Question

The following financial data relate to Big Bang Pty Ltd for the years ended 30 June Year 2019 and 30 June Year 2018. Financial item 30 June Year 2019 Year 2018 $630 000 $490 000 Net credit sales Cost of goods sold Cash 290 000 250 000 12 000 18 000 Accounts receivable 70 000 60 000 130 000 Inventory 150 000 Current liabilities 105 000 81 000 Additional information: The amount of Accounts receivables at 30 June Year 2017 was $78 000 (net). The inventory figure at 30 June Year 2017 was $130 000. The company provides its credit customers 30 days to pay. The average inventory turnover for the industry in which the company operates is 101 days. You are required to explain and calculate the following ratios for the years ended 30 June Year a. 2019 and 30 June Year 2018: - current ratio; quick ratio; accounts receivable turnover (times and in days); and - inventory turnover (times and in days) b. Comment on the short-term solvency, including the efficiency of the business, given the ratio results obtained in your answer in part a.

Answer 1

Answer:

Given that:

a)

30th June 30th June 30th June 2019 2018 2017 Net credit sales 630000 490000 Cost of goods sold 290000 250000 Cash 18000 12000 Accounts receivable 70000 60000 78000 Inventory 130000 150000130000 Current assets 218000 222000 Current liabilities 81000 105000 65000 69000 Average receivables Average inventory 140000 140000 2.74 Times 1) Current ratio Current assets/Current liabilities 2.08 Quick ratio (Cash+Accounts receivable)/Current 2) liabilities 0.84 0.89 Times Accounts receivable turnover (times)Net sales/Average accounts receivable 7.10 Times 9.69 Accounts receivable turnover (Days) 365/Accounts receivable turnover in times 51 Days 38 Cost of goods Inventory turnover (times) 4 sold/Average inventory 207 1.79 Times Inventory turnover (days) 365/Inventory turnover (times) 204 Days 176

b) Short term solvency: The current ratio is above the generally accepted ratio of 2 and is hence satisfactory But, the more stringent quick ratio is lower than the standard ratio of 1 and it indicates a less than satisfactory liquidity position. It means that the firm will not be able to meet its current liabilities at short notice. The overall situation is not satisfactory Efficiency The efficiency of asset management is indicated by the receivable tumover in days and the inventory turmover in days as compared with the norms of the firm or the industry standards. As regards the receivable tumover in days (also called days sales outstanding), the figure is more than the credit period allowed for the customers, which is 30 days. However, there has been significant improvement in 2019 when it has decreased to 38 days from 51 days. The inventory tumover of the firm (days) is very high when compared to the industry nonm of 101 days. It means that the fim is overinvested in inventory which, will entail higher financing and costs associated with stocking excessive inventory. The inventory management is poor and calls for immediate attention. That the inventory tumover in days is high proves why the current ratio is satisfactory but the quick ratio is not.