Question

Summary information from the financial statements of two companies competing in the same industry follows. Barco Company Kyan Company Barco Company Kyan Company Data from the current year-end balance sheets Data from the current year’s income statement Assets Sales $ 810,000 $ 923,200 Cash $ 20,000 $ 35,000 Cost of goods sold 589,100 636,500 Accounts receivable, net 35,400 51,400 Interest expense 9,300 11,000 Current notes receivable (trade) 9,000 8,400 Income tax expense 15,569 25,487 Merchandise inventory 84,940 140,500 Net income 196,031 250,213 Prepaid expenses 5,200 7,600 Basic earnings per share 5.16 5.54 Plant assets, net 280,000 313,400 Cash dividends per share 3.79 3.97 Total assets $ 434,540 $ 556,300 Beginning-of-year balance sheet data Liabilities and Equity Accounts receivable, net $ 30,800 $ 51,200 Current liabilities $ 61,340 $ 101,300 Current notes receivable (trade) 0 0 Long-term notes payable 86,800 103,000 Merchandise inventory 55,600 105,400 Common stock, $5 par value 190,000 226,000 Total assets 408,000 392,500 Retained earnings 96,400 126,000 Common stock, $5 par value 190,000 226,000 Total liabilities and equity $ 434,540 $ 556,300 Retained earnings 44,389 55,231 Required: 1a. For both companies compute the (a) current ratio, (b) acid-test ratio, (c) accounts (including notes) receivable turnover, (d) inventory turnover, (e) days’ sales in inventory, and (f) days’ sales uncollected. (Do not round intermediate calculations.) 1b. Identify the company you consider to be better short-term credit risk.

Answer 1

1a.(a) current ratio - current assets/ current liabilities

(cash + account receivable+ current notes receivable+ merchandise inventory+prepaid expenses ) / current liabilities

(b) acid test ratio = (current assets - prepaid exp - inventory )/ current liabilities

(cash + account receivable+ current notes receivable ) / current liabilities

This ratio shows whether the company has sufficient receivables to cover the immediate liabilities.

(c) accounts receivable turnover = net credit sales / average accounts receivable

(NOTE: here we will assume that all the sales shown are credit sales )

This ratio shows the effectiveness of the credit that is extended to the customers.

average accounts receivable = (opening accounts receivable + closing accounts receivable )/ 2

(d) inventory turnover = cost of goods sold / [( opening inventory + closing inventory )/2]

This ratio tells us how many times the company has sold the average inventory

(e) days sales in inventory = (ending inventory/ cost of goods sold )*365

(NOTE: we have assumed the year contains 365 days )

this ratio tells the average number of days it took to sell average inventory.

(f) days sales uncollected = (accounts receivable/ net sales)*365

This ratio means how long will it take for the creditors to pay off their dues.

RATIO	BARCO CO	KYAN CO
current ratio	(20000+35400+9000+84940+5200)/61340	(35000+51400+8400+140500+7600)/101300
	=2.52	=2.40
acid test ratio	(20000+35400+9000)/61340	(35000+51400+8400)/101300
	1.05	0.94
accounts receivable turnover	810000/{(35400+30800)/2}	923000/{(51400+51200)/2}
	24.47	17.99
inventory turnover	589100/{(84940+55600)/2}	636500/{(140500+105400)/2}
	8.12	5.18
days sales in inventory	(84940/589100)*365	(140500/636500)*365
	52.62	80.57
days sales collected	(35400/810000)*365	(51400/923000)*365
	15.95	20.32

1b.The company at a lesser short term credit risk is Barco company as the company even though has a higher current ratio it is within good limits also has a higher quick ratio which means the company can quickly convert it's receivables into cash and meet it's financial obligations  and higher accounts receivable turnover which means that the extension of credit of the good and it makes timely collection of it's dues. therefore as barco company can convert it's receivables into cash and meet it's obligations it is at a lower risk.