Question

Presented here are a statement of Income and Retained Earnings and Comparative Balance Sheets for Madison's garden PTY LTD, which operates a National chain of sporting goods stores.

Statement of Income and Retained Earnings for the Year ended 31 December 2016

Net Sales R48000

Cost of goods sold R36000

Gross Profit R12000

Selling, general and admin expense R6000

Operating income R6000

Interest Expense R280

Income Before Tax R5720

Income Tax Expense R2280

Net Income R3440

Preference Dividends R100

Income available to ordinary Shareholders R3340

Ordinary Dividends R500

To Retained Earnings R2840

Retained Earnings 1/1/2017 R12000

Retained Earning the end of the year R14840

Comparative Balance sheet as at December 31

2016 2015

Cash 840 2700

Accounts Receivable 12500 9000

Inventory 8000 5500

Prepaid insurance 100 400

Total Current Assets 21440 17600

Land 4000 4000

Buildings and Equipment 12000 9000

Accumulated Depreciation (3700) (3000)

Total Long Term Assets R12300 R10000

Total Assets R33740 R27600

Accounts Payable 7300 5000

Taxes Payabe 4600 4200

Notes Payable 2400 1600

Current Portion of mortgage bond 200 200

Total Current Liabilities 14500 11000

Mortgage Bond 1400 1600

Total Liabilities 15900 12600

Preference Shares 1000 1000

Ordinary shares 2000 2000

Retained Earnings 14840 12000

Total 17840 15000

R33 740 R27 600

Required:

1. Prepare a statement of cash flows for Madison's gardens PTY LTD for the year ended 31,2016, using indirect Method in the Operating Activities section of the statement. (15)

2. Madison Gardens (PTY) LTD 's management is concerned with its short term liquidity and its solvency over the long run. To help management evaluate these, compute the following ratios, rounding all answers to the nearest one-tenth of a percent:

a. Current Ratio

b. Acid-Test Ratio

c. Cash flow from operations to current liabilities Ratio

d. Accounts Receivable turnover ratio

e. Number of days sales in receivable

f. Inventory turn over Ratio

g. Number of days sales in inventory

h. Debt-to-Equity Ratio

i. Debt service coverage Ratio

j.Cash flow from operations to capital expenditures ratio

3. Comment on Madison Garden's liquidity and its insolvency. What additional information do you need to fully evaluate the company?

Answer 1

Cash Flow Statement
Indirect Method
Cash Flow from Operating Activities
Profit for the year		$             3,440.00
Adjustments
Depreciation	$                700.00
Interest Expense	$                280.00
Changes in Current Assets / Current Liabilities
Increase in Inventories	$          (2,500.00)
Increase in Accounts Receivables	$          (3,500.00)
Decrease in Prepaid Insurance	$                300.00
Increase in Accounts Payables	$            2,300.00
Increase in Notes Payable	$                800.00
Increase in Taxes Payable	$                400.00
Total Adjustments		$           (1,220.00)
Cash from Operating Activities			$          2,220.00
Cash flow from Investing Activities
Purchase of Building and Equipment		$           (3,000.00)
Net cash used In investing activities			$        (3,000.00)
Cash flow from Financing Activities
Payment of Mortagage Bond		$               (200.00)
Interest Expense		$               (280.00)
Prefrence Dividend Paid		$               (100.00)
Ordinary Dividend Paid		$               (500.00)
Net cash used in financing activities			$        (1,080.00)
Increase in Cash			$        (1,860.00)
Opening Balance of Cash & Equivalents			$          2,700.00
Ending Balance of Cash & Equivalents			$              840.00

Current Ratio = Current Assets / Current Liabilities
= $21440 / $14500 = 1.48

Acid Test Ratio = (Cash + Accounts receivables) / Current Liabilities
= ($840 + $12500) / $14500 = 0.92

Cash Flow from operations to Current liabilities = Cash Flow from operations / Current Liabilities
= $2220 / $14500 = 0.15

Accounts Receivable Turnover = Credit Sales / Average Receivables
= $480000 / $10750 = 44.65
Average Receivables = ($12500 + $9000) / 2 = $10750

Number of Days Sale in Receivables = 365 / 44.65 = 8.17 days

Inventory Turnover = Cost of Goods Sold / Average Inventory
= $360000 / $6750 = 53.33
Average Inventory = ($8000 + $5500) / 2 = $6750

Number of days' sales in inventory = 365 / 53.33 = 6.84 days

Debt-to-equity ratio = Total Liabilities / Total Equity
= $15900 / $17840 = 0.89

Debt service coverage ratio = Operating Income / Total debt service cost
= 6000 / (280+200) = 12.5

Cash flow from operations to capital expenditures ratio = Cash flow from operations / capital expenditures
= $2220 / $3000 = 0.74

Companies liquidity is fine. Companies current ratio is 1.48 : 1 but ideal current ratio should be 2 : 1, but ratio over 1.33 is also considered good, its quick ratio is 0.92 which is nearly ideal ratio of 1 : 1. Company is able to convert its sales into cash quickly i.e. 8.17 days.