Question

For several years, Anne Schippel has been the business banker for the company, Dry Supply. After reviewing the company balance sheet, she makes the following observations. Three major asset accounts are on the books of Dry Supply: accounts receivable, inventory, and fixed assets. the amount of accounts receivable and inventory are characteristic of a wholesaler.

Please Review the Dry Supply Income Statement Spread and Balance Sheet Spread on the next two pages and follow the instructions below:

INSTRUCTIONS:

For each of Anne Schippel's observations listed below, develop questions you would ask Dry Supply in order to complete your balance sheet analysis.

Observation 1: Accounts receivable have remained in the $114,000 to $118,000 range

Observation 2: Inventory decreased during the period, while sales and accounts receivable increased.

Observation 3: fixed assets increased from $130,000 On December 31, 20 xx, to $163,000 on December 31, 20xy

Observation 4: Accounts payable showed a larger decrease than inventory. Some of the decrease is to be expected because inventory usually is financed by trade creditors.

Observation 5: Loans to shareholders has grown from $48,000 on December 31, 20xx, to $67,000 on December 31, 20xy.

Observation 6: With regard to equity, what two questions immediately come to mind?

Balance Sheet Spread: DRY SUPPLY

Common-sized report

($ in $000S)                           Review 12/31/20xx           Review 12/31/20xy                 Review 12/31/20xz

Assets	Amount	%	Amount	%	Amount	%
Cash	$3	1.2	$ 12	4.6	$ 22	8.1
Accounts Receivable	114	46.9	118	45.4	117	43.3
Less:Allowance for doubtful accounts	5	2.1	5	1.9	5	1.9
Net Accounts Receivable	109	44.9	113	43.5	112	41.5
Inventory	73	30	72	27.7	67	24.8
Total Current Assets	185	76.1	197	75.8	201	74.4
Furniture and fixtures	76	31.3	75	28.8	78	28.9
Leasehold Improvements	1	.4	1	.4	0	0.0
Transportation Equipment	53	218	70	26.9	85	31.5
Gross Fixed Assets	130	53.5	146	56.2	163	60.4
Less: Accum. Depreciation	85	35	97	37.3	110	40.7
Net Fixed Assets	45	18.5	49	18.8	53	19.6
Cash-Value Life Insurance	13	5.3	14	5.4	16	5.9
Total Assets	$243	100	$260	100	$270	100

                                    Review 12/31/20xx                      Review 12/31/20xy             Review 12/31/20xz

Liabilities	Amount	%	Amount	%	Amount	%
Notes Payable bank short- term	$81	33.3	$68	26.2	$59	21.8
Accounts payable-trade	42	17.3	46	17.7	31	11.5
Income taxes payable	5	2.1	6	2.3	7	2.6
Accrued bonuses	10	4.1	11	4.2	12	4.4
Total current liabilities	138	56.8	131	50.4	109	40.4
Subordinated debt officers	48	19.8	58	22.3	67	24.8
Total liabilities	186	76.5	189	72.7	176	65.2
Net Worth
Common stock	2	0.8	2	.8	2	.7
Retained earnings	55	22.6	69	26.5	92.	34.1
Total net worth	57	23.5	71	27.3	94	34.8
Total liabilities and net worth	243	100	260	100	270	100

Income Statement Spread: DRY SUPPLY

                                     Review 20xx                                  Review 20xy                          Review 20xz

	Amount	%	Amount	%	Amount	%
Net sales	895	100	937	100	918	100
Costs of goods sold	645	72.1	667	71.2	631	68.7
Gross profit	250	27.9	270	28.8	287	31.3
Selling, Gen. And admin. Expense	157	17.5	173	18.5	180	19.6
Officer’s compensation	36	4	31	3.3	28	3.1
Rent Expenses	15	1.7	18	1.9	20	2.2
Bad Debt Expense	2	.2	1	.1	0	0
Profit sharing expense	7	.8	7	.7	0	0
Depreciation Expense	12	1.3	12	1.3	13	1.4
Total operating expense	229	25.6	242	25.8	241	26.3
Operating income	21	2.3	28	3.	46	5
Other income	0	0	0	0	0	0
Interest income	2	.2	2	.2	2	.2
Rental income	3	.3	3	.3	3	.3
Interest expense	6	.7	7	.7	11	1.2
Net profit before tax	20	2.2	26	2.8	40	4.4
Taxes	11	1.2	12	1.3	17	1.9
Net profit after tax	9	1	14	1.5	23	2.5

Answer 1

1

Accounts Receivable:

Increase in Accounts receivable is 3.5% in year 2 and 2.6% in year 3. This corresponds to increase in sales;

sales increase in Year 2 is 4.6% and increase in year 3 is 2.6%

- When investment in fixed assets in year 2 has increased by 8.89%, why this has not translated into similar increase in sales?

2

Inventory decreased while, sales and receivable increased:

- When sales is increasing even though marginally, why the strategy of reduced inventory is being followed?

- Will the reduced inventory levels (there is a steep reduction in year 3, by almost 8%) has impacted the service delivery to customers,

by creating a "stockout" situation?

3

Fixed assets increased from $130,000 to $163000.

-when Gross fixed assets has increased in year 2 (from year 1 levels), by 16k$ (12%), mainly in transportation equipments, this should have significantly

impacted in the reduction of COGS (cost of goods sold). Whereas, COGS has remained almost at the same level (72%) to sales. Why?

4

Accounts payable showed a larger decrease than inventory:

- The percentage reduction in inventory in Year 2 is 1.5% and in year 3 is 8.3%, compared to year 1. However trade creditors have reduced to

73.8% in year 3, meaning significant payment was made to reduce the trade liability. As it is a interest free source of finance, why this is not availed, particularly

when the trend of sales is increasing?

- The above is an anomoly, when the company is incurring interest expense on its borrowed funds. Why?

5

Loan from subordinated officers have increased from 48000$ to $67000, in 2 years. What are the terms & covenants subject to which it was taken?

what is the purpose of such loan?

6

On review of Equity:

- When PAT increase in year 2 is $5000, how retained earnings has increased by $14000?

- When Equity is increasing, why there was no steps taken for commensurate reduction in liabilities?