Question

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $670,000 long-term loan from Gulfport State Bank, $185,000 of which will be used to bolster the Cash account and $485,000 of which will be used to modernize equipment. The company’s financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	133,000	$	320,000
Marketable securities		0		14,000
Accounts receivable, net		698,000		470,000
Inventory		1,115,000		765,000
Prepaid expenses		34,000		39,000
Total current assets		1,980,000		1,608,000
Plant and equipment, net		2,015,600		1,380,000
Total assets	$	3,995,600	$	2,988,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	885,000	$	470,000
Bonds payable, 12%		750,000		750,000
Total liabilities		1,635,000		1,220,000
Stockholders' equity:
Common stock, $15 par		860,000		860,000
Retained earnings		1,500,600		908,000
Total stockholders’ equity		2,360,600		1,768,000
Total liabilities and stockholders' equity	$	3,995,600	$	2,988,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,850,000	$	4,860,000
Cost of goods sold		4,045,000		3,620,000
Gross margin		1,805,000		1,240,000
Selling and administrative expenses		687,000		582,000
Net operating income		1,118,000		658,000
Interest expense		90,000		90,000
Net income before taxes		1,028,000		568,000
Income taxes (30%)		308,400		170,400
Net income		719,600		397,600
Common dividends		127,000		106,000
Net income retained		592,600		291,600
Beginning retained earnings		908,000		616,400
Ending retained earnings	$	1,500,600	$	908,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new territories. Sales terms are 2/10, n/30. All sales are on account.

Required:

1. To assist in approaching the bank about the loan, Paul has asked you to compute the following ratios for both this year and last year:

a. The amount of working capital.

b. The current ratio.

c. The acid-test ratio.

d. The average collection period. (The accounts receivable at the beginning of last year totaled $420,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $670,000.)

f. The operating cycle.

g. The total asset turnover. (The total assets at the beginning of last year were $2,948,000.)

h. The debt-to-equity ratio.

i. The times interest earned ratio.

j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,758,000.)

2. For both this year and last year:

a. Present the balance sheet in common-size format.

b. Present the income statement in common-size format down through net income.

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	This Year Last Year a. Working capital b. Current ratio c. Acid-test ratio d. Average collection period days days e. Average sale period days days f. Operating cycle days days g. Total asset turnover h. Debt-to-equity ratio i. Times interest earned ratio j. Equity multiplier

Answer 1

Answer to Part a.

Working Capital = Current Assets – Current Liabilities

This Year:
Working Capital = $1,980,000 - $885,000
Working Capital = $1,095,000

Last Year:
Working Capital = $1,608,000 - $470,000
Working Capital = $1,138,000

Answer to Part b.

Current Ratio = Current Assets / Current Liabilities

This Year:
Current Ratio = 1,980,000 / 885,000
Current Ratio = 2.24: 1

Last Year:
Current Ratio = 1,608,000 / 470,000
Current Ratio = 3.42: 1

Answer to Part c.

Acid Test Ratio = (Current Assets – Inventory – Prepaid Expense) / Current Liabilities

This Year:
Acid Test Ratio = (1,980,000 – 1,115,000 – 34,000) / 885,000
Acid Test Ratio = 831,000 / 885,000
Acid Test Ratio = 0.94: 1

Last Year:
Acid Test Ratio = (1,608,000 – 765,000 – 39,000) / 470,000
Acid Test Ratio = 804,000 / 470,000
Acid Test Ratio = 1.71: 1

Answer to Part d.

Average Collection Period = 365 * Average Accounts Receivable / Sales

This Year:
Average Accounts Receivable = (698,000 + 470,000) / 2
Average Accounts Receivable = $584,000

Average Collection Period = 365 * 584,000 / 5,850,000
Average Collection Period = 36.44 or 36 days

Last Year:
Average Accounts Receivable = (470,000 + 420,000) / 2
Average Accounts Receivable = $445,000

Average Collection Period = 365 * 445,000 / 4,860,000
Average Collection Period = 33.42 or 33 days