Question

As Beacon Company controller, you are responsible for informing the board of directors about its financial activities. At the board meeting, you present the following information.

	2017	2016	2015
Sales trend percent	147.0%	135.0%	100.0%
Selling expenses to sales	10.1%	14.0%	15.6%
Sales to plant asset ratio	3.8 to 1	3.6 to 1	3.3 to 1
Current ratio	2.9 to 1	2.7 to 1	2.4 to 1
Acid test ratio	1.1 to 1	1.4 to 1	1.5 to 1
Inventory turnover	7.8 times	9.0 times	10.2 times
Accounts receivable turnover	7.0 times	7.7 times	8.5 times
Total asset turnover	2.9 times	2.9 times	3.3 times
Return on total assets	10.4%	11.0%	13.2%
Return on stockholder’s equity	10.7%	11.5%	14.1%
Profit margin ratio	3.6%	3.8%	4.0%

After the meeting, the company’s CEO holds a press conference with analysts in which she mentions the following ratios.

	2017	2016	2015
Sales trend percent	147.0%	135.0%	100.0%
Selling expenses to sales	10.1%	14.0%	15.6%
Sales to plant asset ratio	3.8 to 1	3.6 to 1	3.3 to 1
Current ratio	2.9 to 1	2.7 to 1	2.4 to 1

Required

1. Why do you think the CEO decided to report 4 ratios instead of the 11 prepared?

2. Comment on the possible consequences of the CEO’s reporting of the ratios selected.

Short answer

1. CEO has reported only 4 rather than 11 ratios because all other 7 ratiosreflectunfavorable trends.
2. Reporting only 4 ratios will not provide complete information and mislead external users.

Step-by-step solution

Definition of Financial Ratios

Financial ratios are the metric that determines the financial health of the business entity by comparing various line items of the financial statements. It includes the determination of liquidity position, solvency position, and profitability position of the business entity.

Reporting 4 ratios instead of 11 ratios

The CEO has decided to report the above 4 ratios because these are the only ratios that reflect positive trends from 2015 to 2017. All other ratios reflect an unfavorable trend because they are declining. All other ratios reflect that the profitability of the business entity is declining each year. If the CEO reports these ratios, investors will not be attracted to the company.

Consequences of reporting 4 ratios

When the CEO reports only 4 ratios instead of all 11 ratios, the external users will not be provided with the overall financial health of the business entity and will arrive at misleading figures. It is because the CEO only reports favorable trends. If she reports unfavorable trends in front of analysts, it will change their decision to invest in the business entity.