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Ratios- Industry averages The president of Brewster Company has been concerned about its
operating performance and financial strength. She has obtained, from a trade association, the
averages of certain ratios for the industry. She gives you these ratios and the companys most
recent financial statements (in thousands of dollar). The balance sheet amounts were about that
same at the beginning of the year as they are now.
Brewster Company, Balance Sheet as of December 31, 19X6
Assets Equities
Cash $ 860 Account Payables $ 975
Accounts receivable 3,210 Accrued Expenses 120
Inventory 2,840 Taxes Payable 468
Total current assets $ 6,910 Total current liabilities $ 1,563
Plant and equipment, net 7,000 Bonds Payable, due 19X9 6,300
Common Stock, no par 4,287
Retained earnings 1,850
Total assets $ 14,000 Total equities $ 14,000






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Brewster Company, Income Statement for 19X6

Sales $ 11,800
Cost of goods sold 7,350
Gross profit $ 4,450
Operating Expenses, including $650 depreciation 2,110
Operating Profit $ 2,340
Interest Expenses 485
Income Before Taxes $ 1,855
Income Taxes at 40% 742
Net Income $ 1,113

Brewster has 95,000 shares of common stocks outstanding, which gives earnings per share of $
11.72 ($ 1,113,000/95,000). Dividends are 5$ per share and the market price of the stock is $120.
Average ratios for the industry are as follows:

Current Ratio 3.8 to 1 Return on equity 17.5%
Quick Ratio 1.9 to 1 Price-earnings ratio 12.3
Accounts receivable turn over 4.8 times Dividend Yields 3.9%
Inventory turnover 3.6 times Payout ratio 38.0%
Return on sales 7.6 % Debt Ratio 50.0%
Return on Assets 17.6% Time interest earned 6 times
Cash flow to total debt 25.0%
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Required
1. Compute the ratios shown above for Brewster Company
Prepare comments to the president indicating areas of apparent strength and weaknesses for
Brewster Company in relation to the industry.





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Industry Average

1. Current Ratio = Current Assets = 6,910 = 4.42 VS. 3.8
Current Liabilities 1,563

Strength- higher than industry, better ability to pay current debts.
2. Quick Ratio = Cash + receivables + marketable securities
Current Liabilities
= 860 + 3,210 = 4,070 = 2.61 VS. 1.9
1,563 1,563

Strength- higher than industry, better ability to pay current debts.
3. Accounts Receivables Turnover = Net Credit Sales = 11,800 = 3.68 VS. 4.8
Average Account Receivable 3,210

Weakness- slower in generating sales compared to industry
4. Inventory Turnover = Sales = 11,800 = 4.16
Inventory 2,840
OR
Cost of Good sold = 7,350 = 2.59 VS. 3.60
Average Inventory 2,840

Weakness- slower in converting inventories to sales
5. Return on Sales = net income (before interest and tax)
Sales
= 1,855 + 485 = 2,340 = .20 or 20% VS. 7.6
11,800 11,800

Strength- able to generate more income from its sales (higher
profitability rate compared to peers- more efficient in producing sales
either due to lower cost or higher sales price imposed to market)
6. Return on Assets = Net Income = 1,113 = 0.08 or 8% VS. 17.6%
Total Assets 14,000
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Weakness lower than industry, not being able to generate income
from its assets
7. Cash Flow to Total Debt = Operating Cash Flow = 860
Total Debt 975 + 468+ 6,300
= 860 = .12 or 12% VS. 25%
7,743

Weakness not enough cash to pay-off debts compared to industry
8. Return on Equity = Net Income = 1,113 = 1,113 = .18 or 18% VS. 17.5%
Share Holders Equity 4,287 + 1,850 6,137

Strength- higher than industry, able to generate more income from
money invested by owners

9. Price earnings Ratio = Marketing Value Per Share = 120 = 10.24 VS. 12.3%
Earnings per share 11.72

Weakness - Lower than industry, market perception has to be
improved
10. Dividends Yield = Annual Dividends Per Share = 5 = 0.5 or 5 % VS. 3.9%
Price per Share 120

Strength- higher than industry, able to pay-out more than industry-
favorable to owners
11. Payout Ratio = Dividends Per Share = 5 = 0.43 or 43% VS. 38%
Earnings Per Share 11.72

Strength- higher than industry, able to pay-out more than industry-
favorable to owners
12. Debt Ratio = Total Debt = 975 + 120 + 468 +6,300 = 7,863 = .56 or 56% VS. 50%
Total Assets 14,000 14,000
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Weakness higher than industry, more leveraged than others in the
industry
13. Time Interest Earned = Earnings Before Interest & Taxes (Ebit)
Total Interest payable on Bonds & other Contractual Debt

= 2,340 = 4.82 VS. 6.00
485

Weakness earnings is much more lower than industry in covering
interest payments


Brewster needs to find ways and means to maximize use of its assets to further improve its
earnings as evidenced by 8% return on their assets compared to industry average of 17.6%. This
is also shown in its 10.24% price-earnings ratio as compared to the industry average of 12.3 %
and further in earning interest only 4.8 times over as a compared to the industrys rate of 6. The
company, as a result, obtains only 12% cash to cover its debts as against industry average of
25%.

The company is able to pay out its shareholders well as evidenced by 5% dividends yields and
43% payout ratio compared to industry averages of 3.9% and 38% respectively. Other ratios
directly related to operations, such as its current ratio of 4.42 and quick ratio of 2.61 which are
relatively higher industry averages, also help in its achieving profitability although needing
further improvement.