Accounting & FinanceLevel: Intermediate

Financial Ratio Analysis: A Worked Case Study

Prepared by the Assignment Achievers finance team.

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Problem Statement / Assignment Scope

Fenwick Manufacturing has current assets of £240,000 (including inventory of £90,000), current liabilities of £120,000, total debt of £180,000, equity of £360,000 and total assets of £600,000. Revenue for the year was £720,000 and net profit £54,000. Calculate and interpret its liquidity and gearing, and explain its return on equity.

Prerequisites: How a balance sheet and income statement are laid out, and basic percentages.

Step-by-Step Worked Solution

1. Liquidity

Current ratio: £240,000 / £120,000 = 2.0. Current assets cover short-term debts twice over.
Quick (acid-test) ratio: (£240,000 − £90,000) / £120,000 = 1.25. Even without selling any stock, the business can meet its short-term debts.

2. Gearing

Debt-to-equity: £180,000 / £360,000 = 0.5. The company is financed mostly by its owners, so its borrowing looks moderate.

3. Return on equity, broken down (DuPont)

Net profit margin: £54,000 / £720,000 = 7.5%
Asset turnover: £720,000 / £600,000 = 1.2 times
Equity multiplier: £600,000 / £360,000 = 1.67
ROE: 7.5% × 1.2 × 1.67 = 15%, which matches £54,000 / £360,000.

The breakdown shows the 15% return comes from using assets efficiently and a modest amount of debt rather than from high margins, a useful point to make in your discussion.

Key Takeaways & Core Principles

The quick ratio is stricter than the current ratio because it leaves out inventory, which may be slow to sell.
Compare ratios with the industry average and with previous years, not with general rules of thumb.
DuPont analysis shows whether ROE is driven by margins, efficiency or borrowing.
Always say what a ratio means for the business, not just its value.

Frequently Asked Questions

What are the three parts of the DuPont formula?

Return on equity = net profit margin × asset turnover × equity multiplier (total assets ÷ equity). Multiplying them back together should give the same ROE as net profit ÷ equity.

Academic References & Standards

[1]Ross, S., Westerfield, R., & Jaffe, J. (2022). Corporate Finance. McGraw-Hill. Source Link

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