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ABS Tire Company Financial Ratios

1. ABC Tire Company has grown a lot and has noticed that they are starting to take on a lot of debt in opening new retail installation locations. You are brought in as a consultant to analyze their financial situation. Look through the four types of financial ratios (liquidity, leverage, profitability, and market measure ratios). Briefly describe each type of ratio. Then figure out which type of financial ratios you would use to look at ABC Tires debt issues.

2. Selected information from the comparative financial statements of ABCTire Company for the year ended December 31, appears below:

2014

2013

Accounts receivable (net)
$ 180,000

$200,000

Inventory
140,000

160,000

Total assets
1,200,000

800,000

Current liabilities
140,000

110,000

Long-term debt
400,000

300,000

Net credit sales
1,330,000

700,000

Cost of goods sold
900,000

530,000

Interest expense
50,000

25,000

Income tax expense
60,000

29,000

Net income
150,000

85,000

There is no preferred stock and the tax rate is 30%.

Required:

Calculate each of the following for 2014:

a. Debt ratio

b. Debt-to-equity ratio

c. Times interest earned ratio

d. Gross margin percentage

e. Return on assets

f. Return on common stockholders' equity

Solution Preview

1) A description of each type of ratio is provided below:

Liquidity ratio—these ratios show if the company is able to fulfill its short-term debts. Hence, these ratios involve current assets and/or current liabilities.

Leverage ratios—these ratios indicate how much of the company's funds were borrowed. These ratios are used to analyze a company's ability to pay debts back in the long term. Creditors may use these ratios to determine if a company is able to satisfy its debt obligations in the long term. A high leverage ratio could indicate that the company has an increased risk ...

Solution Summary

This solution provides a description of each type of financial ratio that has been provided. An explanation of which type of financial ratio is appropriate in a certain situation is given. Formulas and step-by-step computations have been provided.

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