Question

The following information for 2021 and 2020 is presented for XYZ

 

			December   31
Assets		2021		2020
Current   assets:
Cash	$	42,000		$     54,000
Accounts   receivable		580,000		445,000
Inventory		5,010,000		4,950,000
Prepaid expenses		84,000			79,000
Total   current assets		5,716,000		5,528,000
Building   and equipment, net		1,097,000			1,095,000
Total   assets	$	6,813,000		$6,623,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts   payable	$	605,000		$  628,000
Bank   loan payable		679,000		625,000
Other accrued payables		215,000					315,000
Total   current liabilities		1,499,000		1,568,000
Long-term   debt		1,729,000		1,791,000
Total   liabilities		3,228,000		3,359,000
Stockholders’ equity:
Common   stock		1,307,000		1,307,000
Retained earnings		2,278,000				1,957,000
Total   stockholders’ equity		3,585,000				3,264,000
Total   liabilities and stockholders’ equity	$	6,813,000		$6,623,000

 

There were 100,000 shares of common stock outstanding throughout both 2020 and 2021.

 

Additional information follows:

 

		2021				2020
Market price per share at   the end of year	$		134		$	110
Net income for the year		815,000				639,000
Cost of goods sold for   the year		2,900,000				2,700,000
Net sales for the year		5,568,000				5,253,000

 

1.            Calculate the 1) current ratio, 2) acid-test ratio, and the 3) debt-to-equity ratio for 2020 and 2021. Calculate to three significant digits.

 

2.            The company intends to apply for a loan. What concerns might the loan officer have about lending to the company? 

Answer 1

SOLUTION :

Ratios :

1.

Current ratio (CR ) 

=  Current Assets, CA / Current Liabilities, CL

So,

CR (2020) = 5528000/1568000 = 3.526 (ANSWER)

CR(2021) = 5716000/1499000 = 3.813 9ANSWER).

2.

Acid test ratio (ATR)

= (CA - Inventories) / CL

So,

ATR (2020) = (5528000 - 4950000) / 1568000 = 0.369 (ANSWER)

ATR (2021) = (5716000 - 5010000) / 1499000 = 0.471(ANSWER)

3.

Debt-equity ratio (DE) 

=Total liabilities / Equity

So,

DE (2020) = 3359000 / 3264000 = 1.029 (ANSWER)

DE (2021) = 3228000 / 3585000 = 0.900 (ANSWER).

Concerns for lending :

Current ratio is greater than 3 in both 2020 and 2921 . It is good. However, ATR is much lower than 1.0 in both the years and seems to be deteriorating. This indicates poor liquidity condition of the company. In case of liquidation, current liabilities could not be neutralised by cash like assets. There is too much of inventories. As regards DE ratio, It is around 1.0 and improving over 2020 in 2021. It is reasonably alright.

Hence, low ATR and too much of inventories are the concern in lending loan to the company. There is risk that company may face cash crunch and may fail to service the loan repay it.