Chapter 14, Problem 15P

To determine

To compute:

The following ratios for last year and this year −

Working capital

Current ratio

Acid-test ratio

Average collection period

Average sale period

Operating cycle

Total asset turnover

Answer to Problem 15P

Solution:

	Ratios	This year	Last year
a	Working capital	39,00,000	31,80,000
b	Current Ratio	2	2.15
c	Acid-test ratio	0.94	1.22
d	Average collection period	52.14	49.13
e	Average sale period	91.25	79.69
f	Operating cycle	143.39	128.82
g	Total asset turnover	0.99	0.9

Explanation of Solution

The ratios are calculated as under −

Working Capital−

For this year −

Current assets = $ 7,800,000

Current Liabilities = $ 3,900,000

  $\begin{array}{l}WorkingCapital=Currentassets–Currentliabilities\hfill \\ WorkingCapital=\$7,800,000–\$3,900,000\hfill \\ WorkingCapital=\$3,900,000\hfill \end{array}$

For last year −

• Current assets = $ 5,940,000
• Current Liabilities = $ 2,760,000

  $\begin{array}{l}WorkingCapital=Currentassets–Currentliabilities\hfill \\ WorkingCapital=\$5,940,000–\$2,760,000\hfill \\ WorkingCapital=\$3,180,000\hfill \end{array}$

Current Ratio −

For this year −

Current assets = $ 7,800,000

Current Liabilities = $ 3,900,000

  $\begin{array}{l}Current\text{ Ratio }=\frac{Currentassets}{Currentliabilities}\hfill \\ Current\text{ Ratio }=\frac{\$7,800,000}{\$3,900,000}\hfill \\ Current\text{ Ratio }=\text{ 2 }\hfill \end{array}$

For last year −

• Current assets = $ 5,940,000
• Current Liabilities = $ 2,760,000

  $\begin{array}{l}Current\text{ Ratio }=\frac{Currentassets}{Currentliabilities}\hfill \\ Current\text{ Ratio }=\frac{\$\text{ 5},940,000}{\$\text{ 2},760,000}\hfill \\ Current\text{ Ratio }=\text{ 2}\text{.15 }\hfill \end{array}$

Acid test ratio −

For this year − Given,

Cash = $ 960,000

Marketable securities = $ 0

Accounts receivables, net = $ 2,700,000

Current liabilities = 3,900,000

  $\begin{array}{l}Acid–testratio=\frac{Quickassets}{Currentliabilities}\hfill \\ Acid–testratio=\frac{Cash+Marketablesecurities+Accountsreceivables,net}{Currentliabilities}\hfill \\ Acid–testratio=\frac{\$960,000+0+\$2,700,000}{\$3,900,000}\hfill \\ Acid–testratio=0.94\hfill \end{array}$

For last year − Given,

• Cash = $ 1,260,000
• Marketable securities = $ 300,000
• Accounts receivables, net = $ 1,800,000
• Current liabilities = 2,760,000

  $\begin{array}{l}Acid–testratio=\frac{Quickassets}{Currentliabilities}\hfill \\ Acid–testratio=\frac{Cash+Marketablesecurities+Accountsreceivables,net}{Currentliabilities}\hfill \\ Acid–testratio=\frac{\$1,260,000+\text{ \$ 30}0,000+\$\text{ 1},800,000}{\$\text{ 2},760,000}\hfill \\ Acid–testratio=\text{ 1}.22\hfill \end{array}$

Average collection period −

For this year − Given,

Sales on account = $ 15,750,000

Accounts receivables, beginning = $ 1,800,000

Accounts receivables, ending = $ 2,700,000

  $\begin{array}{l}Averageaccountsreceivables=\frac{Accountsreceivables,beginning+Accountsreceivables,ending}{2}\hfill \\ Averageaccountsreceivables=\frac{\$1,800,000+\$2,700,000}{2}\hfill \\ Averageaccountsreceivables=\$2,250,000\hfill \\ Accountsreceivablesturnover=\frac{Sales}{Averageaccountsreceivables}\hfill \\ Accountsreceivablesturnover=\frac{\$15,750,000}{\$2,250,000}\hfill \\ Accountsreceivablesturnover=7\hfill \\ Averagecollectionperiod=\frac{365days}{Accountsreceivablesturnover}=\frac{365days}{7}\hfill \\ Averagecollectionperiod=52.14or53days\hfill \end{array}$

For last year − Given,

• Sales on account = $ 12,480,000
• Accounts receivables, beginning = $ 1,560,000
• Accounts receivables, ending = $ 1,800,000

  $\begin{array}{l}Averageaccountsreceivables=\frac{Accountsreceivables,beginning+Accountsreceivables,ending}{2}\hfill \\ Averageaccountsreceivables=\frac{\$1,560,000+\$\text{ 1},800,000}{2}\hfill \\ Averageaccountsreceivables=\$\text{ 1},680,000\hfill \\ Accountsreceivablesturnover=\frac{Sales}{Averageaccountsreceivables}\hfill \\ Accountsreceivablesturnover=\frac{\$12,480,000}{\$\text{ 1},680,000}\hfill \\ Accountsreceivablesturnover=7.43\hfill \\ Averagecollectionperiod=\frac{365days}{Accountsreceivablesturnover}=\frac{365days}{7.43}\hfill \\ Averagecollectionperiod=\text{ 49}.13or50days\hfill \end{array}$

