Question

Question 1 Shown below are selected financial data for AB and XY Limited at the end of the current year: AB Ltd XY Ltd Net credit sales $675,000 $560,000 Cost of goods sold 504,000 480,000 Cash 51,000 20,000 Accounts receivable 75,000 70,000 Inventory 84,000 160,000 Current liabilities 105,000 100,000 Required: a) For each of the two companies, compute the following: 1. Working capital 2. Current ratio 3. Quick ratio 4. Inventory turnover ratio and average number of days required to turn over inventory 5. Accounts receivable ratio and average accounts receivable collection period. b) From the viewpoint of a short-term creditor, comment on the quality of each company's working capital. To which company would you prefer to sell $20,000 in goods on a 30-day open account? Question 2 The selected financial statements data of NGX Ltd. for the years ended 31 December 20x4 and 20x5 are as follows Year 20x5 (Sm 2.100 700 NGX Ltd. Trial Balances as of 31 December Year 20x4 (Sm) Cash 1,000 Trade Debtors 500 Closing stock 200 Equipment (net) 2.000 Trade Creditors Long term debt 1,000 Capital 1.000 Sales 4,900 Cost of goods sold (COGS) Depreciation 250 Salary expenses 1,2501 Tax 1001 600 2.800 3000 1.400 50 REQUIRED: a) Calculate (to 2 decimal places) the following ratios for the company in year 20x4 and 20x5. i. Net profit ratio vi. Creditors ratio ii. Gross profit ratio vii. Stock turnover ratio iii. Current ratio viii. Gearing ratio iv. Quick ratio V. Debtors ratio b) Comment on the profitability, efficiency, and short term liquidity of NGX Lid.

please help solving the all the questions from question1a b to question2 a b.
Please give a detailed explanation. Thank you!

Answer 1

Solution

(1)

(a)

(1)

	AB Ltd.	XY Ltd.
Working Capital
Current Assets:
Cash	$       51,000.00	$       20,000.00
Accounts Receivable	$       75,000.00	$       70,000.00
Inventory	$       84,000.00	$   1,60,000.00
	$   2,10,000.00	$   2,50,000.00
Less: Current Liabilities	$ -1,05,000.00	$ -1,00,000.00
WORKING CAPITAL	$   1,05,000.00	$   1,50,000.00

(2)

	AB Ltd.	XY Ltd.
Current Ratio:
(Current Assets / Current Liabilities)
Current Assets:
Cash	$       51,000.00	$       20,000.00
Accounts Receivable	$       75,000.00	$       70,000.00
Inventory	$       84,000.00	$   1,60,000.00
	$   2,10,000.00	$   2,50,000.00
Current Liabilities	$   1,05,000.00	$   1,00,000.00
CURRENT RATIO	2.00	2.50

(3)

	AB Ltd.	XY Ltd.
Quick Ratio:
[(Current Assets - Inventory) / Current Liabilities]
Current Assets:
Cash	$       51,000.00	$       20,000.00
Accounts Receivable	$       75,000.00	$       70,000.00
Inventory	$       84,000.00	$   1,60,000.00
	$   2,10,000.00	$   2,50,000.00
Less: Inventory	$     -84,000.00	$ -1,60,000.00
	$   1,26,000.00	$       90,000.00
Current Liabilities	$   1,05,000.00	$   1,00,000.00
CURRENT RATIO	1.20	0.90

(4)

	AB Ltd.	XY Ltd.
Inventory Turnover Ratio
(Sales / Inventory)
Sales	$   6,75,000.00	$   5,60,000.00
Inventory	$       84,000.00	$   1,60,000.00
INVENTORY TURNOVER RATIO	8.04	3.50
Average Number of days required to turn over inventory
(365 Days / Inventory Turnover Ratio)	45	104

(5)

	AB Ltd.	XY Ltd.
Accounts Receivable Ratio
(Sales / Accounts Receivable)
Sales	$   6,75,000.00	$   5,60,000.00
Accounts Receivable	$       75,000.00	$       70,000.00
INVENTORY TURNOVER RATIO	9.00	8.00
Average Accounts Receivable collection period
(365 Days / Accounts Receivable Ratio)	41	46

(b)

Generally Working Capital measures a company's ability to pay off its current liabilities. The higher the Working Capital, the healthier the company, and thus it can assure any short-term creditor about his recovery of the dues to the company. In the given case, AB Ltd has a Working Capital of $ 105,000, whereas XY Ltd. has $ 150,000. Therefore it is clear that XY Ltd. is more better than AB Ltd.

For deciding to whom $ 20,000 goods should be sold on 30 day open account, following measures should be considered,

	AB Ltd.	XY Ltd.
Average Number of days required to turn over inventory	45 Days	104 Days
Average Accounts Receivable collection period	41 Days	46 Days

Here it can be seen that AB Ltd. takes 45 Days to sell out inventory in hand, and takes 41 Days to recover credit sales, whereas the same for XY Ltd. is 104 Days and 46 Days respectively. Hence, in both the cases AB Ltd. is taking less time than XY Ltd., and should be preferred to sell $ 20,000 goods as the Short-term Creditor could recover his due more quickly.

