Chapter 14, Problem 12E

To determine

Compute the ratios: a. Current ratio, b. Quick ratio. , c. Working capital. , d. Debt ratio. , e. Accounts receivable turnover (all sales were on credit). , f. Inventory turnover. , g. Book value per share of capital stock for Corporation B.

Explanation of Solution

Ratio analysis: The analysis of a company using the financial ratios and comparing its trends and measure its performance within the company and the companies of the industry is known as ratio analysis. The main categories of ratio analyses are liquidity ratios, profitability ratios, activity ratios, and leverage ratios.

Compute ratios for Corporation B.

a. 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. Current ratio is calculated by using the formula:

$\text{Current ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$

Determine current ratio.

 $\begin{array}{c}\text{Current ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}\\ =\frac{\$580,000(1)}{\$150,000(2)}\\ =3.87:1\end{array}$

Hence, the current ratio is 3.87:1.

b. Quick ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.

$\text{Quick ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

Determine quick ratio.

 $\begin{array}{c}\text{Quick ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}\\ =\frac{\$250,000(3)}{\$150,000(2)}\\ =1.67:1\end{array}$

Hence, the quick ratio is 3.87:1.

c. Working capital: Working capital refers to the excess amount of current assets over its current liabilities of a business. It measures the excess funds that are required for the companies to carry out their day to day operations, excluding any new funds that have been invested during the year. Working capital is calculated by using the formula:

$\text{Working capital}=\text{ Current assets}-\text{Current liabilities }$

Determine working capital.

 $\begin{array}{c}\text{Working capital}=\text{ Current assets (1)}-\text{Current liabilities (2)}\\ =\$580,000-\$150,000\\ =\$430,000\end{array}$

Hence, the working capital is $430,000.

d. Debt to assets ratio: The debt to asset ratio shows the relationship between total asset and the total liability of the company. Debt ratio reflects the financial strategy of the company. It is used to measure the percentage of company’s assets that are financed by long term debts.  Debt to assets ratio is calculated by using the formula:

$\text{Debt-to-assets ratio}=\frac{\text{Total Liabilities}}{\text{Total Assets }}$

Determine debt ratio.

$\begin{array}{c}\text{Debt-to-assets ratio}=\frac{\text{Total Liabilities}}{\text{Total Assets }}\\ =\frac{\$510,000\left(4\right)}{\$1,240,000}\\ =41.12\%\end{array}$

Hence, the debt ratio is 41.12%.

e. Accounts 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 average accounts receivables.

$\text{Accounts receivables turnover}=\frac{\text{}\text{Net credit sales}}{\text{Average accounts receivables}}$

Determine accounts receivable turnover ratio.

$\begin{array}{c}\text{Accounts receivables turnover}=\frac{\text{}\text{Net credit sales}}{\text{Average accounts receivables}}\\ =\frac{\$2,950,000}{\$145,000}\\ =20.34\text{ times}\end{array}$

Hence, the accounts receivable turnover ratio is 20.34 times.

f. Inventory Turnover Ratio: 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 by using the formula:

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

Determine accounts receivable turnover ratio.

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$1,834,000\left(5\right)}{\$270,000}\\ =6.8\text{ times}\end{array}$

Hence, the inventory turnover ratio is 6.8times.

g. Book value per share of capital stock.

Book value per share of capital stock: This ratio is a measure of a share of common stock that is used to determine the value of per share based on the equity available to the common stockholders. This ratio is calculated by using the formula:

$\begin{array}{l}\text{Book value per share }\\ \text{of captal stock}\end{array}\}\text{=}\frac{\text{Common stockholders' equity}}{\text{Shares of common stock outstanding }}$

Determine book value per share of capital stock.

$\begin{array}{c}\begin{array}{l}\text{Book value per share }\\ \text{of captal stock}\end{array}\}\text{=}\frac{\text{Common stockholders' equity}}{\text{Shares of common stock outstanding }}\\ =\frac{\$730,000\left(6\right)}{\$60,000\text{ shares }\left(\text{7}\right)}\\ =12.17\text{ per share}\end{array}$

Hence, the book value per share of capital stock is 12.17 per share.

Working Note:

Calculate current assets.

$\begin{array}{c}\text{Currrent Assets}=\text{Cash}+\text{Accounts receivable}+\text{Inventory}+\text{Prepaid expenses}\\ \text{=\$105,000}+\$145,000+\$270,000+60,000\\ =\$580,000\end{array}$ (1)

Calculate current liabilities.

$\begin{array}{c}\text{Currrent liabilities}=\text{Accounts payable}+\text{Notes payable}\\ \text{=\$110,000}+\$40,000\\ =\$150,000\end{array}$ (2)

Calculate quick assets.

$\begin{array}{c}\text{Quick Assets}=\text{Cash}+\text{Accounts receivable}\\ \text{=\$105,000}+\$145,000\\ =\$250,000\end{array}$ (3)

Calculate total liabilities.

$\begin{array}{c}\text{Total Liabilities}=\text{Current liabilities }\left(2\right)+\text{Long term liabilities}\\ \text{=\$150,000}+\$360,000\\ =\$510,000\end{array}$ (4)

Calculate cost of goods sold.

$\begin{array}{c}\text{Cost of goods sold}=\text{Sales}-\text{Gross profit}\\ \text{=\$2,950,000}-\$1,116,000\\ =\$1,834,000\end{array}$ (5)

Calculate common stockholders’ equity.

$\begin{array}{c}\text{Common stockholders' equity}=\text{Capital stock}+\text{Retained earnings}\\ \text{=\$300,000}+\$430,000\\ =\$730,000\end{array}$ (6)

Calculate shares of common stock outstanding.

$\begin{array}{c}\begin{array}{l}\text{Shares of common }\\ \text{stock outstanding}\end{array}\}\text{=}\frac{\text{Capital stock}}{\text{Par value of capital stock}}\\ =\frac{\$300,000}{\$5}\\ =60,000\text{ shares}\end{array}$ (7)