Question

In: Accounting

Below you can find the comparative financial statements of “Alpha – Beta” company in € for...

Below you can find the comparative financial statements of “Alpha – Beta” company
in € for years 2017 and 2018:

Comparative Balance Sheet of “Alpha- Beta”
Assets 2018 2017 Liabilities &
Stockholders’ Equity
2018 2017
Fixed Assets
Property, Plant and
Equipment
Accumulated
depreciation
Net Property, Plant and
Equipment
Other Assets
Total Fixed Assets
Current Assets
Cash and Cash
Equivalents
Accounts receivables
Inventory
Prepaid Expenses
Total Current Assets
Total Assets

3,250,000
(425,000)
2,825,000
725,000
3,550,000
300,000
900,000
1,100,000
100,000
2,400,000
5,950,000

2,100,000
(250,000)
1,850,000
550,000
2,400,000
300,000
750,000
800,000
100,000
1,950,000
4,350,000
Shareholders’ Equity
Common Stock
Retained earnings
Total Stockholders’
Equity
Long-term Liabilities
Long-term debt
Total Long-term
Liabilities
Current Liabilities
Accounts Payable
Short-term Debt
Total Current
Liabilities
Total Liabilities
Total Liabilities and
Stockholders’ Equity
1,250,000
997,600
2,247,600
2,200,000
2,200,000
502,400
1,000,000
1,502,400
3,702,400
5,950,000
1,250,000
600,000
1,850,000
1,150,000
1,150,000
450,000
900,000
1,350,000
2,500,000
4,350,000
Comparative Income Statement of “Alpha- Beta”
2018 2017
Sales
Cost of Goods Sold
Gross Profit
Selling and Administrative Expenses
Net Operating Income
Interest Expenses
Income Before Taxes
Tax
Net Income
5,000,000
(3,200,000)
1,800,000
(1,000,000)
800,000
(240,000)
560,000
(162,400)
397,600
3,000,000
(1,800,000)
1,200,000
(900,000)
300,000
(110,000)
190,000
(55,100)
134,900


Required:
1. Assume that you want to conduct a credit analysis. In doing so, you need to
calculate the following series of amounts and financial ratios for years 2017 and
2018, so to decide whether to provide a shot-term loan or not to “Alpha – Beta”:
a) net working capital, b) current ratio, c) quick ratio, d) cash to current liabilities
ratio, e) days’ sales in receivables (based on accounts receivables at the end of the
period), f) days’ sales in inventory (based on sales and inventory at the end of the
period), g) operating cycle, h) debt to equity ratio and i) times interest earned. For
your computations, assume that a year has 365 days. (10%)
2. According to the above analysis of “Alpha – Beta”, what do you notice about the
company? Make a recommendation as a credit analyst if it is a smart choice to
lend the company or not. (10%)
3. The cash balance (i.e., cash and cash equivalents) is the most objectively
measured asset relative to other current assets (i.e., inventories, account
receivables) and thus, a credit analyst should trust it, when analyzing a firm’s
short-term liquidity. Do you agree? (10%)

Solutions

Expert Solution

1 Particulars                          2017                            2018
a Net Working Capital (1950000-1350000) (2400000-1502400)
CA-CL $600,000 $897,600
b Current Ratio (1950000/1350000) (2400000/1502400)
CA/CL 1.4 times 1.59 times
c Quick Ratio (1950000-800000)/1350000 (2400000-1100000)/1502400
CA-Inventory/CL .8 times .86 times
d Cash to CL Ratio 300000/1350000 300000/1502400
.2 times .19 times
e Days sale in receivables 750000/3000000*365 900000/5000000*365
Receivables /sales*365 91.25 days 65.7 days
f Days sale in inventory 800000/1800000*365 1100000/3200000*365
Inventory/COGS *365 162.2 days 125.4 days
g Operating Cycle
Days sale of inventory +days sale O/S-days payable O/S (162.2+91.25-91.25) (65.7+125.4-57.3)
162.2 days 133.8 days
h Debt to equity ratio (1150000+1350000)/18500000 (2200000+15024000)/2247600
debt/equity 1.35 times 1.64 times
i Times interest earned 300000/110000 800000/240000
PBIT/Interest 2.7 times 3.3 times
Note
Days payable O/S 450000/1800000*365 502400/3200000*365
Accounts Payable/COGS*365 91.25 days 57.305 days
2 We can lend to short term borrowing to the company. The company ratios are favorable with respect to current ratio and times interest earned ratio. The company could service three times more interest than it is paying in the present context. Similarly debt to equity ratio is also decent enough. It increased to 1.6 times in 2018. Increase up to 2.0 times could be considered for general business. So the lending amount should be capped accordingly. The operating cycle of the company has also improved in 2018. The company is able to rotate inventory faster compared to 2017 and realize debtors quickly compared to 2017.
3 Cash balance would indicate the immediate liquidity available for a company. However is not the sole measure of liquidity. The company would maintain cash to the extent required only for petty expenses and not for meeting all the current liabilities. The idle cash would always be invested in short term assets for better return. Hence while analyzing the liquidity all the current assets should be considered and not mere cash. Net working capital should be analyzed and not mere cash for understanding the liquidity position. Further analysis could also be done by taking into consideration quick ratio which does not take inventory as immediate realizable asset.

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