Solvency ratios like current ratio and quick ratio measure the firm’s ability to meet its short-term maturity obligations as and when they fall due, they measure the liquidity risk of the firm whereby the lower the liquidity ratio the higher the liquidity risk and vice versa (Meir, 2008: Universalteacher4u.com, 2011). The users of Nike’s financial statements like creditors might need to calculate solvency ratios to determine the firm’s margin of safety for the creditors where the higher the ratio the more liquid Nike is and the more confident the creditors will be with the firm.
Profitability ratios, on the other hand, measure management effectiveness as shown by returns generated on sales and investment. If a firm has made a profit, then it will be able to meet its short-term obligations and shareholders will obtain reasonable returns on their investments in form of dividends (Meir, 2008: Universalteacher4u.com, 2011). These ratios enable the user of Nike’s financial statements to determine whether Nike’s management was able to control financial, production, and operating costs.
Table 1: Solvency and profitability ratios.
|Current ratio/ Current liabilities||=2,045,928/1,107,535 |
|Current assets – current liabilities||=2,045,928-1,107,535 |
|(Sales – cost of goods sold)/ sales x 100||= (4,760,834-2,865,280)/4,760,834 |
|= (3,789,668-2,301,423)/3,789,668= 39.27%|
|iv||Return on equity (ROE)|
|(Net income – Preferred dividends)/ Average common shareholders’ equity||= 399,664/((1,740,949 + 1,964,689)/2) |
|v||Return on assets (ROA)|
|[Net income + interest expense (1- tax rate)]/ Average total assets||=[399,664+(24,208 x 0.615 )/[(2,373,815+3,142,745)/2] |
|=[298,794+(15,282 x 0.609 )]/[(2,186,269+2,373,815)/2] |
Nike earned more money in 1995 than in 1994 using the figures in the income statement; this was due to its high sales, an increase of 25.63% compared with 1994 sales. The gross profit for 1995 was also higher than 1994 with a margin of 39.82% compared with the 1994 margin of 39.27%. But when using the cash flow statement, Nike made less money in 1995 than in 1994, which was due to high figures of non-cash items like depreciation, and deferred income among others as well as an increase in current assets like inventory, account receivables which reduced the cash from operations. On May 31, 1995, the firm had $216,071,000 in cash.
The profitability ratios as measured by ROE and ROA show an increase in the firm’s profitability from 1994 to 1995. The ROE shows an increase in profitability of the firm and the company’s ability to generate returns to equity shareholders from the owner-supplied fund. In 1995 the firm was more efficient than in 1994 in generating returns to providers of funds as shown by an increase in ROA from 13.51% to 15.03%.
Nike was more liquid in 1994 than 1995 but it was still able to pay its short-term obligations at a ratio of 2:1 in 1995 as the ratio was more than 1 which represented a margin of safety for the creditors where the higher the ratio the more liquid the firm was and the more confident the creditors were with the firm. Similarly, the firm had a less positive figure of working capital in 1995 compared with 1994 which indicates that the current assets were more than current liabilities in both years.
In 1995, the firm’s operations used cash instead of generating cash, for instance, the increase in account receivables, increase in inventory, and increase in other current assets. The major sources of cash in 1995 were from accounts payable, notes payable increase, and income from the Options exercise.
Table 2: Efficiency and Debt ratios.
|1||Fixed asset turnover|
|Sales/Total fixed assets||=4,760,834/1,096,817 |
= 4.34 times
|Cost of sales/ average stock||=2865280/((629742+470023)/2) |
= 5.12 times
|Number of days in a year/stock turnover||=365/5.21 |
= 70.06 days
|Total debt/ capital employed x 100||=1,178,056/3,142,745 |
|Long-term debt/ Equity x 100||= 10,565/1,964,689 |
The debt ratio indicates that Nike was not highly geared in 1995 as the ratio was less than 50%; it raised 37.48% of debt from total capital employed. Thus, the level of gearing was satisfactory since the ratio was less than 50% which means that the firm had low financial risk. The debt-to-equity ratio indicates that the firm was not highly geared as the ratio was less than 100%. This means that the firm raised only 0.54% of long-term debt as a proportion of the owners’ supplied fund or contribution.
Efficiency, as measured by fixed asset turnover, indicates that in 1995 the firm generated $4.34 of sales from every dollar invested in fixed assets. While inventory turnover shows that stock was turned 5.12 times and inventory days indicate that the firm took 70.06 days to convert its stock to sales.
In conclusion, in 1995 Nike was facing low financial risk as we have seen above, and it was also efficient in its stock turnover as it turned stock 5.12 times. The firm was very profitable and liquid which means that it was efficient in controlling costs of production, operating, and financing, and at the same time it was able to meet its short-term obligations. In the same year, the firm used more cash than in 1994 through increased current assets like inventory and account receivables.
Universalteacher4u. Ratio Analysis (2011). Web.
Meir, L. (2008). Financial ratio analysis. Web.