Chapter 13, Problem 4AP

1.

To determine

Compute the turnover, liquidity, and solvency ratios for the current year of Company T.

Answer to Problem 4AP

Turnover, liquidity, and solvency ratios for the current year of Company T are as follows:

Ratios or percentages	Result
Turnover Ratios
Total asset turnover	0.55
Fixed asset turnover	1.10
Receivable turnover ratio	1.59
Inventory turnover ratio	1.65
Liquidity Ratios
Current ratio	2.59
Quick ratio	2.01
Cash ratio	1.15
Solvency Ratios
Debt-to-equity ratio	0.67
Cash coverage ratio	3.84
Times interest earned ratio	5.50

Table (1)

Explanation of Solution

Determine the ratios of Company T as given below:

Ratios		Formula	Calculation	Result
Turnover Ratios
Total asset turnover		$\frac{\text{Net Sales Revenue}}{\text{Average total assets}}$	$\frac{\text{\$110,000}}{\$199,750\left(1\right)}$	0.55
Fixed asset turnover		$\frac{\text{Net Sales Revenue}}{\text{Average net fixed assets}}$	$\frac{\text{\$110,000}}{\$100,000\left(2\right)}$	1.10
Receivable turnover ratio		$\frac{\text{Net credit sales }}{\text{Average net receivables}}$	$\frac{\text{\$55,000}\left(3\right)}{\$34,500\left(4\right)}$	1.59
Inventory turnover ratio		$\frac{\text{Cost of goods sold}}{\text{Average inventory}}$	$\frac{\text{\$52,000}}{\$31,500\left(5\right)}$	1.65
Liquidity Ratios
Current ratio	$\frac{\text{Current assets}}{\text{Current liabilities}}$		$\frac{\text{\$111,500}\left(6\right)}{\text{\$43,000}\left(7\right)}$	2.59
Quick ratio	$\frac{\left(\begin{array}{l}\text{Cash and }\\ \text{equivalents}\end{array}\right)+\left(\begin{array}{l}\text{Accounts }\\ \text{receivable}\end{array}\right)}{\text{Current liabilities}}$		$\frac{\text{\$86,500}\left(8\right)}{\text{\$43,000}\left(7\right)}$	2.01
Cash ratio	$\frac{\text{Cash and Cash Equivalents}}{\text{Current liabilities}}$		$\frac{\text{\$49,500}}{\text{\$43,000}\left(7\right)}$	1.15
Solvency Ratios
Debt-to-equity ratio	$\frac{\text{Total liabilities}}{\text{Total stockholders' equity}}$		$\frac{\text{\$83,000}\left(9\right)}{\text{\$123,500}\left(10\right)}$	0.67
Cash coverage ratio	$\begin{array}{l}\text{Cash }\\ \text{coverage ratio }\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Cash flows from }\\ \text{operating activities }\end{array}\right)}{\text{Interest paid}}$		$\frac{\text{\$14,600}\left(\text{Given}\right)}{\text{\$3,800}\left(\text{Given}\right)}$	3.84
Times interest earned ratio	$\frac{\text{Net income}+\text{Interest expense}+\text{Tax expense}}{\text{Interest expense}}$		$\frac{\text{\$12,600}+\$4,000+\$5,400}{\text{\$4,000}\left(\text{Given}\right)}$	5.50

Table (2)

Working Note 1: Determine the amount of average total assets:

$\begin{array}{c}\text{Average total assets}=\frac{\left(\text{Ending total assets}\right)+\left(\text{Beginning total assets}\right)}{2}\\ =\frac{\$206,500+\$193,000}{2}\\ =\frac{\$399,500}{2}\\ =\$199,750\end{array}$

Working Note 2: Determine the amount of average net fixed assets.

$\begin{array}{c}\text{Average net fixed assets}=\frac{\left(\begin{array}{l}\text{Ending net }\\ \text{fixed assets}\end{array}\right)+\left(\begin{array}{l}\text{Beginning net }\\ \text{fixed assets}\end{array}\right)}{2}\\ =\frac{\$95,000+\$105,000}{2}\\ =\frac{\$200,000}{2}\\ =\$100,000\end{array}$

Working Note 3: Determine the amount of net credit sales.

$\begin{array}{c}\text{Net credit sales}=\text{Total sales revenue}\times \frac{1}{2}(\text{Given})\\ =\$110,000\times \frac{1}{2}\\ =\$55,000\end{array}$

Working Note 4: Determine the amount of average net receivables.

$\begin{array}{c}\text{Average net receivables}=\frac{\left(\begin{array}{l}\text{Ending accounts }\\ \text{receivable}\end{array}\right)+\left(\begin{array}{l}\text{Beginning accounts }\\ \text{receivable}\end{array}\right)}{2}\\ =\frac{\$37,000+\$32,000}{2}\\ =\frac{\$69,000}{2}\\ =\$34,500\end{array}$

Working Note 5: Determine the amount of average inventory.

$\begin{array}{c}\text{Average net receivables}=\frac{\left(\text{Ending inventory}\right)+\left(\text{Beginning inventory}\right)}{2}\\ =\frac{\$25,000+\$38,000}{2}\\ =\frac{\$63,000}{2}\\ =\$31,500\end{array}$

Working Note 6: Determine the amount of current assets.

$\begin{array}{c}\text{Current assets}=\text{Cash}+\left(\begin{array}{l}\text{Accounts }\\ \text{receivable}\end{array}\right)+\text{Inventories}\\ =\$49,500+\$37,000+\$25,000\\ =\$111,500\end{array}$

Working Note 7: Determine the amount of current liabilities.

$\begin{array}{c}\text{Current liabilities}=\text{Accounts payable}+\text{Income taxes payable}\\ =\$42,000+\$1,000\\ =\$43,000\end{array}$

Working Note 8: Determine the amount of quick assets.

$\begin{array}{c}\text{Quick assets}=\text{Cash}+\text{Accounts receivable}\\ =\$49,500+\$37,000\\ =\$86,500\end{array}$

Working Note 9: Determine the amount of total liabilities.

$\begin{array}{c}\text{Total liabilities}=\left(\begin{array}{l}\text{Accounts}\\ \text{ payable}\end{array}\right)+\left(\begin{array}{l}\text{Income taxes}\\ \text{ payable}\end{array}\right)+\left(\begin{array}{l}\text{Note payable, }\\ \text{long-term}\end{array}\right)\\ =\$42,000+\$1,000+\$40,000\\ =\$83,000\end{array}$

Working Note 10: Determine the amount of total stockholders’ equity.

$\begin{array}{c}\text{Total stckholders' equity}=\text{Capital stock}+\text{Retained earnings}\\ =\$90,000+\$33,500\\ =\$123,500\end{array}$

2.

To determine

Write a comment on the turnover ratios for the current year of Company T.

Explanation of Solution

From Table (1), the results reveal that the average collection period and the average days to sell inventory is very long. Company T takes 229.56 days $\left(\frac{365\text{ days}}{1.59}\right)$ to collect its receivable and 221.21 days $\left(\frac{365\text{ days}}{1.65}\right)$ to sell its inventory. These ratios reveal that the Company T is very inefficient in managing receivables and maintaining inventory levels. The management of Company T needs to improve the inventory levels and the collection of receivables. The total asset turnover and fixed asset turnover ratio is quite satisfactory.