BUS 5110 - Managerial Accounting

Written Assignment Unit 7

23 December - 29 December
Dr. Angela Palmer
Professor
Instructions for submission

Submit a paper which is 2-3 pages in length (no more than 4-pages), exclusive of the reference page.
The paper should be double spaced in Times New Roman (or its equivalent) font which is no greater
than 12 points in size. The paper should cite at least three sources in APA format. One source can be
your textbook.

Please describe the circumstances of the following case study and recommend which company to
purchase. Explain your approach to the problem, perform relevant calculations and analyses, and
justify your recommendation. Ensure your work and conclusions are thoroughly supported

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

• Return on Assets
• Current Ratio
• Quick Ratio
• AR Turnover Ratio
• Average Collection Period
• Inventory Turnover Ratio
• Average Sales Period
• Debt to Equity 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.

• Articulate how the calculations were performed.
• Evaluate the ratios computed and explain the meaning of the ratios.
• Compare the companies.
• Recommend which company to pursue, supported by well-thought-out rationale and
considering any other factors that could impact the recommendation.

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.
 INTRODUCTION
Many different ratios can be used to evaluate a company's financial performance. In addition to trend analysis and
standard size analysis, financial ratios benefit managers, investors, and other stakeholders. Financial analysts
frequently employ ratios in their work. Financial health metrics by themselves don't reveal much about a company's
state of health but using industry averages or those of a competitor, can help to alleviate this problem (Mowen et
al., 2018).

Financial Ratio Analysis are categorized into four groups as follows (Heisinger & Hoyle, n.d):

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.

The table below shows the computation of ratios followed by calculation description and evaluation of ratios for
two companies: Kindly take note that back up calculations can be found in the attached excel file for this
assignment.

CASE ANALYSIS
Fashion Forward Dream Designs
Ratio Analysis Formula REMARKS
Computation Answer Computation Answer
Profitability Measure
The ratios for both businesses are positive however
they are quite low.A good margin will vary
Profit Margin Ratio Profit Margin Ratio = 212
considerably by industry, but as a general rule of
Profit Margin Ratio Net Income/Net Sales =136,500/ 5.46% ,500/ 3.94%
thumb, a 10% net profit margin is considered
2,500,000 5,400,000
average, a 20% margin is considered high (or
“good”), and a 5% margin is low

Both businesses have positive return on assets.

This indicates an upward profit trend.An ROA of 5%
Return on Asset =136,500/ Return on Asset = 212 ,500/ or better is typically considered good, while 20% or
Return in Assets Net Income/Average Total Assets 4.92% 4.81%
2,776,000 4,415,625 better is considered great. In general, the higher
the ROA, the more efficient the company is at
generating profits.
Short Term Liquidity Measures
Dream Designers has a higher current ratio which
Current Ratio =1,297,000/ Current Ratio = 2,280,500/ indicates that it has (1.4 current asset to 1 current
Current Ratio Current Asset/Current Liabilities 1.11 to 1 1.40 to 1
1,170,000 1,625,750 liabilities) more current assets than liabilities to
covers its debts as compared to Fashion Forward.

Dream Designer has a $1.21 to cover each $1 of

(Cash, Marketable Securities+Accounts 950,000 +200,000/ 1,710,000+250,000/ debt and is fully equipped with exactly enough
Quick Ratio .98 to 1 1.21 to 1
Receivable)/Total Current Liabilities 1,170,000 1,625,750
assets to be instantly liquidated to pay off its
current liabilities than that of Fashion Forward.

Dream Designs receivables collections is higher

Credit Sales/Average Accounts 2,000,000/ 4,320,000/ than that of fashion forward which indicate that a
AR Turn Over Ratio 11.43 to 1 16.46 to 1 company's collection of accounts receivable is
Receivable ( 200,000+ 150,000)/ 2 ( 250,000+ 275,000)/ 2
efficient and the company has a high proportion of
quality customers that pay their debts quickly.
Dream Design has better collection
Average Collection Period 365 Days /AR Turn Over Ratio 365 Days /11.43 31.94 Days 365 Days /16.46 22.18 Days period than Fashion Forward as it only takes 22
days to convert Accounts Receivable into cash.
Dream designs is more efficient in
converting inventory to cash.The higher the
105000+112000 / 200,000+215,000/
Inventory Turn Over Ratio Cost of Goods Sold/Average Inventory 12.90 Times 15.66 Times inventory turnover, the better, since high inventory
2 2 turnover typically means a company is selling goods
quickly, and there is considerable demand for their
products.

Dream design has a shorter time to sale in

Average Sales Period 365 Days /Inventory Turn Over Ratio
Total Liabilities/Total Shareholders
Debt to Equity Ratio
Equity
365 Days /12.90 28.29 Days 365 Days /15.66 23.30 Days comparison to fashion forward which can indicate
that the sales team of this company is
outperforming Fashion Forward..
Long Term Solvency Measures
Although both companies as lower than 1 Debt to
1, 345,000/ 1, 901,250/ Equity ratio, Dream Designs has a much lower debt
.96 to 1 .77 to 1
1,40 2,000 2,480 ,000/ to equity ratio meaning they run operations with
more of owner’s funds than debt.
• 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

This ratio helps in determining the efficiency with which the affairs of business are being managed.
Fashion Forward has Profit Margin of 5.46% , indicating the net mar- gin of 5.46 for every 100 of
sale. Dreams Design has a Profit margin of 3.9% which indicates a net margin of 3.9 for every 100 of
sale.
The ratios for both businesses are positive however they are quite low. A good margin will vary
considerably by industry, but as a general rule of thumb, a 10% net profit margin is considered
average, a 20% margin is considered high (or “good”), and a 5% margin is low. Fashion Forward,
according to the conclusions of the investigation, has a higher profit margin ratio and is more
efficient at converting its investment into earnings than Dream Design.

