Question

Unity designs and manufactures uniforms for corporation throughout the United States. Selected finacial information follows. Compute the following ratios for Year 2: receivable turnover ratio (assume that 80% of sales were credit sales), inventory turnover ratio, cash ratio, times interest earned ratio, and cash coverage ratio.

	Year 2	Year 1
Net income	$60,000
Net sales revenue	$1,200,000
Cost of goods sold	$650,000
Interest expense	$25,000
Income tax expense	$65,000
Cash and cash equivalents	$12,000	$15,000
Accounts receivable	$120,000	$160,000
Inventories	$65,000	$60,000
Accounts payable	$20,000	$21,000
Current accrued expenses	$22,000	$20,000
Current portion of long-term debt	$40,000	$35,000
Cash flows from operating activities	$170,000
Cash paid for interest	$20,000

Answer 1

1. Receivable turnover ratio = Net credit sales / Average accounts receivables

where, Average accounts receivables = Beginning accounts receivables + Ending receivables / 2

For Year 2:

Beginning accounts receivables = $160000, Ending accounts receivables = $120000

Average accounts receivables = ($160000 + $120000) / 2 = $280000 / 2 = $140000

Net Credit sales = 80% * $1200000 = $960000

Putting these values in the receivable turnover ratio formula, we get,

Receivables turnover ratio = $960000 / $140000 = 6.86

2. Inventory turnover ratio = Cost of the goods sold / Average inventory

where, Average inventory = Beginning inventory + Ending inventory / 2

For year 2:

Ending inventory = $65000, Beginning inventory = Ending inventory of previous year = $60000

Average inventory = ($60000 + $65000) / 2 = $125000 / 2 = $62500

Cost of the goods sold = $650000

Putting these values in the inventory turnover ratio formula, we get,

Inventory turnover ratio = $650000 / $62500 = 10.4

3. Cash ratio = Cash & cash equivalents / Current liabilities

Current liabilities = Accounts payable + Current accrued expenses + Current portion of long term debt

Current liabilities = $20000 + $22000 + $40000 = $82000

Now, putting these values in the cash ratio formula, we get,

For Year 2:

Cash & cash equivalents = $12000, Current liabilities = $82000

Cash ratio = $12000 / $82000 = 0.15

4. Formula for times interest earned ratio is:

Times interest earned ratio = Income before interest and taxes / Interest expense

This can be further analysed as per below:

Times interest earned ratio = Net income + income taxes + interest expense / Interest expense

For Year 2:

Income before interest & taxes = $60000 + $25000 + $65000 = $150000, Interest expense = $25000

Times interest earned ratio = $150000 / $25000

Times interest earned ratio = 6

7. Cash flow coverage ratio = Cash flows from operating activities / Total debt

Cash flows from operating activities = $170000

Total debt = Accounts payable + Current accrued expenses + Current portion of long term debt

Total debt = $20000 + $22000 + $40000 = $82000

Cash flow coverage ratio = $170000 / $82000 = 2.07