Current Ratio
The current ratio is considered as one of the components of liquidity ratios utilized when determining the ability of a given company to clear off its short term financial debts after one year. The current ratio is identified by conducting a comparison of the organization’s current assets and current liabilities. If the current ratio acquired is greater or exceeds one, the company is in a good financial position to manage its operations effectively. However, when the current ratio is less than one, it indicates that the company’s financial position is compromising, and it would not be in a position to pay off all its debts. A company with more liabilities than assets is a bad investment and will result in accrual losses and bad debts in the long run.
Current Ratio = Current Assets Ă· Current Liabilities
$20,358Ă·$6,583 = 3.09
The company’s current ratio is greater than one, which implies that it is a good investment since it can clear all its debts and still ensure profitability. The owners of the company are also in a safe position of not losing their company because of appropriate liquidity ratio.
Debt to Asset Ratio
The debt to asset ratio represents the financial risk assessment results that a company is exposed to by financing a more significant percentage of their assets by borrowing debts from external sources such as financial institutions. It is advantageous when a firm utilizes their owners’ equity as capital to acquire the required assets. However, a company’s capital structure should strive to ensure that the going concern principle of the entity is effectively enhanced. The firm’s Debt to Asset Ratio is determined by dividing the total liabilities to the company’s total assets. If the ratio is high it implies that the company has financed most of its assets by debts and is in a risky position of losing its rights to the financiers of their assets.
Debt to Asset Ratio = Total liabilities Ă·Total Assets
Total Liabilities + Owners Equity= $96,255
Total Equity= $47,942
Total Assets= $96,255
Debt to Asset Ratio= ($96,255-$47,942)Ă·$96,255 =0.5 or 50%
The company’s debt to asset ratio is less than 1 or 100% which implies that the organization has financed most of its assets through equity capital and is able to service all its outstanding debts from external financial sources.
Return on Assets
The Return on Asset ratio is used to measure the percentage of income brought when the company utilizes their assets in different stages of production. The results acquired on return on investment enable the company to determine whether the amounts of money they invest in acquiring assets are converted into profits. A company with a higher return on investment number is in a better position since it is recording more financial returns from lower investments. Most companies strive to keep the return on investments rising over time to increase their profitability. Return on assets is determined by dividing the net profits by the total assets as a percentage.
Return on Assets= (Net Profit Ă·Total Assets) Ă—100%
N.P = $4,189
T.A = $96,255
= ($4,189Ă·$96,255) Ă—100% = 4.3%
The company’s return on assets is very low, which implies that they are not getting expected amounts of profits from their investments in an asset acquisition.
Increasing Net Income
The main area that requires improvements within the company is the Return on Assets since they are allocating a lot of resources to acquire assets that are not contributing towards the company’s profitability. The resources used to acquire resources can be channeled to other investments that will generate income for the company. Some of the measures that the company can undertake to improve the performance on return on assets are investing more resources to increase the production of quality commodities to increase sales volume.
Another option is to increase their commodities’ prices and consider the advantages of sourcing from other producers in the market. Evading options that may lead to increased tax debts and interest rates are also some of the effective ways of increasing the company’s income.
Reducing Expenditure on Assets
Reducing the amount and channeling the resources to other production factors will help increase the company’s profitability. Some of the ways of decreasing expenditure on assets are by implementing shorter credit terms to their customer to reduce the number of debts, putting up a proper mechanism to ensure efficiency in receivables collection to enhance financial income for the company.
Another effective way of reducing expenditure on assets is by making appropriate decisions on whether to lease or buy an asset. Leasing an asset may be convenient to the company since they will only have to pay for the period of time they utilized the asset. This helps reduce the amount of resources that go into wastage due to acquiring an asset that is not helpful during production. Increasing the rate of inventory turns and ensuring proper utilization of the significant assets will also enable the company to benefit from the investments made towards the assets.