Fashion Forward and Dream Design Investment Case Study

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Financial ratio analysis is a method for assessing firm performance based on comparative data included in financial statements such as balance sheets, income statements, and cash flows for a given period (The Finance Storyteller, 2019). Financial ratio analysis is used to determine whether a firm is healthy enough to get investment or loan capital to run. Profitability, short-term liquidity, long-term solvency, and market valuation are all measured using four measures (Heisinger & Hoyle, n.d.).

Calculation and Analysis

Profit Margin Ratio

According to Heisinger & Hoyle (n.d.), the profit margin ratio displays the profit made per dollar of net sales.” It is computed as net income divided by net sales. Hence, the calculation would be:

Profit margin ratio = Net income / Net sales

1. Profit Margin Ratio Fashion Forward (2018) = $136,500/$2,500,000 = 5.46%
2. Profit Margin Ratio Dream Design (2018) = $212,500/$5,400,000 = 3.94%

Profit margin ratio and ROA on the income statement are used to gauge profitability since they reflect the company’s capacity to create profits (Heisinger & Hoyle n.d.). According to the profit margin ratio, Fashion Forward produced 5.46% of net income for every dollar of net sales, whereas Dream Design generated 3.94%.

Return on Assets (ROA)

The return on asset’s ratio is used to calculate the amount of net income earned for every dollar invested in average assets. This ratio measures a company’s performance by comparing its profit (net income) to the capital it has invested in assets (Heisinger & Hoyle).

ROA = Net Income / Average Total Assets

Average Total Asset of Fashion Forward = (Total Asset in 2018 + Total Asset in 2017)/2 = ($2,747,000 + $2,805,000)/2 = $2,776,000

Average Total Asset of Dream Designs = ($4,381,250 + $4,450,000)/2 = $4,415,625

1. ROA Fashion Forward (2018) = $136,500/$2,776,000 = 4.92%
2. ROA Dream Designs (2018) = $212,500/$4,415,625 = 4.81%

According to the Return of Assets Ratio, Fashion Forward produced 4.92% of net income for every dollar of invested assets, whereas Dream Design generated 4.81%.

Current Ratio

The current ratio determines if a corporation has enough current assets to meet its current liabilities. The higher the current asset to current liability ratio, the stronger the company’s capacity to meet its short-term liabilities (Heisinger & Hoyle, n.d.).

Current Ratio = Current Assets / Current Liabilities

1. Current Ratio Fashion Forward (2018) = $1,297,000/$1,170,000 = 1.11
2. Current Ratio Fashion Forward (2017) = $1,285,000/$1,045,000 = 1.23
3. Current Ratio Dream Designs (2018) = $2,280,500/$1,625,750 = 1.40
4. Current Ratio Dream Designs (2017) = $2,295,000/$1,675,000 = 1.37

According to the current ratio, Fashion Forward had $1.11 (2018) and $1.23 (2017) in current assets for every dollar in current liabilities, whereas Dream Design had $1.40 (2018) and $1.37(2017) in current assets for every dollar in current liabilities (2017). From 2017 to 2018, the Fashion Forward ratio declined, but the Dream Design ratio climbed. Dream Design has a somewhat greater ratio than Fashion Forward, which has a 1.40 to 1 ratio. In general, a current ratio greater than one to one is better, indicating that the firm has enough current assets to meet current obligations.

Quick Ratio

The Quick ratio reflects a company’s short-term liquidity situation and capacity to satisfy short-term commitments using quickly convertible assets (Seth, 2022). It’s also known as the acid-test ratio (Heisinger & Hoyle). Thus, can be used to determine if a corporation has enough liquid assets to meet its current liabilities.

Quick Ratio = (Total current assets — Inventory) / Current liabilities

1. Quick Ratio Fashion Forward (2018) = ($1,297,000 — $112,000) / $1,170,000 = 1.01
2. Quick Ratio Fashion Forward (2017) = ($1,285,000-$105,000) / $1,045,000 = 1.13
3. Quick Ratio Dream Design (2018) = ($2,280,500-$200,000) / $1,625,750 = 1.28
4. Quick Ratio Dream Design (2017) = ($2,295,000-$215,000) / $1,675,000 = 1.24

According to the quick ratio, Fashion Forward had $1.13 in quick assets for every dollar in current liabilities in 2017 and $1.01 in 2018. This ratio declined somewhat from 2017 to 2018, although Dream Design improved slightly from 2017 ($1.24) to 2018 ($1.28). Dream Design has a significantly higher 1.28 to 1 ratio than Fashion Forward.

AR (Account Receivable) Turnover Ratio

This ratio assesses how successfully a firm uses and manages credit extended to consumers, as well as how fast short-term debt is recovered or paid (Murphy, 2022).

