# Ratios Tell A Story 2007 Harvard Case Solution & Analysis

Return on Equity:

Return on equity is calculated using the net income and the equity capital of the ordinary shareholders. However, the fact that how much equity value a company has depended on the requirement of capital expenditure for developing the infrastructure at the establishment date of a company, the higher the initial expenditure is, the higher will be the required equity investment. Therefore, industries that require low initial investment in infrastructure or the other capital expenditure will have the lower shareholdersâ€™ equity and hence the highest return on equity. The analysis of the 13 companies reveals that company at #7 has the highest return on equity ratio, meanwhile, the analysis of provided industries shows that the airline industry does not require heavy investment in building the distribution channel because the airplanes are largely financed through debt capital and do not require a high level of equity investment for the purchase of airplanes.

Therefore, company number eleven can be classified in the airline industry. Further, the second highest return on equity ratio is of company at #3 and this company can be classified in the internet retail industry because the sales are made through the internet, hence, no investment is needed to develop infrastructure or distribution channels, therefore, they require low equity finance and as a result generate higher returns on shareholdersâ€™ equity.

Current Ratio:

The current ratio is calculated using the current assets and the current liabilities of a company and it measures that how much current liquid assets and the company has to pay off \$1 of its current liabilities. Further, the variables used in the calculation of current ratio are also used in determining the working capital of a company and the working capital itself depends on the working capital cycle. Meanwhile, the working capital cycles vary industry to industry, additionally, the industry that deals largely in cash transaction would have the lowest current ratio. Therefore, it can be evaluated that the companies in food and retail industries will have the lowest current ratio because they will have the shorter working capital cycle; hence, they will not need to maintain a high level of liquid assets to pay off the current liabilities. Therefore, the analysis shows that companies at #1, 6 and 10 are in the retail industry because they have the lowest current ratio of 0.78, 0.81 and 0.90 respectively.

Receivables Collection Period:

Receivable collection period measures the time period a company takes to convert its sales revenues into cash, hence, it uses the trade receivables and annual sales revenues calculate this ratio. However, the longest receivable collection period will mean that company is allowing a longer credit period for the customer to the payment their debts. Meanwhile, the analysis of given industries reveals that the banking industry issues loan for a much longer time period than in any other industry and even banking industry allows a credit period of more than one year for the repayment of a loan advanced to the customer either in the form of lease financing or a straight debt. Therefore, the company at #11 has the highest receivable collection period of 4803 days, which confirms that his company is in commercial banking industry. Further, the lowest collection period is of company at #6 which has been classified in merchandise retailer industry because companies in merchandise retail industry largely deal with cash transactions.

Inventory Turnover:

Inventory turnover ratio measures that how many times a company has sold its inventory equal to the average closing inventory during a year. Further, the highest inventory turnover means that company has sold more inventories while keeping the lowest inventory levels during the period and requires less investment in inventories. However, analysis of providing industries reveals that industries that deal in perishable goods will definitely have the highest inventory turnover, because the inventory is sold almost within four to seven days due the nonperishable nature of goods. Therefore, it can be established that companies in the food distribution industry will have the highest inventory turnover ratio, further; the analysis of the 13 companies reveals that company #10 and 12 has the highest inventory turnover ratio of 12.2 and 44.1 days respectively. Therefore, the company at number #10 and 12 can be categorized as in the food distribution and fast food industries respectively.

Gross Profit Margin:

Gross profit margin is calculated using the sales revenues and the gross profits, which in turn are calculated after deducting the cost associated with the provision of services or the cost of goods sold in manufacturing or trading industry. However, since the gross profit margins indirectly depends on the cost of goods sold or the cost associated with the provision of services, therefore, it can be established that companies in service or software industries will have the lowest direct cost of sales...................................

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