Himalaya Tea Company has provided you the following financial statements along with the relevant industry average ratios. Balance Sheet as on December 31, 2024 : : : : Accounts payable Rs 80,000…

a. Calculation of Financial Ratios

1. Liquidity Ratios

i. Current Ratio The current ratio measures the company’s ability to pay short-term obligations with its current assets. $$\text{Current Ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$$ Current assets = Cash (Rs 50,000) + Marketable securities (Rs 40,000) + Accounts receivables (Rs 100,000) + Inventories (Rs 200,000) = Rs 390,000 Current liabilities = Accounts payable (Rs 80,000) + Notes payable (Rs 60,000) + Other current liabilities (Rs 40,000) = Rs 180,000 $$\text{Current Ratio}=\frac{390,000}{180,000}=\text{2.17 times}$$

ii. Quick Ratio (Acid-Test Ratio) The quick ratio assesses immediate liquidity by excluding inventories. $$\text{Quick Ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$$ Quick assets = Cash (Rs 50,000) + Marketable securities (Rs 40,000) + Accounts receivables (Rs 100,000) = Rs 190,000 $$\text{Quick Ratio}=\frac{190,000}{180,000}=\text{1.06 times}$$

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2. Turnover Ratios

i. Total Assets Turnover This ratio indicates how efficiently assets generate sales. $$\text{Total Assets Turnover}=\frac{\text{Sales Revenue}}{\text{Total Assets}}$$ Total assets = Rs 650,000 $$\text{Total Assets Turnover}=\frac{1,500,000}{650,000}=\text{2.31 times}$$

ii. Inventory Turnover Measures how quickly inventory is sold. $$\text{Inventory Turnover}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$$ Assuming opening inventory = Closing inventory (Rs 200,000): $$\text{Inventory Turnover}=\frac{1,050,000}{200,000}=\text{5.25 times}$$

iii. Accounts Receivable Turnover Indicates how efficiently receivables are collected. $$\text{Accounts Receivable Turnover}=\frac{\text{Sales Revenue}}{\text{Average Accounts Receivable}}$$ Assuming opening receivables = Closing receivables (Rs 100,000): $$\text{Accounts Receivable Turnover}=\frac{1,500,000}{100,000}=\text{15 times}$$

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3. Profitability Ratios

i. Profit Margin Measures net income as a percentage of sales. $$\text{Profit Margin}=\frac{\text{Net Income}}{\text{Sales Revenue}}\times 100$$ \text{Profit Margin} = \frac{150,000}{1,500,000} \times 100 = \textbf{10%}

ii. Return on Assets (ROA) Assesses profitability relative to total assets. $$\text{ROA}=\frac{\text{Net Income}}{\text{Total Assets}}\times 100$$ \text{ROA} = \frac{150,000}{650,000} \times 100 = \textbf{23.08%}

iii. Return on Equity (ROE) Evaluates profitability for shareholders. $$\text{ROE}=\frac{\text{Net Income}}{\text{Shareholders’ Equity}}\times 100$$ Shareholders’ equity = Common stock (Rs 200,000) + Retained earnings (Rs 170,000) = Rs 370,000 \text{ROE} = \frac{150,000}{370,000} \times 100 = \textbf{40.54%}

iv. Times Interest Earned (TIE) Ratio Measures ability to cover interest payments. \text{TIE Ratio} = \frac{\text{Earnings Before Interest & Taxes (EBIT)}}{\text{Interest Expenses}} $$\text{TIE Ratio}=\frac{268,000}{18,000}=\text{14.89 times}$$

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b. Strengths and Weaknesses of Financial Position

Strengths

1. Strong Liquidity Position

   • The current ratio (2.17) exceeds the industry average (2), indicating good short-term solvency.
   • The quick ratio (1.06) is slightly below the industry average (1), but still acceptable, showing the company can meet immediate obligations.

2. High Profitability

   • Profit margin (10%) is significantly higher than the industry average (3%), suggesting efficient cost management.
   • ROA (23.08%) and ROE (40.54%) far exceed industry averages (9% and 12.9%, respectively), indicating strong profitability and efficient asset utilization.

3. Strong Interest Coverage

   • The TIE ratio (14.89) is well above the industry average (7), showing the company can comfortably cover interest payments.

4. Efficient Asset Utilization

   • The total assets turnover (2.31) is close to the industry average (3), indicating efficient use of assets to generate sales.

Weaknesses

1. Inventory Management Issues

   • While the inventory turnover (5.25) is high, the company holds Rs 200,000 in inventories, which may tie up excessive working capital. If sales decline, excess inventory could strain liquidity.

2. High Accounts Receivable Turnover but Potential Collection Risk

   • The accounts receivable turnover (15) is very high, but if credit policies are too lenient, the company may face bad debts, affecting cash flow.

3. Dependence on Retained Earnings

   • The company relies heavily on retained earnings (Rs 170,000) for equity financing, which may limit growth opportunities if dividends are prioritized.

4. Moderate Leverage

   • The company has long-term debt (Rs 100,000), but the TIE ratio (14.89) suggests it can handle debt comfortably. However, excessive debt could become risky if interest rates rise.

Conclusion

Himalaya Tea Company demonstrates strong profitability and liquidity compared to industry averages, with efficient asset management. However, inventory and receivables management require attention to prevent cash flow disruptions. The company’s high ROE and ROA suggest it is a financially sound entity, but monitoring working capital efficiency will be crucial for sustained growth.