Ratios in Order to Evaluate

Ratios

In order to evaluate the level of liquidity in each company, we will calculate, analyze and compare two liquidity ratios: the current ratio and the quick ratio. The current ratio is calculated by dividing the value of current assets by the value of current liabilities. An optimal value for this rate would be between 1 and 1.5. Anything lower than 1 would show that the company is not able to current is most pressing liabilities with cash it will make in the short run. A current rate that is higher than 1.5 means that the company has an unnecessary cash reserve, which could be used otherwise.

In January 2004, the current ratio for Liz Clairborne was:

Current ratio - Current assets/Current liabilities = 1,348,401/526,642 = 2.56, while at the end of 2002, the current ratio was 2.11. This shows an increase with 0.44 in the company's current ratio.

On the other hand, the current ratio for Kenneth Cole was, in 2003, 4.22, as compared to 3.3 in 2002. This significant increase of almost 1.0 in the company's current ratio is explained by the significant decrease in the current liabilities value, simultaneously with an increase in current assets.

If we compare the two values obtained for each company in 2003, we can notice that the current ratio in the case of Kenneth Cole is 65% greater than the one at Liz Clairborne. In my opinion, both companies have values that are much too big for the current ratio indicator. It may show a deficiency in handling current assets and a large reserve of unused cash.

The same situation is noticed when discussing the quick ratio, which is calculated as Quick Ratio = (Current Assets - Inventory)/Current Liabilities. In this case, for Kenneth Cole, the quick ratio indicator shows 3.3, while for Liz Clairborne, the quick ratio indicator is 1.64. As we can see, the 2:1 ratio between the two companies when discussing the liquidity indicators is a generic observation. I would say that Liz Clairborne is doing better in this case.

The asset turnover ratio and the inventory turnover ratio are two indicators that may give us a clue about the companies' performance in this area. The asset turnover ratio is calculated as the net sales value divided by the total assets value and shows how much of the company's revenue is generated by the company's assets. In Liz Clairborne's case, this is equal to 1.63, while in Kenneth Cole's case, the total asset turnover is equal to 1.57. As we can see, the two values are almost equal, with a slight plus in the way assets are used for Liz Clairborne.

The inventory turnover ratio is calculated by dividing the net sales value by the total inventory value. As such, in Kenneth Cole's case,

Inventory Turnover = Net Sales/Inventory = 430,101,000/44,851,000 = 9.6

For Liz Clairborne, the inventory turnover ratio is equal to 8.7.

The inventory turnover value shows the surplus of stock that a company has to deal with. In general, the smaller the indicator, the higher the surplus. It is obvious that it is less desirable for a company to have large amounts of stock that is not being sold and that high values are generally preferable.

As such, both values seem to be consistent enough, as we would expect the industrial average to be somewhere between 8.5 and 9.5. Kenneth Cole has an inventory turnover value with 0.9 higher than Liz Clairborne's, but the difference itself is not significant enough.

In order to evaluate the level of debt and its sustainability by the companies, we will be using two debt management ratios: the debt ratio and the times interest earned (TIE) ratio.

The first rate is calculated by dividing the total debt value by the total asset value. It is an indicator that most companies use to determine the financial leverage they are using and to evaluate how much of the business (total asset value) is financed by foreign debt.

In Liz Clairborne's case,

Debt Ratio = Total Debt/Total asset value = 78%.

In Kenneth Cole's case,

Debt Ratio = Total Debt/Total Asset = 77%

As we can see, the debt ratio value is similar in the two companies and shows a reasonable financing of the business with outside financial sources.

The Times Interest Earned value (TIE) shows how much income can decrease in the company without financial problems appearing, as an incapacity to pay the annual interest rates.

At Kenneth Cole, TIE = Earnings Before Interest and Taxes/Interest Expense = 32,890,000/40,000 = 822 times. The value itself may appear ludicrous, but the reason is quite simple. If we look at the statement of cash flows, the cash paid for interest in 2003 is only $40,000, similar to the previous years.

In Liz Clairborne's case, TIE = 392,072/30,509 = 12.85

The large difference between the two companies can be explained by the different financial structure in each case. If in Liz Clairborne's case, financing by foreign capital is used quite often, as a proportion of overall capital, Kenneth Cole uses very little, with low interest expenses.

In terms of profitability ratios, we shall be using the profit margin on sales indicator and the return on total assets ratio. The former shows how much profit is retained at each dollar of goods sold.

Kenneth Cole: Profit margin on sales = Net Income after Taxes/Net Sales = 7.6%

Liz Clairborne: Profit margin on sales = Net Income after Taxes/Net Sales = 6.6%

The figures obtained show a higher net income as a proportion of net sales obtained in Kenneth Cole's case. This shows either that the company is selling at higher prices (which does not necessarily mean a positive thing) or that the operating costs are lower in Kenneth Cole's case.

The return on total assets indicator shows the overall return of the entire capital invested in the company (total assets) and is also referred to as the return on investment. This is calculated by dividing net profit by the total asset value.

Liz Clairbone: Return on Total Assets = 10.7%

Kenneth Cole: Return on Total Assets = 11.9%

As we can see, the difference in overall return on investment between the two companies is 1.2%. This comes to complete the result previously obtained and shows that the higher profit margin on sales obtained at Kenneth Cole have reverberations in the overall return as well.

In terms of market ratios, the earnings per share indicator and the price-to-earnings ratio should give us a clear picture of each company's presence on the stock exchange.