Ratio Analysis Practice Problems

Based on: Financial Statements & Spreading of Income Statement

Problem 1: Basic Income Statement Spreading & Profitability Ratios

Company: RetailPlus Inc. (Fiscal Year 2025)

Given Financial Data:

Item Amount ($000)

Total Sales Revenue 850,000

Cost of Goods Sold (COGS) 595,000

Depreciation & Amortization (included in COGS) 25,000

Selling, General & Administrative Expenses 142,000

Interest Expense 18,500

Other Non-operating Income 3,200

Income Tax Rate 25%

Total Assets (Year-End) 620,000

Total Equity 310,000

Required:
1. Spread the income statement to calculate: Gross Profit, EBITDA, EBIT, EBT, and Net Profit.
2. Calculate the following ratios:
Gross Profit Margin
Operating Margin (EBIT Margin) Net
Profit Margin
Return on Assets (ROA)
Return on Equity (ROE)
3. Interpret the company's profitability position.
 Solution to Problem 1
Step 1: Income Statement Spreading

Description Calculation Amount ($000)

Total Sales Revenue 850,000

Less: Cost of Goods Sold (COGS) (595,000)

Gross Profit 850,000 – 595,000 255,000

Less: Operating Expenses (SG&A) (142,000)

EBITDA 255,000 – 142,000 113,000

Less: Depreciation & Amortization (25,000)

EBIT (Operating Profit) 113,000 – 25,000 88,000

Less: Interest Expense (18,500)

EBT (Pre-Tax Profit) 88,000 – 18,500 69,500

Add: Other Non-operating Income 3,200

Profit Before Tax 69,500 + 3,200 72,700

Less: Income Tax (25%) 72,700 × 0.25 (18,175)

Net Profit 72,700 – 18,175 54,525

 Step 2: Profitability Ratio Calculations

Ratio Formula Calculation Result

Gross Profit Margin Gross Profit ÷ Revenue 255,000 ÷850,000

30.0%

Operating Margin EBIT ÷ Revenue 88,000 ÷850,000

10.4%

Net Profit Margin Net Profit ÷ Revenue 54,525 ÷850,000

6.4%

Net Profit ÷ Total Assets 54,525 ÷620,000

ROA 8.8%

Net Profit ÷ Total Equity 54,525 ÷310,000

ROE 17.6%

Step 3: Interpretation
Retail Plus Inc. demonstrates solid profitability:

Gross margin of 30% indicates healthy markup over cost of goods sold, typical for retail businesses.

Operating margin of 10.4% shows effective cost control after operating expenses.

Net margin of 6.4% reflects impact of interest expense (financial leverage) and taxes.

ROE (17.6%) > ROA (8.8%) confirms positive financial leverage – the company earns more on

borrowed funds than the cost of debt, creating value for shareholders.

The 2.0x spread between ROE and ROA (17.6% ÷ 8.8% ≈ 2.0) suggests moderate use of debt

financing.
 Problem 2: Liquidity & Solvency Analysis
Company: Tech Growth Ltd. (Balance Sheet as of Dec 31, 2025)

Balance Sheet Data ($000):

Assets Amount Liabilities & Equity Amount
Current Assets: Current Liabilities:
Cash & Equivalents 42,000 Accounts Payable 38,000
Accounts Receivable 65,000 Short-term Debt 25,000
Inventory 88,000 Accrued Expenses 12,000
Prepaid Expenses 5,000 Total Current Liabilities 75,000
Total Current Assets 200,000
Intangible Assets 50,000 Long-term Debt 200,000
Total Assets 600,000 Total Liabilities 275,000
Common Equity 325,000
Total Liabilities & Equity 600,000
Net PPE 350,000 Long-term Liabilities:
Net PPE 350,000 Long-term Liabilities:

Additional Information:

EBIT for 2025: $65,000,000

Interest Expense for 2025: $15,000,000
Annual COGS: $420,000,000
Required:
1. Calculate liquidity ratios:
Current Ratio
Quick Ratio (Acid-Test)
2. Calculate solvency/leverage ratios:
Debt-to-Equity Ratio
Debt-to-Assets Ratio Interest
Coverage Ratio
3. Evaluate the company's short-term liquidity risk and long-term solvency position.
Solution to Problem 2

Step 1: Liquidity Ratios

Current Ratio = Current Assets ÷ Current Liabilities

Quick Ratio = (Current Assets – Inventory) ÷ Current Liabilities

Ratio Calculation Result

Current
200,000 ÷ 75,000 2.67
Ratio

Quick (200,000 – 88,000) ÷ 75,000 =

1.49
Ratio 112,000 ÷ 75,000

Step 2: Solvency/Leverage Ratios

Debt-to-Equity = Total Debt ÷ Total Equity

Debt-to-Assets = Total Debt ÷ Total Assets
Interest Coverage = EBIT ÷ Interest Expense

Ratio Calculation Result

(25,000 + 200,000) ÷ 325,000 =

Debt-to-Equity 0.69
225,000 ÷ 325,000

Debt-to-
225,000 ÷ 600,000 37.5%
Assets

Interest
65,000 ÷ 15,000 4.33x
Coverage
 Step 3: Risk Evaluation

Liquidity Position (Short-term):

Current Ratio of 2.67 exceeds the healthy benchmark of 1.5–2.0, indicating strong ability
to cover short-term obligations.
Quick Ratio of 1.49 remains above 1.0 even after excluding inventory, confirming liquidity
isn't dependent on inventory liquidation.