AR Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Average AR Fashion Forward = (AR in 2018 + AR in 2017)/2 = ($200,000 + $150,000)/2 = $175,000

Average AR Dream Design = ($250,000 + $275,000)/2 = $265,000

1. AR Turnover Ratio Fashion Forward = $2,000,000 / $175,000 = 11.43
2. AR Turnover Ratio Dream Design = $4,320,000 / $262,500 = 16.46

According to the AR turnover ratio, Fashion Forward collected receivables 11.43 times in 2018. It is less than the 16.46 times of Dream Design.

Average Collection Period

The average collection duration describes how long it takes to collect on credit sales on average (Heisinger & Hoyle, n.d.).

Average Collection Period = 65 / AR Turnover Ratio

1. Average Collection Period Fashion Forward = 365 / 11.43 = 31.94
2. Average Collection Period Dream Design = 365 / 16.46 = 22.18

Fashion Forward collected credit sales in 31.94 days on average, while Dream Design has shorter period 22.18 days.

Inventory Turnover Ratio

The inventory turnover ratio shows how many times inventory is sold and refilled in a certain time period (Heisinger & Hoyle, n.d.).

Inventory Turnover Ratio = Cost of Sales / Average inventory

Average Inventory Fashion Forward = (Inventory (2018) + Inventory (2017))/2 = ($112,000 + $105,000)/2 = $108,500

Average Inventory Dream Design = ($200,000 + $215,000)/2 = $207,500

1. Inventory Turnover Ratio Fashion Forward = $1,400,000 / $108,500 = 12.90
2. Inventory Turnover Ratio Dream Design = $3,250,000 / $207,500 = 15.66

According to the inventory turnover ratio, Fashion Forward sold and refilled goods 12.90 times in 2018, which is much less than Dream Design’s 15.66 times.

Average Sales Period

According to Heisinger and Hoyle (n.d.), the average sales period indicates how many days it takes to sell the company’s goods on average.

Average Sales Period = 365 / Inventory Turnover Ratio

1. Average Sales Period Fashion Forward = 365 / 12.90 = 28.29
2. Average Sales Period Dream Design = 365 / 15.66 = 23.30

Fashion Forward sold their inventory in 28.29 days on average, which is much longer than Dream

Design’s 23.30 days.

Debt to Equity Ratio

The debt-to-equity ratio is a variant of the debt to assets ratio that analyzes the balance of obligations and shareholders’ equity used to fund assets (Heisinger & Hoyle, n.d.).

Debt to Equity Ratio = Total Liabilities / Total Stockholders Equity

1. Debt to Equity Ratio Fashion Forward (2018) = $1,345,000 / $1,402,000 = 0.96
2. Debt to Equity Ratio Fashion Forward (2017) = $1,120,000 / $1,685,000 = 0.66
3. Debt to Equity Ratio Dream Design (2018) = $1,685,000 / $1,901,250 = 0.77
4. Debt to Equity Ratio Dream Design (2017) = $1,901,250 / $2,480,250 = 0.79

According to the debt to equity ratio, Fashion Forward had $0.66 in liabilities for every dollar in shareholders’ equity in 2017 and $0.96 in 2018. The Fashion Forward ratio climbed dramatically from 2017 to 2018, but the Dream Design ratio decreased somewhat, from 0.79 to 1 in 2017 to 0.77 to 1 in 2018. (2018).

Recommendation

According to the financial ratio analysis results, Fashion Forward has a greater profitability ratio than Dream Design and the industry average profit, as well as a larger debt to equity ratio that climbed significantly in the second year. Meanwhile, calculations using other assessment techniques, such as the liquidity ratio and solvency ratio, suggest that Dream Design outperforms Fashion Forward in terms of its capacity to cover its short-term liabilities. Despite the fact that both firms have adequate current assets to meet current liabilities due to a ratio greater than one to one. They also have more long-term debt and less capital than Fashion Forward. As a result, organizations are advised to invest in Dream Design.

Conclusion

To summarize, I would advise the organization to invest in Dream Design since Dream Design has a shorter time to sell inventories, better inventory management, faster credit-to-cash conversion, better liquidity management, and more flexibility in paying liabilities with current assets. All of these will make Dream Design a better choice.

References

Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers. https://2012books.lardbucket.org/books/accounting-for-managers/index.html

Murphy, C. B. (2022, July 10). Why the receivables turnover ratio matters. Investopedia. Retrieved August 1, 2022, from https://www.investopedia.com/terms/r/receivableturnoverratio.asp

Seth, S. (2022, July 27). What is the quick ratio? Investopedia. Retrieved August 1, 2022, from https://www.investopedia.com/terms/q/quickratio.asp

The Finance Storyteller. (2019, January 290). Financial Ratio Analysis. [Video]. YouTube. https://youtu.be/MTq7HuvoGck

Note:
This article is written based on University of The People Managerial Accounting (BUS 5110) written assignment by Fristy Tania in June 2022