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Accounting Ratio Analysis

Accounting Ratio Analysis and Memo For Peyton Approved

Introduction
Financial ratios in company analysis reflect the financial position or the state of a company’s
financial status at a particular time or for a specified period of time. These ratios reveal the
profitability of the firm, liquidity position, debt or gearing ratio. Ratio analysis provides a
diagnostic tool that assists to identify the problematic areas as well as the areas that the company
can exploit and the opportunities involved. This information is critical to investors who are
mostly interested in earning profits from their investments (Harrison & Hongren, 2001).
The following are the ratios of Peyton;
Peyton Approved 2014
Current Ratio Total Current Assets/Total current liabilities 2.74
Quick Ratio TT C/ Assets – inventories /TT/ C Liabilities 2.68
Receivable turnover Annual credit sales/average receivables
Inventory Turnover Cost of goods sold/Average inventory 63.81
Asset turnover Sales/Average total assets 2.12
Dividend yield Div per Share / Current Share price 0.03
Dividend cover EPS/ Dividend per Share 4.55
Net assets turnover Net assets / total sales 0.31
Times interest earned EBIT/Annual Interest Expense 58.05
Debt to total Asset Debt/Assets 0.17
Book value per share Value of shares/div paid 1.58
Interest cover EBIT/Annual Interest Expense 58.05

Accounting Ratio Analysis and Memo 2
Profit margin on sale GP/sales 0.40
R.R return on assets EAT/Total Assets 0.57
R.R com stock equity Profit after taxes/Shareholders equity 0.86
Earnings per share Profit after taxes-pref div)/No. of comm O/S 1.54
Payout Ratio cash dividends/income 0.27
ROE Return On Equity (ROE) 0.86
ROA Return on average Assets 0.57
Liquidity ratios
These ratios stem from assets that can be quickly converted into liquid cash and they provide
short term financial relief for the company in cases of emergency cash needs. Higher ratios
indicate better and greater liquidity for the company. The rule of thumb in most cases require a
ratio of at least 2:1 for the current ratios while for quick ratio should be 1:1. These ratios indicate
that the current assets should be higher than the current liabilities in the case of the current ratio
while the assets and the liabilities should be similar or the same incase of quick ratio. The current
ratio for Peyton Approved is 2.74:1. These mean that the current assets are 2.74 times more than
the current liabilities. The current assets are adequate to honor any commitments or obligations
that may arise because of the current liabilities (Hermanson, Edwards & Invacevich, 2011).
Peyton Approved quick ratio is 2.68:1. The current assets are more than the current liabilities by
2.68 to 1. The quick ratio is very favorable and the liquidity position of Peyton approved is very
stable. Instead of the standard 1:1 its 2.68:1.
Analyzing debt or Leverage ratios
The debt ratios indicate how much or to what extent a company is relying on debt to fund its
business operations and also investments. A company that cannot manage its debt portfolio
effectively may find itself with a lot of debts that may lead to bankruptcy in case of insolvency.

Accounting Ratio Analysis and Memo 3
However, planned use of debt can be beneficial to the company as it may provide tax incentives
and benefits.
Peyton Approved debt to asset ratio is 0.17:1 that’s the ratio of debt to total assets is 17%. The
long term debts of Peyton Approved are only 17% of the total assets. The ratio shows a positive
picture for the company.
The interest coverage ratio for Peyton Approved is 58.05 that’s the net earnings of the company
can payback the interest for the company’s debts 58.05 times. The company has enough ability
to pay all the fixed interest expenses that may accrue to the company because of the debt.
Analyzing Profitability ratios
It’s not easy to quantify the amount of profit that may be considered as relatively better than the
others but it can only be compared to the industry’s average. The net profit margin for Peyton
Approved is 3.72 the Return On Assets and the Return On Equity are 0.57 and 0.86 respectively.
It means that for every dollar invested in the company as equity the company pays back 0.86
dollars while the amount invested in the company as assets the company pays back 0.57. The
payout ratio for Peyton Approved is cash dividends divided by the net income = 9500/34830 =
0.27.

\$   \$
Peyton Approved \$ TT Assets- Inventories 55192
GP 52198 Interest Expense 600
Net Profit 34830 Average Receivables 1395
EAT 34830 Current Assets 56413
Share holders Equity 40330 Current Liabilities 20625
Total Assets 60955 Average total assets 60955
Total Liabilities 20625 Receivables 1395
Inventories 1221.05 Outstanding shares 15000

Accounting Ratio Analysis and Memo 4
Cost of Goods 77914 Payables 525
Average inventory 1221.05 Dividend per share 0.63333
Debt 10600 Earnings per share 2.322
EBIT 34830 Net assets 40330
Sales 129500 Net assets turnover 0.31143
Total Dividend Paid 9500 Net profit margin 3.71806
Analyzing Efficiency
The inventory turnover reflects how fast a company’s inventory is actually being produced and
the rate of sales. A higher ratio indicates more efficiency i.e. the rate of inventory turn-over to
make or generate sales. The inventory turnover for Peyton Approved is 63.81 times in six
months. The assets turnover for the company is equal to total sales divided by total assets =
129500/60955 = 2.13. The sales cover the assets 2.13 times more which means the company’s
performance is good.

