Financial Ratios
1. Liquidity ratios. Edison, Stagg, and Thornton have the following financial information at the close of business on July 10:
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Edison
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Stagg
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Thornton
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Cash
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$4,000
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$2,500
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$1,000
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Short-term investments
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3,000
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2,500
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2,000
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Accounts receivable
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2,000
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2,500
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3,000
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Inventory
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1,000
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2,500
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4,000
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Prepaid expenses
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800
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800
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800
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Accounts payable
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200
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200
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200
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Notes payable: short-term
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3,100
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3,100
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3,100
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Accrued payables
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300
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300
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300
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Long-term liabilities
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3,800
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3,800
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3,800
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- Compute the current and quick ratios for each of the three companies. (Round calculations to two decimal places.) Which firm is the most liquid? Why?
- Suppose Thornton is using FIFO for inventory valuation and Edison is using LIFO. Comment on the comparability of information between these two companies.
- If all short-term notes payable are due on July 11 at 8 a.m., comment on each company's ability to settle its obligation in a timely manner.
2. Computation and evaluation of activity ratios. The following data relate to Alaska Products, Inc:
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19X5
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19X4
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Net credit sales
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$832,000
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$760,000
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Cost of goods sold
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440,000
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350,000
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Cash, Dec. 31
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125,000
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110,000
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Accounts receivable, Dec. 31
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180,000
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140,000
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Inventory, Dec. 31
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70,000
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50,000
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Accounts payable, Dec. 31
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115,000
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108,000
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The company is planning to borrow $300,000 via a 90-day bank loan to cover short-term operating needs.
- Compute the accounts receivable and inventory turnover ratios for 19X5. Alaska rounds all calculations to two decimal places.
- Study the ratios from part (a) and comment on the company's ability to repay a bank loan in 90 days.
- Suppose that Alaska's major line of business involves the processing and distribution of fresh and frozen fish throughout the United States. Do you have any concerns about the company's inventory turnover ratio? Briefly discuss.
3. Profitability ratios, trading on the equity. Digital Relay has both preferred and common stock outstanding. The company reported the following information for 19X7:
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Net sales
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$1,500,000
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Interest expense
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120,000
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Income tax expense
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80,000
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Preferred dividends
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25,000
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Net income
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130,000
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Average assets
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1,100,000
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Average common stockholders' equity
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400,000
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- Compute the profit margin on sales and the rates of return on assets and common stockholders' equity, rounding calculations to two decimal places.
- Does the firm have positive or negative financial leverage? Briefly explain.
4. Financial statement construction via ratios. Incomplete financial statements of Lock Box, Inc., are presented below.
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LOCK BOX, INC.
Income Statement
For the Year Ended December 31, 19X3
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Sales
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$ ?
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Cost of goods sold
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?
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Gross profit
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$15,000,000
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Operating expenses & interest
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?
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Income before tax
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$ ?
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Income taxes, 40%
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?
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Net income
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$ ?
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LOCK BOX, INC.
Balance Sheet
December 31, 19X3
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Assets
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Cash
Accounts receivable
Inventory
Property, plant, &. equipment
Total assets
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$ ?
?
?
8,000,000
$24,000,000
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Liabilities & Stockholders' Equity
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Accounts payable
Notes payable (short-term)
Bonds payable
Common stock
Retained earnings
Total liabilities & stockholders' equity
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$ ?
600,000 4,600,000
2,000,000
?
$24,000,000
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Further information:
- Cost of goods sold is 60% of sales. All sales are on account.
- The company's beginning inventory is $5 million; inventory turnover is 4.
- The debt to total assets ratio is 70%.
- The profit margin on sales is 6%.
- The firm's accounts receivable turnover is 5. Receivables increased by $400,000 during the year.
Instructions:
Using the preceding data, complete the income statement and the balance sheet.