Question

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $590,000 long-term loan from Gulfport State Bank, $145,000 of which will be used to bolster the Cash account and $445,000 of which will be used to modernize equipment. The company’s financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	104,000	$	240,000
Marketable securities		0		27,000
Accounts receivable, net		594,000		390,000
Inventory		1,035,000		685,000
Prepaid expenses		26,000		31,000
Total current assets		1,759,000		1,373,000
Plant and equipment, net		1,751,000		1,420,000
Total assets	$	3,510,000	$	2,793,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	845,000	$	520,000
Bonds payable, 12%		700,000		700,000
Total liabilities		1,545,000		1,220,000
Stockholders' equity:
Common stock, $15 par		780,000		780,000
Retained earnings		1,185,000		793,000
Total stockholders’ equity		1,965,000		1,573,000
Total liabilities and stockholders' equity	$	3,510,000	$	2,793,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,450,000	$	4,620,000
Cost of goods sold		3,965,000		3,540,000
Gross margin		1,485,000		1,080,000
Selling and administrative expenses		671,000		566,000
Net operating income		814,000		514,000
Interest expense		84,000		84,000
Net income before taxes		730,000		430,000
Income taxes (30%)		219,000		129,000
Net income		511,000		301,000
Common dividends		119,000		98,000
Net income retained		392,000		203,000
Beginning retained earnings		793,000		590,000
Ending retained earnings	$	1,185,000	$	793,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new territories. Sales terms are 3/10, n/30. All sales are on account.

Required:

1. To assist in approaching the bank about the loan, Paul has asked you to compute the following ratios for both this year and last year:

a. The amount of working capital.

b. The current ratio.

c. The acid-test ratio.

d. The average collection period. (The accounts receivable at the beginning of last year totaled $340,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $590,000.)

f. The operating cycle.

g. The total asset turnover. (The total assets at the beginning of last year were $2,690,000.)

h. The debt-to-equity ratio.

i. The times interest earned ratio.

j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,563,000.)

2. For both this year and last year:

a. Present the balance sheet in common-size format.

b. Present the income statement in common-size format down through net income.

Answer 1

Ans. 1 A	Working capital =     Total current assets - Total current liabilities
	This year	$1,759,000 - $845,000	$914,000
	Last year	$1,373,000 - $520,000	$853,000
Ans. B	Current ratio   =   Total current assets / Total current liabilities
	This year	$1,759,000 / $845,000	2.08 : 1
	Last year	$1,373,000 / $520,000	2.64 : 1
Ans. C	Acid test ratio   =   (Total current assets - Inventory - Prepaid expenses) / Total current liabilities
	This year	($1,759,000 - $1,035,000 - $26,000) / $845,000	0.83 : 1
	Last year	($1,373,000 - $685,000 - $31,000) / $520,000	1.26 : 1
Ans. D	Average collection period   =   No. of days in year / Net credit sales * Average accounts receivables
	This year	365 / $5,450,000 * $492,000	32.95	days
	Last year	365 / $4,620,000 * $365,000	28.84	days
	*Average receivable = (Beginning receivables + Ending receivables) / 2
	This year	($390,000 + $594,000) / 2	$492,000
	Last year	($340,000 + $390,000) / 2	$365,000
Ans. E	Average sales period   =   No. of days in year / Cost of goods sold * Average inventory
	This year	365 / $3,965,000 * $860,000	79.17	days
	Last year	365 / $3,540,000 * $637,500	65.73	days
	*Average inventory = (Beginning inventory + Ending inventory) / 2
	This year	($685,000 + $1,035,000) / 2	$860,000
	Last year	($590,000 + $685,000) / 2	$637,500
Ans. F	Operating cycle = Average collection period + Average sales period
	This year	32.95 + 79.17	112.12	days
	Last year	28.84 + 65.73	94.57	days
Ans. G	Total assets turnover = Sales / Average assets
	This year	$5,450,000 / $3,151,500	1.73	times
	Last year	$4,620,000 / $2,741,500	1.69	times
	*Average assets = (Beginning assets + Ending assets) / 2
	This year	($2,793,000 + $3,510,000) / 2	$3,151,500
	Last year	($2,690,000 + $2,793,000) / 2	$2,741,500
Ans. H	Debt to equity ratio   =   Total liabilities / Total stockholder's equity
	This year	$1,545,000 / $1,965,000	0.79
	Last year	$1,220,000 / $1,573,000	0.78
Ans. i	Time interest earned = Net operating income / Interest expenses
	This year	$814,000 / $84,000	9.69	times
	Last year	$514,000 / $84,000	6.12	times
Ans. J	Equity multiplier   =   Average assets / Average stockholder's equity
	This year	$3,151,500 / $1,769,000	1.78	times
	Last year	$2,741,500 / $1,568,000	1.75	times
	*Average equity = (Beginning equity + Ending equity) / 2
	This year	($1,573,000 + $1,965,000) / 2	$1,769,000
	Last year	($1,563,000 + $1,573,000) / 2	$1,568,000

Ans. 2 a SABIN ELECTRONICS Common - Size Balance Sheets This Year Amount % Last Year Amount % $104,000 $0 $594,000 $1,035,000 $26,000 $1,759,000 $1,751,000 $3,510,000 3.0% 0.0% 16.9% 29.5% 0.7% 50.1% 49.9% 100.0% $240,000 $27,000 $390,000 $685,000 $31,000 $1,373,000 $1,420,000 $2,793,000 8.6% 1.0% 14.0% 24.5% 1.1% 49.2% 50.8% 100.0% Assets Current Assets: Cash Marketable securities Accounts receivable (net) Inventory Prepaid expenses Total current assets Plant and equipment (net) Total assets Liabilities and Stockholder's Equity: Liabilities: Current Liabilities Bonds payable, 12% Total liabilities Stockholder's equity: Common stock, $15 par Retained earnings Total stockholder's equity Total liabilities and owner's equity $845,000 $700,000 $1,545,000 24.1% 19.9% 44.0% $520,000 $700,000 $1,220,000 18.6% 25.1% 43.7% $780,000 $1,185,000 $1,965,000 $3,510,000 22.2% 33.8% 56.0% 100.0% $780,000 $793,000 $1,573,000 $2,793,000 27.9% 28.4% 56.3% 100.0%

*In a common size balance sheet, all precentages are calculated on the base of total assets. Amount is percentage for this year = Particular amount of This year / Total assets * 100 Amount is percentage for Last year = Particular amount of Last year / Total assets * 100 Ans. 2 B Last Year Sales Cost of goods sold Gross profit Selling and administrative expenses Net operating income Interest expense Net income before taxes Income taxes Net income SABIN ELECTRONICS Common -Size Income Statements This Year Amount $5,450,000 100.00% $3,965,000 72.75% $1,485,000 27.25% $671,000 12.31% $814,000 5.15% $84,000 0.53% $730,000 4.62% $219,000 1.39% $511,000 3.23% Amount $4,620,000 $3,540,000 $1,080,000 $566,000 $514,000 $84,000 $430,000 $129,000 $301,000 100.00% 76.62% 23.38% 4.33% 3.93% 0.64% 3.29% 0.99% 2.30% *In a common size income statement, all precentages are calculated on the base of sales. Amount is percentage for this year = Particular amount of This year / Sales * 100 Amount is percentage for Last year = Particular amount of Last year / Sales * 100