• 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

Fashion Forward has Return on Assets =4.9% which indicates a net income of 4.9 for using 100 of
net assets. Dreams Design has Return on Assets =4.8% which indicates a net income of 4.8 for using
100 of net assets.
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)

Both businesses have positive return on assets. This indicates an upward profit trend. An ROA of 5%
or better is typically considered good, while 20% or better is considered great. In general, the higher
the ROA, the more efficient the company is at generating profits.

• Current Ratio – is a short-term liquidity ratio which shows whether an organisation has
enough current assets to cover current liabilities. It helps credit analysts decide the ability of a
business to repay its debts.
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. Dream Designers has a higher current ratio which indicates that it has (1.4 current asset to
1 current liabilities) more current assets than liabilities to covers its debts as compared to Fashion
Forward.

• Quick Ratio – is a short-term liquidity ratio which shows whether a company has
enough quick, or highly liquid, assets to cover current liabilities. This ratio is an indicator of
Short term solvency of a company. How much liquid assets are there to satisfy the current
debts are examined by this ratio.
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.
Dream Designer has a $1.21 to cover each $1 of debt and is fully equipped with exactly enough
assets to be instantly liquidated to pay off its current liabilities than that of Fashion Forward.

• 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 ratio indicates the speed with which money is collected from the debtor. Average receivable
includes both the Debtors and Bills receivables during the period.
The receivables turnover ratio indicates Fashion Forward collected receivables 11.43 times during
2018. This ratio is lower than Dream Designs’ 16.46 times.

Dream Designs receivables collections is higher than that of fashion forward which indicate that a
company's collection of accounts receivable is efficient, and the company has a high proportion of
quality customers that pay their debts quickly.

• 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: This indicates the credit period allowed to debtor to repay his debt.
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.

Dream Design has better collection period than Fashion Forward as it only takes 22 days to convert
Accounts Receivable into cash.

• 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

Inventory Turnover Ratio is a measure of the number of times inventory is sold or used in a time
period, such as a year (Lumen, B.F (n.d)). This ratio indicates whether the investment in inventory is
efficiently used and whether it is in proper limits and also the liquidity of inventory. High inventory
turnover indicates risk sales and vice-versa.
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.
Dream designs is more efficient in converting inventory to cash. The higher the inventory turnover,
the better, since high inventory turnover typically means a company is selling goods quickly, and
there is considerable demand for their products.
• 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 days sales of inventory is a financial ratio that indicates the average time in days that a company
takes to turn its inventory, including goods that are a work in progress, into sales.
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.
Dream design has a shorter time to sale in comparison to fashion forward which can indicate that the
sales team of this company is outperforming Fashion Forward.

• 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
Although both companies as lower than 1 Debt to Equity ratio, Dream Designs has a much lower
debt to equity ratio meaning they run operations with more of owner’s funds than debt.

ANALYSIS and CONCLUSION

Fashion Forward, according to the conclusions of the investigation, has a higher profit margin ratio
and is more efficient at converting its investment into earnings than Dream Design. In part because
to its short-term assets, Dream Design is in a better position to satisfy short-term liabilities, and in
part due to its current assets, Dream Design has the most easily available current assets to satisfy
short-term commitments. Dream Design is also more aggressive than the competitors when it comes
to collecting money from clients (debt). The cash conversion period for Fashion Forward is
significantly shorter when compared to the time for other retailers. Apart from that, Dream Design is
incredibly efficient in the management of its stocks, as well as in the collecting of commissions from
the sales of its products to consumers (trade receivables). Finally, Dream Design has a smaller debt-
to-equity ratio than the average for the industry, indicating that the firm is less risky in general.
After conducting the case study, it is feasible to determine that Dreams Design is more efficient in
terms of corporate management than the industry average as compared to Fashion Forward.
However, Dream Design can consider improving its cost of goods sold while simultaneously raising
its sales, and only a modest amount of additional effort is necessary; otherwise, the entity is in a
competitive position in all aspects of the business. Because of this, I highly recommend to pursue
merger with DREAM DESIGN.
 REFERENCES

Corporate Finance Institute. (2020, March 2). Debt to Equity Ratio.

https://corporatefinanceinstitute.com/resources/knowledge/finance/debt-to-equity-ratio-

formula/

Giacomino, D. E., & Mielke, D. E. (1993). Cash Flows: Another Approach to Ratio Analysis. Journal

of Accountancy, 175(3), 55-58.

Heisinger,K.,&Hoyle,J.B.(n.d.).AccountingforManagers.https://2012books.lardbucket.org/books/ac

counting-for-managers/index.html

Horrigan, J. O. (1968). A short history of financial ratio analysis. The Accounting Review, 43(2), 284-

294.

Johnson, C. G. (1970). Ratio analysis and the prediction of firm failure. The Journal of finance, 25(5),

1166-1168.

Lumen , B.F (n.d). Asset Management Ratios. Retrieved from https://courses.lumenlearning.com/

boundless-finance/chapter/asset-management-ratios/

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.

My Accounting Course. (n.d.). Profit Margin Ratio. Retrieved August 5, 2020, from

https://www.myaccountingcourse.com/financial-ratios/profit-margin-ratio

Nissim, D., & Penman, S. H. (2001). Ratio analysis and equity valuation: From research to

practice. Review of accounting studies, 6(1), 109-154.

Salmi, T., & Martikainen, T. (1994). A review of the theoretical and empirical basis of financial ratio

analysis. News Group, (_001).