Question

Marta Enterprise is a large corporation that had business activities in such areas as building, maintenance services, real-estate investment, and truck leasing and auto parts distribution. The   following selected data was obtained from the company’s comparative income statements and statements of financial position.

Income Statements Data For the Year ended
	31/12/ YEAR 2	31/12/YEAR 1
	Ksh. ‘000’	Kshs. ‘000’
Net sales	97,000	82,000
Cost of goods sold	57,500	47,500
Selling expenses	14,000	12,000
Administrative expenses	16,500	15,000
Interest expense on long-term debt	1,500	2,100
Statement of Financial Position
	31/12/ YEAR 2	31/12/YEAR 1
	Ksh. ‘000’	Ksh. ‘000’
Cash	127,000	119,500
Short-term investments	52,500	68,000
Inventories	18,000	14,000
Pre-paid expenses	79,000	65,500
Total current liabilities	3,500	5,000
Long-term debt	112,000	107,500
	15,000	21,500

At the beginning of year 2, top management implemented a firm-wide cost control program aimed at selling and administrative expenses. The company rounds all computations to one decimal place and has no cash sales.

Required:

3. Compute the following ratios for year 2.

1. Current ratio
2. Quick ratio
3. Accounts Receivable Turnover
4. Inventory turnover
5. Times interest earned                                                                       

Answer 1

Answer :

1. Current ratio :

Current ratio = Current assets / Current liabilities

Current assets = Cash + Short-term investments + Inventory + Pre-paid expenses

Year - 1

Current ratio = ($119,500 + $68,000 + $14,000 + $65,500) / $5,000

= $267,000 / $5,000

= 53.4 :1

Year - 2

Current ratio = ($127,000 + $52,500 + $18,000 + $79,000) / $3,500

= $276,500 / $3,500

= 79 : 1

2. Quick ratio :

Quick ratio = (Cash + Short-term investments) / Current liabilities

Year - 1

Quick ratio = ($119,500 + $68,000) / $5,000

= $187,500 / $5,000

= 37.5 :1

Year - 2

Quick ratio = ($127,000 + $52,500) / $3,500

= $179,500 / $3,500

= 51.3 : 1

3. Accounts Receivable Turnover ratio :

Can't calculate because accounts receivable value is missing or we have to take assumptions.

4. Inventory turnover ratio :

Inventory turnover ratio = Cost of goods sold / Average Inventory

Year - 1

Average Inventory = ($0 + $14,000) / 2 = $7,000

Inventory turnover ratio = $47,500 / $7,000

= 6.8 times

Year - 2

Average Inventory = ($14,000 + $18,000) / 2 = $16,000

Inventory turnover ratio = $57,500 / $16,000

= 3.6 times

5. Times interest earned ratio :

Times interest earned ratio = Earning before Interest & taxes / Interest expense

Year -1

EBIT = Net sales - (Cost of goods sold + Selling expenses + Administrative expenses)

= $82,000 - ($47,500 + $12,000 + $15,000)

= $82,000 - $74,500

= $7,500

Times interest earned ratio = $7,500 / $2,100

= 3.6

Year -2

EBIT = Net sales - (Cost of goods sold + Selling expenses + Administrative expenses)

= $97,000 - ($57,500 + $14,000 + $16,500)

= $97,000 - $88,000

= $9,000

Times interest earned ratio = $9,000 / $1,500

= 6