Question

Question 3 (25 marks)

Unit 10 - Financial Statement Analysis

Following is a comparative balance sheet for Summer Days Corporation:

                                                                             

                                                    Summer Days Corporation

                                                    Comparative Balance Sheet

                                                   December 31, 2019 and 2018

                                                                                                       2019                       2018

Current assets:

Cash                                                                                    $ 140,000                $ 90,000

Short-term investments                                                     90,000                    80,000

Accounts receivable, net                                                 350,000                 220,000

Inventory                                                                              500,000                 430,000

Prepaid expenses                                                                 30,000                    30,000

Total current assets                                                      $1,110,000              $ 850,000

Property, plant, and equipment, net                           750,000                 500,000

Other assets                                                                         280,000                 300,000

Total assets                                                                     $2,140,000            $1,650,000

Current liabilities:

Short-term notes payable                                              $650,000               $670,000

Accounts payable                                                              200,000                 225,000

Total current liabilities                                                  $850,000               $895,000

Non-current debt                                                               380,000                 220,000

Total liabilities                                                               $1,230,000            $1,115,000

Shareholders' equity:

Common shares                                                               $500,000               $500,000

Retained earnings                                                              410,000                    35,000

Total shareholders' equity                                           $ 910,000               $535,000

Total liabilities and shareholders' equity             $2,140,000            $1,650,000

Notes: Net sales (all on credit) and cost of goods sold for the year ended December 31, 2019, were $2,000,000 and $1,200,000, respectively. The number of common shares outstanding has been 50,000 since the company began operations.

Required:

Calculate the following ratios for the year ended December 31, 2019:

            a. current ratio

            b. acid-test ratio

            c. inventory turnover

            d. accounts receivable turnover

            e. debt ratio

            f. book value per common share of stock

Answer 1

a) Current Ratio

By current ratio we can estimate the company's ability to meet short-term debt obligations.

The higher the current ratio, the more liquid the company is.

Commonly acceptable current ratio is 2.

Formula for Current ratio is as below.

Current Ratio = Current assets / Current Liabilities

Current Ratio for the year ended Dec 2019.

Current Ratio = 1.31 ($1,110,000 / $850,000)

b) Acid test ratio.

Acid Test ratio is also known as quick ratio.

Acid test ratio indicates how a company's short term assets are to cover its current liabilities.

formula for Acid test ratio is as below.

Acid test ratio = Cash& cash equivalents +marketable securities +Accounts receivable Current Liabilities

Acid test ratio for the year 2019 = 0.68 {($140,000+90,000+350,000) / $850,000}

c) Inventory turnover ratio

Inventory turnover ratio is the number of times a business sells and replaces its stock of goods during a given period. It considers the cost of goods sold, relative to its average inventory for a year or in any a set period of time.

Formula for Inventory turnover ratio is as below.

Inventory turnover ratio = Cost of goods sold / Average Inventory

Inventory turnover ratio for the year end Dec 2019

Average inventory = ( opening inventory + closing inventory ) /2

Ineventory turnover ratio = 2.58 {( $1,200,000 / ($500,000+$430,000)/2 }

d) Accounts receivable turnover ratio

The accounts receivable turnover ratio, also known as the debtor’s turnover ratio, is an efficiency ratio that measures how efficiently a company is collecting revenue.

The accounts receivable turnover ratio measures the number of times over a given period that a company collects its average accounts receivable

formula for accounts receivable turnover ratio is as below.

accounts receivable turnover ratio = Net credit sales / Average accounts receivable

accounts receivable turnover ratio for the year Dec 2019

Average accounts receivable = (opening accounts receivable + closing accounts receivable) /2

Accounts receivable turnover ratio =7.02 {($2,000,000 / ($350,000+$220,000)/2}

e) Debt ratio

The debt ratio shows a company’s ability to pay off its liabilities with its assets.

Companies with higher levels of liabilities compared with assets are considered highly leveraged and more risky for lenders.

Formula for debt ratio is as below.

Debt ratio = Total Liabilities / Total Assets.

Debt ratio for the year Dec 2019.

Debt ratio = 0.57 or 57% ( $1,230,000 / $2,140,000 )

f) Book value per common share of stock

Book value of equity per share is the ratio of equity available to common shareholders divided by the number of outstanding shares.

Formula for book value per common share of stock = (Total equity - preferred equity )/ Total shares outstanding

Book value per common share of stock for the year Dec 2019 = 18.20 ( $910,000 / 50,000).

Note : There is no preferred stock in the given problem.

Ratios for the year Dec 2019 are as below.

2019 1.31 0.68 2.58 current ratio acid test ratio inventory turnover ratio accounts receivable turnover debt ratio book value per common share of stock 7.02 0.57 (57%) 18.20