Return on Assets

 Current Ratio

 Quick Ratio

 AR Turnover Ratio

 Average Collection Period

 Inventory Turnover Ratio

 Average Sales Period

 Debt to Equity Ratio

PROFIT MARGIN RATIO

A profit margin ratio is often used by investors and creditors to determine a company's ability to

convert the profit made from sales into net income. Indeed Editorial Team (February 23, 2021).

The profit margin ratio will be computed by employing this calculation:

Profit margin = (net income / net sales) x 100

Fashion Forward = 136,500/250,000= 5.46%

Dream Designs = 212,500 / 5,400,000=3.94%

In this case, Fashion Forward has a better profit margin th an Dream Designs.

RETURN ON ASSETS

Return on assets. Calculates the ability of management to efficiently use assets to

generate profits. A low return indicates a bloated investment in assets.

Accountingtools.com (March 10, 2021 ). Return on assets is found by taking the net income

divided by the average total assets.

Fashion Forward = 136,500/ (2,747,000 + 2,805,000)/2 = 136,500/2,776,000 = 4.92%

Dream Designs = 212,500 / (4,381,250 +4,450,000)/2=212,500/4,415,625=4.81%

Fashion Forward has a better return on assets ratio.

CURRENT RATIO
Current ratio. Compares current assets to current liabilities, to see if a business has

enough cash to pay its immediate liabilities. Accountingtools.com ( March 10, 2021 ). To

calculate the ratio, current assets are divided by current liabilities.

Fashion Forward = 1,297,000/1,170,000=1.11

Dream Designs =2,280,500/1,625,750=1.40

Dream Designs current ratio is higher than Fashion Forward.

QUICK RATIO

Quick ratio is used to determine if accompany has adequate quick assets that can measure a

company’s ability to meet its short-term obligations (Heisinger & Hoyle, n.d.). It is found by

taking the current assets minus the current inventory divided by liabilities.

Fashion Forward = (1,297,000-112,000)/1,170,000=1.01

Dream Designs = (2,280,500-200,000)/1,625,750=1.28

From the above, Dream Designs has a higher quick ratio than Fashion Forward.

AR TURNOVER RATIO

The accounts receivable turnover ratio is useful for companies because it gives the business owner an

idea of how well the company is managing its revenue and assets. A better turnover ratio means that

a company has been more successful at receiving payments from customers over a given period of

time for products or services they have delivered. Indeed Editorial Team (March 5, 2021)

The formula for calculating the accounts receivable turnover ratio is:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Fashion Forward = 2,000,000 / (200,000 + 150,000) / 2 = 2,000,000/ 175,000 = 11.43

Dream Designs = 4,320,000 / (250,000 + 275,000) / 2 = 4,320,000 / 262,500 = 16.46

Here, Dream Designs has a better AR turnover ratio.

AVERAGE COLLECTION PERIOD

The average collection period is the average amount of time it takes for companies to receive

payments from its customers. For example, if you pay for a product using your credit card, the

amount of money due to the business is accounts receivable. The time it takes these businesses to

receive your payment is the average collection period. Companies use it to determine if they have the

financial means to fulfill their obligations. It's important that the collection period is calculated

accurately in order to determine how well a business is doing financially and to know if they're

maintaining smooth operations. Indeed Editorial Team (March 5, 2021)

The formula for calculating the accounts receivable turnover ratio is:

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Fashion Forward = 365 / 11.43 = 31.93 Days

Dream Designs = 365 / 16.46 = 22.17 Days

Dream Designs has a shorter collection period.

INVENTORY TURNOVER RATIO

Inventory turnover. Calculates the time it takes to sell off inventory. A low turnover

figure indicates that a business has an excessive investment in inventory, and therefore is

at risk of having obsolete inventory. Accountingtools.com (March 10, 2021 ). It is found

by the cost of goods sold/ average inventory.

Fashion Forward = 1,400,000 / (112,000 + 105,000) / 2 = 1,400,000 / 108,500 = 12.90

Dream Designs = 3,250,000 / (200,000 + 215,000) / 2 = 3,250,000 / 207,500 = 15.66

Dream Designs has a better inventory turnover.

AVERAGE SALES PERIOD

The average sale period (PMV) is one of the phases of the average maturity period

(PMM) . It is an economic indicator that allows us to have an idea of the time it takes to sell a

product since its completion. Abdullah Sam (March 19, 2020)

It is found by taking the sales period divided by the turnover inventory.

Fashion Forward = 365 / 12.90 = 28.29 Days

Dream Designs = 365 / 15.66 = 23.31 Days.

DEBT TO EQUITY RATIO

Debt to equity ratio. Compares the proportion of debt to equity, to see if a business has

taken on too much debt. Accountingtools.com (March 10, 2021). It is found by taking the

total liabilities divided by the total equity.

Fashion Forward = 1,345,000 / 1,402,000 = 0.959

Dream Designs = 1,901,250 / 2,480,000 = 0.767

In conclusion, I would recommend potential investors to pick Dream Designs based on the

ratios, as while, Forward Fashion had a higher profit margin than Dream Designs, almost

every other metric is significantly more in favor to Dream Designs.

References :

Dheeraj Vaidya, CFA, FRM (n.d).Ratio Analysis. Retrieved from :

https://www.wallstreetmojo.com/ratio-analysis/#vertical

Numerade.com(n.d).Retrieved from : https://www.numerade.com/ask/question/ratio-analysis-

is-a-widely-used-technique-for-evaluating-the-financial-performance-of-companies-for-
purposes-of-making-investment-decisions-it-aids-investors-in-making-comparisons-of-one-
acc46124/?
gclid=EAIaIQobChMIltKV8_jY8wIVThkGAB0uJwM9EAMYAyAAEgIjU_D_BwE
Indeed Editorial Team (February 23, 2021). How to Calculate a Profit Margin Ratio. Retrieved
from : https://www.indeed.com/career-advice/career-development/how-to-calculate-profit-
margin ratio#:~:text=Profit%20margin%20is%20the%20ratio,Total%20Expenses
%20)%20%2F%20Total%20Revenue.

Accountingtools.com (March 10, 2021 ). Ratio analysis definition. Retrieved from :

https://www.accountingtools.com/articles/ratio-analysis.html

(Heisinger & Hoyle, n.d.). Accounting for Managers. 

. Indeed Editorial Team(March 5, 2021). How To Calculate Accounts Receivable and Related
Formulas. Retrieved from : https://www.indeed.com/career-advice/career-development/how-
to-calculate-accounts-receivable

Abdullah Sam, (March 19, 2020). Average sales period (PMV). Retrieved from :
https://notesread.com/average-sales-period-pmv/