Solution of Case Study 3—Ratio Analysis
Cuthbert & Co
This company will enjoy a high gross margin but the majority of the gross profit will be utilized by overhead expenses so that the profit margin will be low.
The inventory holding period and receivables collection period will be lengthy.
The company may suffer liquidity problems as it attempts to replenish inventory especially from those suppliers who do not offer credit terms in excess of 30 days.
The company will probably need short- and long-term finance which will be shown in a high debt/equity ratio and low return on equity.
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Conversely this company will have a much lower gross margin, but due to lower overhead expenses a superior profit.
The inventory holding period and receivables collection period will be very short in comparison.
Liquidity, especially cash, will be high.
If the company continues enjoying high levels of profits coupled with high levels of cash flow, it will be able to grow organically and easily source credit.