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Plume and Arrow: Ratio Analysis
Financial ratios are regarded important decision making tools for financial analysts, business owners, investors and lenders. In addition to helping users determine the stability or profitability of a given entity, ratios can also be used to diagnose the underlying problems of a given business. This text seeks to determine which company between Plume and Arrow is healthier and hence less risky from a financial perspective based on the interpretation of the ratio computations provided.
To begin with, Plume's ROE happens to be higher than that of Arrow. This effectively means that Plume's shareholders are better off than those of Arrow given the ability of the former to earn a higher profit than the latter for each invested dollar. When it comes to ROA, Porter and Norton (2010) define the same as "a measure of a company's success in earning a return for all providers of capital." In the presented scenario, Plume's ROA is higher than that of Arrow. This means that Plume's assets are in one way or the other used more efficiently...
The gross margin of Plume is also higher (although minimally) than that of Arrow meaning that when it comes to covering administrative as well as selling costs, the former is more efficient that the latter.
Arrow has a higher inventory turnover than Plume. In basic terms, this ratio seeks to determine the number of times a given entity 'turns over' its stock. Thus Arrow's stock is essentially sold out and subsequently restocked more times than that of Plume. However, when it comes to the collection period, the same seems to be higher in the case of Plume. This ratio according to Besley, Besley and Brigham (2011), "is used to evaluate the firm's ability to collect its credit sales in a timely manner." Hence in our case, Plume is more efficient in the collection of its credit sales than Arrow. Next, the fixed asset turnover of Arrow is significantly higher than that of Plume. This ratio as Besley, Besley and Brigham (2011) point out measures how effective an entity is in the utilization of its…
References
Besley, S., Besley, S. & Brigham, E.F. (2011). Principles of Finance (5th ed.). Mason, OH: Cengage Learning.
Porter, G.A. & Norton, C.L. (2010). Financial Accounting: The Impact on Decision Makers (7th ed.). Mason, OH: Cengage Learning.
Arrow Company and Plume Inc. Ratio Analysis Arrow Company and Plume Inc. Financial Ratio Computations Ratio Computation Arrow Company Computation Plume Inc. Rate of Return on Equity (ROE) $610,000/$2,189,200 $887,000/$2,682,000 Return on Assets $610,000/$3,855,700 $887,000/$4,477,500 Gross Margin $1,720,000/$4,175,000 $2,117,000/$4,705,000 Inventory Turnover $2,550,000/$435,000 $2,800,000/$595,000 The Collection Period $380,000/($4,175,000/365) $585,500/($4,705,000/365) Fixed Asset Turnover $4,175,000/1,695,000 $4,705,000/$2,512,000 Debt to Assets Ratio $1,601,500/$3,855,700 $1,790,500/$4,477,500 Debt to Equity Ratio $1,601,500/$2,189,200 $1,790,500/$2,682,000 Current Ratio $2,105,700/$845,500 $1,940,500/$1,375,000 Acid Test ($2,105,700 - $435,000)/$845,500 ($1,940,500 - $595,000)/$1,375,000 Analysis: Interpretation From the ratios computed in Table 1 above, it may be possible to tell which company is in better financial health than the other. To begin with, we can
This ratio eliminates the stock figure from that of current assets and like the current ratio; it is used to measure the liquidity of a firm. The quick ratio may in some instances be preferred over the current ratio as it is inherently difficult to turn some assets into cash. In regard to the two companies, the quick ratio brings out Plume Inc. As being more risky as it