Question

You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company’s financial statements, including comparing Lydex’s performance to its major competitors. The company’s financial statements for the last two years are as follows:

Lydex Company Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	980,000	$	1,220,000
Marketable securities		0		300,000
Accounts receivable, net		2,780,000		1,880,000
Inventory		3,620,000		2,200,000
Prepaid expenses		260,000		200,000
Total current assets		7,640,000		5,800,000
Plant and equipment, net		9,560,000		9,070,000
Total assets	$	17,200,000	$	14,870,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	4,030,000	$	3,020,000
Note payable, 10%		3,680,000		3,080,000
Total liabilities		7,710,000		6,100,000
Stockholders' equity:
Common stock, $75 par value		7,500,000		7,500,000
Retained earnings		1,990,000		1,270,000
Total stockholders' equity		9,490,000		8,770,000
Total liabilities and stockholders' equity	$	17,200,000	$	14,870,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,880,000	$	13,780,000
Cost of goods sold		12,704,000		10,335,000
Gross margin		3,176,000		3,445,000
Selling and administrative expenses		1,208,000		1,612,000
Net operating income		1,968,000		1,833,000
Interest expense		368,000		308,000
Net income before taxes		1,600,000		1,525,000
Income taxes (30%)		480,000		457,500
Net income		1,120,000		1,067,500
Common dividends		400,000		533,750
Net income retained		720,000		533,750
Beginning retained earnings		1,270,000		736,250
Ending retained earnings	$	1,990,000	$	1,270,000

To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:

Current ratio	2.4
Acid-test ratio	1.1
Average collection period	32	days
Average sale period	60	days
Return on assets	9.5	%
Debt-to-equity ratio	0.7
Times interest earned ratio	5.8
Price-earnings ratio	10

Problem 14-15 Part 3

3. You decide, finally, to assess the company’s liquidity and asset management. For both this year and last year, compute:

a. Working capital.

b. The current ratio. (Round your final answers to 2 decimal places.)

c. The acid-test ratio. (Round your final answers to 2 decimal places.)

d. The average collection period. (The accounts receivable at the beginning of last year totaled $1,690,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)

e. The average sale period. (The inventory at the beginning of last year totaled $2,050,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)

f. The operating cycle. (Round your intermediate calculations and final answers to 2 decimal place.)

g. The total asset turnover. (The total assets at the beginning of last year totaled $14,630,000.) (Round your final answers to 2 decimal places.)

Answer 1

		Computation		Analysis
Sl.No.	Particulars	This year	Last year	Industry
3.a	Working capital=Current Assets-Current Liabilities	3610000	2780000		The woring capital of the company is positive which implies that our current assets are more than current liabilities.
3.b	Current Ratio=Current Assets/Current Liabilities	1.90	1.92	2.40	As compared to industry our current ratio is lower which implies that our current liabilities exceeds more than current assets as compared to industry. There is a slight change in our current asset ratio in current year as compared to last year.
3.c	Acid test ratio=(Cash+Marketable securities+Trade receivables,net)/Total current liabilities	0.93	1.13	1.10	During last year our acid test ratio was more than the industry by a marginal amount. The acid test ratio is used to check if a company has enough cash or other short term liquid assets to pay its short term liabilities. During the current year our acid test ratio falls below 1 which implies that our liquids assets are less than current liabilities.
3.d	Average collection period (in days)=Average accounts receivable balance/Average credit sales per day	53.55	47.28	32.00	Our company take more days to collect the amount from trade receivables as compared to industry. If compared to last year our average collection period has increased thereby blocking of company's working capital for longer days.
3.e.	Average sales period (in days)=(Average inventory*365)/Cost of goods sold	83.61	75.05	60.00	Our company take more days to sale the inventoy one time fully as compared to industry. If compared to last year our average sales period has increased.
3.f	Operating cycle (in days)=(Day's sales in inventory or Average sales period+Average collection period)	137.16	122.33		Operating cycle represents the whole cycle of operation startimg from production to realisation from customers.Our operating cycle has increased in current year as compared to previous year by approx 15 days which implies that now we will take more time to complete 1 operating business cycle.
3.g	Total asset turnover ratio=Net sales/Average total assets	0.99	0.93		Total asset turnover ratio measures the efficiency with which the company has used its total assets to generate sales. It has increased from previous year which is a good indication.
	Return on Assets=Net Income generated/Total Assets	6.51%	7.18%	9.50%	Return on assets implied the return earned on total assets engaged in the business. Our return on assets is low as compared to industry and has also decreased in current year as compared to precious year.
	Debt to equity ratio=Total liabilities/Total stockholder's equity	0.81	0.70	0.70	Debt to equity ratio represents the ratio of total outside's fund as compared to total stockholder's equity.Our debt to equity ratio is same as of industry in last year. However, it has increased slightly in current year.
	Time interest earned ratio=Earnings before interest and income tax or Net operating income/Interest expense	5.35	5.95	5.80	Time interest earned ratio represents the number of time that our earnings before interest and income tax can covered our interest expense. It was more as compared to industry in last year. However, in this year it has slightly reduced.

Data used in computing different ratios and amount as shown above
Particulars	This year	Last year
Opening total assets	14870000	14630000
Closing total assets	17200000	14870000
Avergae total assets	16035000	14750000
Net income generated	1120000	1067500
Cost of goods sold	12704000	10335000
Opening Inventory	2200000	2050000
Closing inventory	3620000	2200000
Average inventory	2910000	2125000
Accounts receivables,net opening	1880000	1690000
Accounts receivables,net closing	2780000	1880000
Average accounts receivable,net	2330000	1785000
Sales (all on account)	15880000	13780000
Average credit sales sales per day (Total sales/365 days)	43506.85	37753.42
Cash	980000	1220000
Marketable securities	0	300000
Current assets Total	7640000	5800000
Current liabilities Total	4030000	3020000
Total Liabilities	7710000	6100000
Total stockholder's equity	9490000	8770000
Net operating income	1968000	1833000
Interest expense	368000	308000