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 $680,000 long-term loan from Gulfport State Bank, $190,000 of which will be used to bolster the Cash account and $490,000 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	$	135,000	$	330,000
Marketable securities		0		15,000
Accounts receivable, net		711,000		480,000
Inventory		1,125,000		775,000
Prepaid expenses		38,000		40,000
Total current assets		2,009,000		1,640,000
Plant and equipment, net		2,245,000		1,550,000
Total assets	$	4,254,000	$	3,190,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	850,000	$	400,000
Bonds payable, 12%		800,000		800,000
Total liabilities		1,650,000		1,200,000
Stockholders' equity:
Common stock, $15 par		870,000		870,000
Retained earnings		1,734,000		1,120,000
Total stockholders’ equity		2,604,000		1,990,000
Total liabilities and stockholders' equity	$	4,254,000	$	3,190,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,900,000	$	4,890,000
Cost of goods sold		4,055,000		3,630,000
Gross margin		1,845,000		1,260,000
Selling and administrative expenses		689,000		584,000
Net operating income		1,156,000		676,000
Interest expense		96,000		96,000
Net income before taxes		1,060,000		580,000
Income taxes (30%)		318,000		174,000
Net income		742,000		406,000
Common dividends		128,000		107,000
Net income retained		614,000		299,000
Beginning retained earnings		1,120,000		821,000
Ending retained earnings	$	1,734,000	$	1,120,000

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 3/10, 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 $430,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $680,000.)

f. The operating cycle.

g. The total asset turnover. (The total assets at the beginning of last year were $3,150,000.)

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 $1,980,000.)

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.

Answer 1

Ans. 1
Ans. A	Working capital =     Total current assets - Total current liabilities
	This year	$2,009,000 - $850,000	$1,159,000
	Last year	$1,640,000 - $400,000	$1,240,000
Ans. B	Current ratio   =   Total current assets / Total current liabilities
	This year	$2,009,000 / $850,000	2.36 : 1
	Last year	$1,640,000 / $400,000	4.10 : 1
Ans. C	Acid test ratio   =   (Total current assets - Inventory - Prepaid expenses) / Total current liabilities
	This year	($2,009,000 - $1,125,000 - $38,000) / $850,000	1.00 : 1
	Last year	($1,640,000 - $775,000 - $40,000) / $400,000	2.06 : 1
Ans. D	Average collection period   =   No. of days in year / Net credit sales * Average accounts receivables
	This year	365 / $5,900,000 * $595,500	36.8	days
	Last year	365 / $4,890,000 * $455,000	34.0	days
	*Average receivable = (Beginning receivables + Ending receivables) / 2
	This year	($480,000 + $711,000) / 2	$595,500
	Last year	($430,000 + $480,000) / 2	$455,000
Ans. E	Average sales period   =   No. of days in year / Cost of goods sold * Average inventory
	This year	365 / $4,055,000 * $950,000	85.5	days
	Last year	365 / $3,630,000 * $727,500	73.2	days
	*Average inventory = (Beginning inventory + Ending inventory) / 2
	This year	($775,000 + $1,125,000) / 2	$950,000
	Last year	($680,000 + $775,000) / 2	$727,500
Ans. F	Operating cycle = Average collection period + Average sales period
	This year	36.8 + 85.5	122.3	days
	Last year	34.0 + 73.2	107.2	days
Ans. G	Total assets turnover = Sales / Average assets
	This year	$5,900,000 / $3,722,000	1.59	times
	Last year	$4,890,000 / $3,170,000	1.54	times
	*Average assets = (Beginning assets + Ending assets) / 2
	This year	($3,190,000 + $4,254,000) / 2	$3,722,000
	Last year	($3,150,000 + $3,190,000) / 2	$3,170,000
Ans. H	Debt to equity ratio   =   Total liabilities / Total stockholder's equity
	This year	$1,650,000 / $2,604,000	0.63
	Last year	$1,200,000 / $1,990,000	0.60
Ans. i	Time interest earned = Net operating income / Interest expenses
	This year	$1,156,000 / $96,000	12.04	times
	Last year	$676,000 / $96,000	7.04	times
Ans. J	Equity multiplier   =   Average assets / Average stockholder's equity
	This year	$3,722,000 / $2,297,000	1.62	times
	Last year	$3,170,000 / $1,985,000	1.60	times
	*Average equity = (Beginning equity + Ending equity) / 2
	This year	($1,990,000 + $2,604,000) / 2	$2,297,000
	Last year	($1,980,000 + $1,990,000 ) / 2	$1,985,000
Ans. 2a	SABIN ELECTRONICS
	Common - Size Balance Sheets
		This Year		Last Year
		Amount	%	Amount	%
	Assets
	Current Assets:
	Cash	$135,000	3.2%	$330,000	10.3%
	Marketable securities	$0		$15,000	0.5%
	Accounts receivable (net)	$711,000	16.7%	$480,000	15.0%
	Inventory	$1,125,000	26.4%	$775,000	24.3%
	Prepaid expenses	$38,000	0.9%	$40,000	1.3%
	Total current assets	$2,009,000	47.2%	$1,640,000	51.4%
	Plant and equipment (net)	$2,245,000	52.8%	$1,550,000	48.6%
	Total assets	$4,254,000	100.0%	$3,190,000	100.0%
	Liabilities and Stockholder's Equity:
	Liabilities:
	Current Liabilities	$850,000	20.0%	$400,000	12.5%
	Bonds payable, 12%	$800,000	18.8%	$800,000	25.1%
	Total liabilities	$1,650,000	38.8%	$1,200,000	37.6%
	Stockholder's equity:
	Common stock	$870,000	20.5%	$870,000	27.3%
	Retained earnings	$1,734,000	40.8%	$1,120,000	35.1%
	Total stockholder's equity	$2,604,000	61.2%	$1,990,000	62.4%
	Total liabilities and owner's equity	$4,254,000	100.0%	$3,190,000	100.0%
	*In a common size balance sheet, all percentages are calculated on the base of total assets.
	Amount is percentage for This year =   Particular amount of This year / Total assets * 100
	Amount is percentage for Last year =   Particular amount of Last year / Total assets * 100