Conclusion: Low short-term liquidity risk; company can comfortably meet upcoming
obligations.

Solvency Position (Long-term):

Debt-to-Equity of 0.69 indicates moderate leverage (69 cents debt per $1 equity) –
conservative capital structure.
Debt-to-Assets of 37.5% shows 62.5% of assets are equity-financed, providing
substantial cushion against downturns.
Interest Coverage of 4.33x means EBIT covers interest expense more than 4 times
– healthy but warrants monitoring if EBIT declines.
Conclusion: Strong long-term solvency with manageable debt levels; low risk of
default.
Problem 3: Comprehensive Ratio Analysis & Trend Interpretation

Company: Global Mart Corp. – Comparative Data for 2024 and

2025

Income Statement Data ($ millions):

Item 2025 2024

Revenue 1,250 1,100
Gross Profit 312.5 286.0
EBIT 95.0 88.0
Net Profit 58.0 55.0

Balance Sheet Data ($ millions):

Item 2025 2024

Total Assets 950 880

Total Equity 475 440

Inventory 210 180

Accounts Receivable 145 125

COGS 937.5 814.0

Required:
1. Calculate for both years:
Gross Profit Margin
Net Profit Margin ROA
ROE
Asset Turnover Ratio
Inventory Turnover Ratio
2. Analyze trends: Which ratios improved? Which deteriorated? Explain possible reasons.
3. Using DuPont Analysis, decompose ROE for 2025 into its three components and
interpret.
Solution to Problem 3

Step 1: Ratio Calculations for Both Years

Ratio Formula 2025 2024

Gross Profit 312.5 ÷ 1,250 = 286.0 ÷ 1,100 =

Gross Profit ÷ Revenue
Margin 25.0% 26.0%

58.0 ÷ 1,250 = 55.0 ÷ 1,100 =

Net Profit Margin Net Profit ÷ Revenue
4.64% 5.00%

Net Profit ÷ Avg. Total 58.0 ÷ 915 = 55.0 ÷ 840 =

ROA
Assets* 6.34% 6.55%

58.0 ÷ 457.5 = 55.0 ÷ 420 =

ROE Net Profit ÷ Avg. Equity*
12.68% 13.10%

Revenue ÷ Avg. Total 1,250 ÷ 915 = 1,100 ÷ 840 =

Asset Turnover
Assets* 1.37x 1.31x

Inventory Turnover 937.5 ÷ 195 = 814.0 ÷ 165 =

COGS ÷ Avg. Inventory*
4.81x 4.93x

*Avg. = (Beginning + Ending) ÷ 2. For 2025: Avg. Assets = (880+950)/2 = 915; Avg. Equity =
(440+475)/2 = 457.5; Avg. Inventory = (180+210)/2 = 195
Step 2: Trend Analysis

Improving Ratios:

Asset Turnover ↑ (1.31x → 1.37x): Company generated more revenue per dollar
of assets, indicating improved operational efficiency despite asset growth.
Revenue Growth: 13.6% increase (1,100 → 1,250) shows successful market
expansion.

Deteriorating Ratios:

Gross Margin ↓ (26.0% → 25.0%): Increased competition or rising input costs

compressed markup.

Net Margin ↓ (5.00% → 4.64%): Combined effect of lower gross margin and
possibly higher operating expenses relative to revenue growth.
ROA ↓ (6.55% → 6.34%) & ROE ↓ (13.10% → 12.68%): Profitability declined
despite revenue growth – "growth at the expense of margins."
Inventory Turnover ↓ (4.93x → 4.81x): Slower inventory movement suggests
potential overstocking or weakening demand.

Overall Assessment: GlobalMart is growing revenue but sacrificing profitability.

Management must address cost pressures before growth becomes value-destructive.
Step 3: DuPont Analysis for 2025

ROE = Net Profit Margin × Asset Turnover × Equity Multiplier

Where Equity Multiplier = Avg. Assets ÷ Avg. Equity

Component Calculation Value

Net Profit Margin 58.0 ÷ 1,250 4.64%

Asset Turnover 1,250 ÷ 915 1.37x

Equity Multiplier 915 ÷ 457.5 2.00x

ROE (DuPont) 4.64% × 1.37 × 2.00 12.70% ✓

DuPont Interpretation:

ROE of 12.68% is driven by moderate leverage (Equity Multiplier = 2.0x means

50% debt financing).
The primary weakness is low net margin (4.64%) – retail industry typically
operates on thin margins, but further compression threatens returns.
Asset turnover (1.37x) is respectable for retail but cannot fully compensate for
margin pressure.

Strategic Recommendation: Focus on cost control and inventory optimization to

restore gross margins before pursuing further growth.