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Assignment: Financial Statements of Business Organizations Scenario Jim Connor is the owner of Wave Riders, a...

Assignment: Financial Statements of Business Organizations
Scenario

Jim Connor is the owner of Wave Riders, a surf shop located in West Palm Beach, Florida. Jim has just received his end of the year financial statements from his accountant. When he sees his gross and net income he is dismayed. With almost $250,000 in gross profit he just doesn’t understand why he is always short on cash to pay his employees and suppliers. One of his largest suppliers of surf boards notified him just last month that they would no longer extend him credit and he would have to pre-pay all of his orders. He puts a call into his accountant to set up a meeting with her to discuss the financial health of his business.

Questions

Part 1
1. Using the financial statements provided, calculate the 12 financial ratios discussed in your text using the financial information that is provided below for Wave Riders,
2. Looking at these ratios, are there any of them that look suspicious? If so, which ratios are they and what about them do you believe is cause for concern?
Part 2
1. Using the industry ratios that have been provided, compare Wave Rider’s ratios with those for the industry. What “red flags” do you see when making this comparison?
2. What do you think might be causing the deviations that you see between Wave Riders ratios and the industry ratios?
Part 3
1. What recommendations would you make to Jim to help him improve the financial performance of Wave Riders in the future? Prepare a memo to Jim outlining your recommendations, making certain to include your reasons for the recommendation (i.e. ratio analysis and/or comparison to industry ratios).


Financial Statements

Wave Riders
Income Statement
For the year ended December 31, 20XX
Merchandise Sales: $500,000
Cost of Goods Sold: $255,000
Gross Profit: $245,000
Wage Expense: $140,000
Rent Expense: $45,000
General and Administrative: $45,000
Total Expenses: $230,000
Earnings Before Interest & Taxes (EBIT): $15,000
  
Interest: $5,000
Income before tax: $10,000
Tax (@ 25% rate): $2,500

Net Income/(Loss): $7,500
Wave Riders
Statement of Owner's Equity
For the year ended December 31, 20XX
Beginning Capital: $0

Owner Contributions: $5,000

Net Income/(Loss): $7,500
total: $12,500

Owner Withdrawals: $0

Ending Capital: $12,500

Wave Riders
Balance sheet as of December 31. 20xx

Current Assets
Cash and Cash Equivalents: $29,500
Accounts Receivable: $10,000
Merchandise Inventory: $100,000
Prepaid Expenses: $7,500
Total Current Assets: $147,000
Property, Plant, and Equipment: $5,000

Current Liabilities
Accounts Payable: $74,250
Wages Payable: $10,250
  
Total Current Liabilities: $84,500
Long-Term Debt: $55,000

Total Liabilities: $139,500
Owner's Equity: $12,500

Total Liabilities and Owner's Equity: $152,000
Wave Riders
Statement of Cash Flows
For the year ended December 31, 20XX

Cash provided by operating activities
Net Income (loss): $7,500
Changes in operating assets & liabilities

Inventories: ($100,000)
Accounts Receivables: ($10,000)
Accounts Payable: $10,250
Accrued expenses: $7,500
Cash provided by (used by) operations: ($85,000)

Cash provided by investing activities
Purchases of fixed assets: ($5,000)
Cash provided by (used by) investing: ($5,000)

Cash provided by financing
Long-term borrowing: $55,000
Owner contributions: $5,000
Payment of Debt and Financing Costs: ($5,000)
Cash provided by (used by) financing: $55,000
Change in cash: ($35,000)

Beginning cash balance: $0

Ending cash balance: ($35,000)
Industry Ratios
Liquidity & Solvency Ratios
Current Ratio 2.1
Quick Ratio 0.95
Debt Ratio 1.05
Debt to Net Worth Ratio 8.5
Times Interest Earned Ratio 4.2
Return on Equity (ROE) 5.25


Operating Ratios
Average Inventory Turnover Ratio 6.85
Average Receivables Turnover Ratio 10
Average Collection Period Ratio 36.5
Payables Turnover Ratio 5.8
Average Payable Period Ratio 62.9
Net Sales to Total Assets Ratio 3.3

Profitability Ratios
Net Profit on Sales Ratio 4.8%
Net Profit to Assets Ratio 4.55%
Net Profit to Equity Ratio 1.8

Solutions

Expert Solution

Wave Riders Ratio Formula

Wave Riders Ratio

Industry Ratios

Comparative

Liquidity & Solvency Ratios

Current Ratio = Current Assets/Current Liabilities

=147000/84500 1.74 2.1 acceptable

Quick Ratio =(Current Assets-Inventory)/Current Liabilities

=(147000-100000)/ 84500 0.56 0.95 Red Flag

Debt Ratio =Total Liabilities/Total Assets

=139500/152000 0.92 1.05 acceptable

Debt to Net Worth Ratio= Debt / Net Worth

=55000/12500 4.40 8.5 acceptable

Times Interest Earned Ratio =(Operating Income+Depreciation) / Interest

=15000/5000 3.00 4.2 acceptable

Return on Equity (ROE) =Net Income/Equity fund *100

=(7500/12500)*100 60% 5.25 acceptable

Operating Ratios

Average Inventory Turnover Ratio = Cost of Goods Sold/ Avg Inventory

= 255000 / (100000-50000) 5.10 6.85 acceptable
To compute Avg Inventory, we have Closing Inventory as per the Balance Sheet, and the change in the Inventory from the Cash Flow Statement. There is a negative cgange in the Inventory for 100,000. So to compute the Avg Inventory, we reduce the half of the change in Inventory from the Closing Inventory Value.

Average Receivables Turnover Ratio = Net Sales/ Avg Receivables

=500000/(10000-5000) 100.00 10 Red Flag

Average Collection Period Ratio =365 days / Avg Recevables TO Ratio

=365/100 3.65 36.5 acceptable

Payables Turnover Ratio = Total Purchase / Avg. Accounts Payable

=255000/(74250+5125) 3.21 5.8 acceptable

Average Payable Period Ratio =(Accounts Payable * 365) / Net Credit Purchases

=(74250*365)/ 255000 106.28 62.9 Red Flag

Net Sales to Total Assets Ratio= Net Sales / Avg Total Assets

=500000/(152000-2500) 3.34 3.3 acceptable

Profitability Ratios

Net Profit on Sales Ratio =(Net Profit/Sales)*100

=(7500/500000)*100 1.50 4.80% Red Flag

Net Profit to Assets Ratio =(Net Profit/Assets)*100

=(7500/152000)*100 4.93 4.55% Acceptable

Net Profit to Equity Ratio =(Net Profit/Equity)

=(7500/12500) 0.60 1.8 Acceptable
The given Company is performing very Poorly as compared to the Industry Standards is shown by the detailed comparisons of various Ratios with the Industry Standard.
Each Ratio states different meanings, as given Below :-
the Quick Ratio is very less, it should be maintained at 1
Avg Recevibles T/O Ratio is very high. We should make more sales in Cash instead of credit sales
Avg Payable Ratio is also very high, this makes us loos credibility in market and we can not buy goods on credit basis and it may sometimes adversoly impact the business.
Net Profit to Sales Ratio is very low as compared to the Industry, and so focus should be made in reducing Costs and Increasing the Sales.

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