Memo

To: The Bank Manager 26 th April 2015
From: Peyton Approved Accountant
Re: Peyton Approved Financial Status
Ratio analysis provides a diagnostic tool that assists to identify the problematic areas as well as
the areas that the company can exploit and the opportunities involved. This information is critical
to investors who are mostly interested in earning profits from their investments. The investors
use these information to decide whether to invest in a company or not depending on its
profitability, leverage or liquidity position.
The accounting system that Peyton Approved Company uses is based on accrual system where
the revenues are recognized when the sales have been made and not when cash has been

Accounting Ratio Analysis and Memo 5
received. For example when sales have been made on credit and the invoices have been raised
then the records reflect that the sales have taken place and when cash is received then the debtors
are credited with the amounts paid while the cash account is debited with the cash received.
These strategies have been selected to ensure that the accounting records comply with the
provisions of the company law that provide for accurate, fair and true representations of financial
statements.
The general accounting process commences with the subsidiary books that are known as the
journals and the day books. These are the journal proper, the sales day book, the purchases day
book, the purchases and the sales return day books. These books record the first transactions
before they are posted to the ledgers. The ledgers are made of the real, personal and the nominal
accounts. The general entry method is to debit the accounts that have received money goods or
services and to credit the accounts that have given money, goods or services.
The invoices are raised every time there is a credit transaction and the statements are sent to the
debtors at the end of the month. All the cash sales are banked the following day after the receipt
books have been reconciled. The receipts and the invoices are reviewed every day to control and
prevent any errors or omissions that may be committed or to unearth any fraud that may have
taken place.
The major internal controls that have been instituted to ensure that proper controls are followed
while handling cash are 1). All cash receipted immediately it has been received on receipts that
have been pre-numbered. 2). All the dates are also written clearly together with the quantities of
the sales involved. 3). The receipts are then added up and the stock sold is reconciled with the

Accounting Ratio Analysis and Memo 6
balance available in the stores on daily basis. 4). Ones every year external accountants have to
audit all the books of accounts including all the bank records, banking and bank statements.
Control procedures have been adopted to ensure compliance to the GAAP as well as the adoption
of the major accounting concepts that deal with accounting prudence, valuation and continuity
concepts.
The major results of the operations are the sales that have been made and the purchases that have
to be made to restock the inventory. The Gross profit margin is very favorable which currently
stands at 40% of the turnover.
The income statement shows a gross profit of \$52,198 which is about 40% of the total turnover
of Peyton Approved. The net profit for the company amounted to \$34830 and a net profit margin
of 3.72. The profitability of the company is in positive and favorable. The company’s
performance is encouraging and it may attract a lot of investors.
The balance also shows that debts are minimal and manageable. More debt would enable the
company to expand and also to grow. The company statements reveal that the company‘s
liquidity is very stable and the profitability margins are also favorably high. The financial
strength of the company stems from its strong financial base. The weaknesses of the company
are mostly the low closing stocks that may cause some interruptions in business activities when
apparently the stocks may run out unexpectedly.
The changes would be to increase the minimum stock levels to be about three thousand dollars in
value so as to provide a comfortable lead time in cases of stock shortages or other unforeseen
circumstances.

Accounting Ratio Analysis and Memo 7
The company’s financial weaknesses are its inability to take advantage of the debt portfolio to
expand and enlarge its business operations. The debt ratio for the company is very low. Peyton
Approved debt to asset ratio is 0.17:1 that’s the ratio of debt to total assets is 17%. The long term
debts of Peyton Approved are only 17% of the total assets. The ratio shows a positive picture for
the company but the company is actually loosing the opportunity to expand using the debt
portfolio that also has some tax benefits to the company.
The interest coverage ratio for Peyton Approved is 58.05 that are the net earnings of the
company can payback the interest for the company’s debts 58.05 times. The company has
enough ability to pay all the fixed interest expenses that may accrue to the company because of
the debt (Vance, 2003).
The company can take advantage of its low debt portfolio to seek financing from the banks in
order to finance its investments. Its stable profitability and leverage status are also part of its
strength. The significance of a stable liquidity can only be useful if the banks can advance you
loans based on the strength of its financial statements.
The company can explore its expansion strategy to expand its operations to foreign markets as
well adopt aggressive marketing strategies to increase its sales and expand to foreign markets.

Accounting Ratio Analysis and Memo 8
References
Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011) Accounting Principles: A Business
Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.
Harrison, W.T. & Hongren, C.T. (2001) Financial accounting (4th Ed). Englewood
Cliffs, NJ: Prentice Hall.
Vance, D. (2003) Financial analysis and decision making: tools and techniques to solve
financial problems and make effective business decisions. New York: McGraw-Hill.