(2)

Information required for calculating a(i) and a(ii)

	Year 20X4 (in $m)	Year 20X5 (in $m)
Sales	$   4,900.00	$   5,200.00
Less: Cost of Goods Sold	$ -2,800.00	$ -3,000.00
GROSS PROFIT	$   2,100.00	$   2,200.00
Less: Salary Expenses	$ -1,250.00	$ -1,400.00
Less: Depreciation	$     -250.00	$     -500.00
NET PROFIT BEFORE TAXES	$      600.00	$      300.00
Less: Taxes	$     -100.00	$       -50.00
NET PROFIT AFTER TAXES	$      500.00	$      250.00

(a)

(i)

	Year 20X4 (in $m)	Year 20X5 (in $m)
Net Profit Ratio
[(Net Profit After Taxes / Sales) X 100]
Net Profit After Taxes	$      500.00	$      250.00
Sales	$   4,900.00	$   5,200.00
NET PROFIT RATIO	10.20%	4.81%

(ii)

	Year 20X4 (in $m)	Year 20X5 (in $m)
Gross Profit Ratio
[(Gross Profit / Sales) X 100]
Gross Profit	$   2,100.00	$   2,200.00
Sales	$   4,900.00	$   5,200.00
GROSS PROFIT RATIO	42.86%	42.31%

(iii)

	Year 20X4 (in $m)	Year 20X5 (in $m)
Current Ratio
(Current Assets / Current Liabilities)
Current Assets:
Cash	$               1,000.00	$               2,100.00
Trade Debtors	$                   500.00	$                   700.00
Closing Stock	$                   200.00	$                   500.00
Total Current Assets	$               1,700.00	$               3,300.00
Current Liabilities:
Trade Creditors	$                   600.00	$               4,000.00
Total Current Liabilities	$                   600.00	$               4,000.00
CURRENT RATIO	2.83	0.83

(iv)

	Year 20X4 (in $m)	Year 20X5 (in $m)
Quick Ratio
(Quick Assets / Current Liabilities)
Current Assets:
Cash	$               1,000.00	$               2,100.00
Trade Debtors	$                   500.00	$                   700.00
Closing Stock	$                   200.00	$                   500.00
Total Current Assets	$               1,700.00	$               3,300.00
Less: Closing Stock	$                 -200.00	$                 -500.00
Quick Assets	$               1,500.00	$               2,800.00
Current Liabilities:
Trade Creditors	$                   600.00	$               4,000.00
Total Current Liabilities	$                   600.00	$               4,000.00
QUICK RATIO	2.50	0.70

Part (v), (vi), and (vii) has been computed as follows,

	Year 20X4 (in $m)	Year 20X5 (in $m)
Sales	$               4,900.00	$               5,200.00
Trade Debtors	$                   500.00	$                   700.00
Trade Creditors	$                   600.00	$               4,000.00
Closing Stock	$                   200.00	$                   500.00
Cost of Goods Sold (COGS)	$               2,800.00	$               3,000.00
(v) Debtors Ratio
(Sales / Trade Debtors)	9.80	7.43
(vi) Creditors Ratio
(COGS / Trade Creditors)	4.67	0.75
(vii) Stock Turnover Ratio
(Sales / Closing Stock)	24.50	10.40

(viii)

	Year 20X4 (in $m)	Year 20X5 (in $m)
Long-term Liabilities
Long-term Debts	$               1,000.00	$                   800.00
Shareholders' Wealth
(Fixed Assets + Current Assets - Current Liabilities)
Fixed Assets
Equipment	$               2,000.00	$               3,000.00
Current Assets
Cash	$               1,000.00	$               2,100.00
Trade Debtors	$                   500.00	$                   700.00
Closing Stock	$                   200.00	$                   500.00
	$               1,700.00	$               3,300.00
Current Liabilities
Trade Creditors	$                   600.00	$               4,000.00
Shareholders' Wealth	$               3,100.00	$               2,300.00
Gearing Ratio (in %)
[(Long-Term Debts / Shareholders' Wealth) X 100]	32.26	34.78

(b)

Comments are furnished as below,

	Year 20X4 (in $m)	Year 20X5 (in $m)
Profitability Ratios
Net Profit Ratio	10.20%	4.81%
Gross Profit Ratio	42.86%	42.31%
Remarks: It can be seen that the profitability of the company has been reduced in 20X5 than in relation to 20X4. Both Gross Profit Ratio and Net Profit Ratio has been reduced in 20X5, which was relatively higher in 20X4. Hence the profitability position of the company has been declined.
Efficiency Ratios
Debtors Ratio	9.80	7.43
In Days	37	49
Creditors Ratio	4.67	0.75
In Days	78	487
Stock Turnover Ratio	24.50	10.40
In Days	15	35
Remarks:
1. Debtors Ratio clarifies that how much time will be required to recover dues from debtors. In the given case it is clear that recovery time has been increased in 20X5 than 20X4.
2. Creditors Ratio shows that how much time the company requires to pay off the creditors' due. In the given case it can be seen that the payment time has been drastically increased in 20X5 than 20X4 which is very much critical indication that the company is not doing good.
3. Stock Turnover ratio shows how much time is required to sell off the inventory holdings. It is also a performance indicator to the concern. Here it is seen that the same has been increased in 20X5 than 20X4, which is a clear sign that the company is mismanaged.
Overall: The efficiency of the concern is deteriorated in 20X5 than in relation to 20X4
Short-Term Liquidity
Current Ratio	2.83	0.83
Quick Ratio	2.50	0.70
Remarks: The given ratios are indicators of company's ability to pay off the current liabilities. As per standards, Current Ratio should be more than 2, and Quick ratio should be more than 1. As per standards, the company has performed well in 20X4, but it has been drastically deteriorated in 20X5. In short, it can be concluded that the company has a very bad liquidity position.