Question

Problem 14-18 Common-Size Statements and Financial Ratios for a Loan Application [LO14-1, LO14-2, LO14-3, LO14-4]

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $520,000 long-term loan from Gulfport State Bank, $110,000 of which will be used to bolster the Cash account and $410,000 of which will be used to modernize equipment. The company’s financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	78,000	$	170,000
Marketable securities		0		20,000
Accounts receivable, net		503,000		320,000
Inventory		965,000		615,000
Prepaid expenses		22,000		24,000
Total current assets		1,568,000		1,149,000
Plant and equipment, net		1,503,800		1,350,000
Total assets	$	3,071,800	$	2,499,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	810,000	$	450,000
Bonds payable, 12%		700,000		700,000
Total liabilities		1,510,000		1,150,000
Stockholders' equity:
Common stock, $15 par		710,000		710,000
Retained earnings		851,800		639,000
Total stockholders’ equity		1,561,800		1,349,000
Total liabilities and stockholders' equity	$	3,071,800	$	2,499,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,100,000	$	4,410,000
Cost of goods sold		3,895,000		3,470,000
Gross margin		1,205,000		940,000
Selling and administrative expenses		657,000		552,000
Net operating income		548,000		388,000
Interest expense		84,000		84,000
Net income before taxes		464,000		304,000
Income taxes (30%)		139,200		91,200
Net income		324,800		212,800
Common dividends		112,000		91,000
Net income retained		212,800		121,800
Beginning retained earnings		639,000		517,200
Ending retained earnings	$	851,800	$	639,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new territories. Sales terms are 2/10, n/30. All sales are on account.

Required:

1. To assist in approaching the bank about the loan, Paul has asked you to compute the following ratios for both this year and last year:

a. The amount of working capital.

b. The current ratio.

c. The acid-test ratio.

d. The average collection period. (The accounts receivable at the beginning of last year totaled $270,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $520,000.)

f. The operating cycle.

g. The total asset turnover. (The total assets at the beginning of last year were $2,480,000.)

h. The debt-to-equity ratio.

i. The times interest earned ratio.

j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,339,000.)

2. For both this year and last year:

a. Present the balance sheet in common-size format.

b. Present the income statement in common-size format down through net income.

Answer 1