Chapter 13, Problem 12E

To determine

Compute the given ratios for Company C.

Answer to Problem 12E

The ratios of Company C are given below:

Ratios determined for Company C
Receivable turnover	8.98
Inventory turnover	10.74
Current ratio	2.06
Cash ratio	0.81
Times interest earned	9.43
Cash coverage ratio	9.35

Table (1)

Explanation of Solution

Receivables turnover ratio: Receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. This ratio is determined by dividing credit sales and sales return. It is determined by the following formula:

$\frac{\text{Net credit sales }}{\text{Average net receivables}}$

Inventory turnover ratio: Inventory turnover ratio is one of the Assets Turnover ratios. This ratio is a financial metric used by a company to quantify the number of times inventory is used or sold during the accounting period. It is calculated as follows:

$\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. The ideal current ratio is 2:1. It is determined by the following formula:

$\frac{\text{Current assets}}{\text{Current liabilities}}$

Cash ratio: This ratio is used to measure the adequacy of the cash in the business. It is determined by dividing cash and cash euqivalents and current liabilities. It is determined by the following formula:

$\frac{\text{Cash and cash equivalents}}{\text{Current liabilities}}$

Times interest earned ratio: Times interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense. It is determined by the following formula:

$\frac{\text{Net income}+\text{Interest expense}+\text{Tax expense}}{\text{Interest expense}}$

Cash coverage ratio: This ratio indicates the relationship between the cash flows from operating activities and the interest payments.

$\text{Cash coverage ratio =}\frac{\text{Cash flows from operating activities }}{\text{Interest paid}}$

Determine the given ratios for Company C:

Ratio	Formula	Calculation	Result
Receivable turnover	$\frac{\text{Net credit sales }}{\text{Average net receivables}}$	$\frac{\text{\$4,552}}{\$506.5\left(1\right)}$	8.98
Inventory turnover	$\frac{\text{Cost of goods sold}}{\text{Average inventory}}$	$\frac{\text{\$2,637}}{\$245.5\left(2\right)}$	10.74
Current ratio	$\frac{\text{Current assets}}{\text{Current liabilities}}$	$\frac{\text{\$1,}298\left(3\right)}{\text{\$630}\left(4\right)}$	2.06
Cash ratio	$\frac{\text{Cash and cash equivalents}}{\text{Current liabilities}}$	$\frac{\text{\$}513}{\text{\$630}\left(4\right)}$	0.81
Times interest earned	$\frac{\text{Net income}+\text{Interest expense}+\text{Tax expense}}{\text{Interest expense}}$	$\frac{\text{\$374}+\$72+\$233}{\text{\$72}}$	9.43
Cash coverage ratio	$\frac{\text{Cash flows from operating activities }}{\text{Interest paid}}$	$\frac{\text{\$608}}{\text{\$65}}$	9.35

Table (2)

Working Note:

Determine the amount of average net receivables.

$\begin{array}{c}\text{Average net receivables}=\frac{\left(\begin{array}{l}\text{Ending accounts }\\ \text{receivable}\end{array}\right)+\left(\begin{array}{l}\text{Beginning accounts }\\ \text{receivable}\end{array}\right)}{2}\\ =\frac{\$508+\$505}{2}\\ =\$506.5\end{array}$ (1)

Determine the amount of average inventory.

$\begin{array}{c}\text{Average net receivables}=\frac{\left(\text{Ending inventory}\right)+\left(\text{Beginning inventory}\right)}{2}\\ =\frac{\$251+\$240}{2}\\ =\$245.5\end{array}$ (2)

Determine the amount of current assets.

$\begin{array}{c}\text{Current assets}=\left(\begin{array}{l}\text{Cash and }\\ \text{equivalents}\end{array}\right)+\left(\begin{array}{l}\text{Marketable}\\ \text{ securities}\end{array}\right)+\left(\begin{array}{l}\text{Accounts }\\ \text{receivable}\end{array}\right)\\ +\left(\text{Inventories}\right)+\left(\begin{array}{l}\text{Prepaid expense and }\\ \text{other current assets}\end{array}\right)\\ =\$513+\$0+\$508+\$251+\$26\\ =\$1,298\end{array}$ (3)

Determine the amount of current liabilities.

$\begin{array}{c}\text{Current liabilities}=\left(\begin{array}{l}\text{Accounts }\\ \text{payable}\end{array}\right)+\left(\begin{array}{l}\text{Current accrued }\\ \text{expenses}\end{array}\right)\\ +\left(\begin{array}{l}\text{Current portion of}\\ \text{long term debt}\end{array}\right)+\left(\begin{array}{l}\text{Other currrent}\\ \text{ liabilities}\end{array}\right)\\ =\$150+\$377+\$1+\$102\\ =\$630\end{array}$ (4)