Question

RNA Inc. manufactures a variety of consumer products. The company’s founders have run the company for 30 years and are now interested in retiring. Consequently, they are seeking a purchaser who will continue its operations, and a group of investors, Morgan Inc., is looking into the acquisition of RNA. To evaluate its financial stability and operating efficiency, RNA was requested to provide the latest financial statements and selected financial ratios. Summary information provided by RNA is as follows.

RNA INC. INCOME STATEMENT FOR THE YEAR ENDED NOVEMBER 30, 2018 (IN THOUSANDS)
Sales (net)	\(30,500
Interest income	500
Total revenue	31,000
Costs and expenses
Cost of goods sold	17,600
Selling and administrative expenses	3,550
Depreciation and amortization expense	1,890
Interest expense	900
Total costs and expenses	23,940
Income before taxes	7,060
Income taxes	2,800
Net income	\) 4,260

RNA INC. BALANCE SHEET AS OF NOVEMBER 30 (IN THOUSANDS)
	2018	2017
Cash	\( 400	\) 500
Short-term investments (at cost)	300	200
Accounts receivable (net)	3,200	2,900
Inventory	6,000	5,400
Total current assets	9,900	9,000
Property, plant, & equipment (net)	7,100	7,000
Total assets	\(17,000	\)16,000
Accounts payable	\( 3,700	\) 3,400
Income taxes payable	900	800
Accrued expenses	1,700	1,400
Total current liabilities	6,300	5,600
Long-term debt	2,000	1,800
Total liabilities	8,300	7,400
Common stock (\(1 par value)	2,700	2,700
Paid-in capital in excess of par	1,000	1,000
Retained earnings	5,000	4,900
Total stockholders’ equity	8,700	8,600
Total liabilities and stockholders’ equity	\)17,000	$16,000

SELECTED FINANCIAL RATIOS
RNA INC
	2017	2016	Current Inventory Average
Current ratio	1.61	1.62	1.63
Acid-test ratio	0.64	0.63	0.68
Times interest earned	8.55	8.50	8.45
Profit margin on sales	13.2%	12.1%	13.0%
Asset turnover	1.84	1.83	1.84
Inventory turnover	3.17	3.21	3.18

Instructions

(b) Explain the analytical use of each of the six ratios presented, describing what the investors can learn about RNA’s financial stability and operating efficiency.

Short answer

Each ratio has a different measurement that results in a different conclusion. The investor can monitor the future and minimize errors with the financial stability and operational efficiency of the RNA.

Step-by-step solution

Meaning of Ratio Analysis

Ratio analysis is a basic approach to assessing a company's health by examining the relationships between key financial indicators. Ratio analysis, according to many analysts, is the most important aspect of the analytical process.

Explaining the analytical use of each of the six ratios

Mentioned below is an analysis of each of the six measures, as well as what investors can learn about RNA’s financial stability and operational efficiency.

Current ratio

1. The ability to meet short-term obligations is measured using short-term assets.
2. The current ratio of RNA has come down from 1.62 to 1.57 in the last three years. This declining trend, along with the fact that it is below the industry average, is not a cause for danger; however, the company must be monitored in the future because the ratio assumes that non-cash current assets (especially inventory) can be converted into cash immediately at or near book value.

Acid-test ratio

1. The ability to pay off short-term debt is measured with the most liquid assets.
2. The acid-test ratio of RNA has remained consistent for the past three years, although it remains below the industry average. In addition, if inventory is not turned over quickly enough, a quick ratio means that RNA may have difficulty paying its short-term obligations.

Times interest earned

1. Current income measures the ability to meet interest obligations. If the ratio is large, long-term creditors will be protected.
2. Over the last three years, RNA's ratio has improved and is now higher than the industry average. This suggests that RNA has been paying off or refinancing debt while also expanding sales and profits, implying long-term stability.

The profit margin on sales

1. Each dollar of sales generates a certain amount of net income. It gives some insight into a company's ability to withstand cost increases or sales cuts.
2. Profit margins for RNA have been rising and are now higher than the industry average, reflecting a trend toward marginal operating efficiency. It also enhances the company's ability to cope with a slowdown in the economy, pay off debt and take fresh loans for expansion.

Asset turnover

1. Resource use measures efficiency, or the ability to produce sales through the use of assets.
2. The RNA ratio has improved somewhat and is now slightly above the industry average, indicating that the company is making good use of its assets and has the potential to generate revenue.

Inventory turnover

1. The efficiency with which inventory is sold and the effectiveness with which inventory investments are rented. It also gives you a starting point to find out if you have any obsolete inventory or pricing issues.
2. The ratio of RNA has been steadily declining and is now lower than the industry average. This slower-than-average pace could signal a drop in operational efficiency, concealed outmoded inventory, or overpriced stock items.