Average sale period −

For this period − Given,

Cost of goods sold = $ 12,600,000

Inventory, Beginning = $ 2,400,000

Inventory, Ending = $ 3,900,000

  $\begin{array}{l}Averageinventory=\frac{Inventory,Beginning+Inventory,Ending}{2}\hfill \\ Averageinventory=\frac{\$2,400,000+\$3,900,000}{2}\hfill \\ Averageinventory=\$3,150,000\hfill \\ Inventoryturnover=\frac{Costofgoodssold}{Averageinventory}\hfill \\ Inventoryturnover=\frac{\$12,600,000}{\$3,150,000}\hfill \\ Inventoryturnover=4\hfill \\ Averagesaleperiod=\frac{365days}{Inventoryturnover}=\frac{365days}{4}\hfill \\ Averagesaleperiod=91.25daysor93days\hfill \end{array}$

For last period − Given,

• Cost of goods sold = $ 9,900,000
• Inventory, Beginning = $ 1,920,000
• Inventory, Ending = $ 2,400,000

  $\begin{array}{l}Averageinventory=\frac{Inventory,Beginning+Inventory,Ending}{2}\hfill \\ Averageinventory=\frac{\$\text{ 1,920,000 + }\$2,400,000}{2}\hfill \\ Averageinventory=\$\text{ 2},160,000\hfill \\ Inventoryturnover=\frac{Costofgoodssold}{Averageinventory}\hfill \\ Inventoryturnover=\frac{\$\text{ 9},900,000}{\$\text{ 2},160,000}\hfill \\ Inventoryturnover=4.58\hfill \\ Averagesaleperiod=\frac{365days}{Inventoryturnover}=\frac{365days}{4.58}\hfill \\ Averagesaleperiod=\text{ 79}.69daysor\text{ 80 }days\hfill \end{array}$

Operating cycle −

For this year − Given,

Average sale period = 52.14 days

Average collection period = 91.25 days

  $\begin{array}{l}Operatingcycle=Averagesaleperiod+Averagecollectionperiod\hfill \\ Operatingcycle=52.14days+91.25days\hfill \\ Operatingcycle=143.39days\hfill \end{array}$

For last year − Given,

• Average sale period = 49.13 days
• Average collection period = 79.64 days

  $\begin{array}{l}Operatingcycle=Averagesaleperiod+Averagecollectionperiod\hfill \\ Operatingcycle=49.13days+\text{ 79}.64days\hfill \\ Operatingcycle=128.77days\hfill \end{array}$

Total assets turnover −

For this year − Given,

Sales = $ 15,750,000

Average total assets = $ 15,990,000

  $\begin{array}{l}Totalassetsturnover=\frac{Sales}{Averagetotalasset}\hfill \\ Totalassetsturnover=\frac{\$15,750,000}{\$15,990,000}\hfill \\ Totalassetsturnover=0.99\hfill \end{array}$

For last year − Given,

• Sales = $ 12,480,000
• Average total assets = $ 13,920,000

  $\begin{array}{l}Totalassetsturnover=\frac{Sales}{Averagetotalasset}\hfill \\ Totalassetsturnover=\frac{\$12,480,000}{\$13,920,000}\hfill \\ Totalassetsturnover=0.90\hfill \end{array}$

Conclusion

Thus, all the ratios have been calculated.

Requirement 4

To determine

To prepare:

A brief memo that summarizes how Lydex is performing relative to its competitors

Answer to Problem 15P

Solution:

The performance of Lydex can be explained as −

• The Lydex Company is doing fine in terms of current ratio and acid-test ratio but for sales period and collection period, it is far behind the industry averages.
• The return on total assets is also less when compared with the industry averages.
• Debt-to-equity ratio was appropriate till last year, but this year it deteriorated.
• The times-interest-earned ratio is also low as compared to industry averages
• Similarly, the price-earnings ratio is low when compared with industry’s price earnings ratio.
Overall, the performance of the company is not up to to the mark as it should be as per the industry.

Explanation of Solution

The above answer can be explained as under −

The table is prepared to compare the ratios of the company for this year and last year −

Ratios	This year	Last year	Industry
Current Ratio	2	2.15	2.3
Acid-test ratio	0.94	1.22	1.2
Average collection period	52.14	49.13	30 days
Average sale period	91.25	79.69	60 days
Return on total assets	5.25%	3.62%	9.50%
Debt-to-equity ratio	0.78	0.63	0.65
Times interest earned ratio	4.33	3.4	5.7
Price-earnings ratio	8.57	7.94	10

Further it can be explained as −

The Lydex Company is doing fine in terms of current ratio as the current ratio of the industry is 2 and for both the years, it was near 2. The acid-test ratio was approprice foe the last year but it decreased this year.

• For the sales period, the average period is 30 days, while it is 52.14 days for this year and 49.13 days for last year. The collection period is very long for the company. The company should change its policies for the collections of accounts receivables.

• Similarly, for the sales period, it is far behind the industry averages.
• The return on total assets is also less when compared with the industry averages. The industry is earning more on total assets, while the company is again behind the industry averages. But from the last year to this year, it improved.

• Debt-to-equity ratio was appropriate till last year, but this year it deteriorated.
• The times-interest-earned ratio is also low as compared to industry averages. The industry is earning more to cover its interest obligations, when compared with the company.
• Similarly, the price-earnings ratio is low when compared with industry’s price-earnings ratio. The industry’s price-earnings ratio is 10, while for company it is low, but for this year it improved.

Conclusion

Thus, the brief memo for the performance of the company has been prepared.