Question

Problem 14-18 Common-Size Statements and Financial Ratios for a Loan Application [LO14-1, LO14-2, LO14-3, LO14-4]

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 $570,000 long-term loan from Gulfport State Bank, $135,000 of which will be used to bolster the Cash account and $435,000 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	$	98,000	$	220,000
Marketable securities		0		25,000
Accounts receivable, net		568,000		370,000
Inventory		1,015,000		665,000
Prepaid expenses		26,000		29,000
Total current assets		1,707,000		1,309,000
Plant and equipment, net		1,686,200		1,400,000
Total assets	$	3,393,200	$	2,709,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	835,000	$	500,000
Bonds payable, 12%		600,000		600,000
Total liabilities		1,435,000		1,100,000
Stockholders' equity:
Common stock, $15 par		760,000		760,000
Retained earnings		1,198,200		849,000
Total stockholders’ equity		1,958,200		1,609,000
Total liabilities and stockholders' equity	$	3,393,200	$	2,709,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,350,000	$	4,560,000
Cost of goods sold		3,945,000		3,520,000
Gross margin		1,405,000		1,040,000
Selling and administrative expenses		667,000		562,000
Net operating income		738,000		478,000
Interest expense		72,000		72,000
Net income before taxes		666,000		406,000
Income taxes (30%)		199,800		121,800
Net income		466,200		284,200
Common dividends		117,000		96,000
Net income retained		349,200		188,200
Beginning retained earnings		849,000		660,800
Ending retained earnings	$	1,198,200	$	849,000

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:

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. (Round your answers to 2 decimal places.)
c. The acid-test ratio. (Round your answers to 2 decimal places.)
d. The average collection period. (The accounts receivable at the beginning of last year totaled $320,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
e. The average sale period. (The inventory at the beginning of last year totaled $570,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
f. The operating cycle. (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
g. The total asset turnover. (The total assets at the beginning of last year were $2,630,000.) (Round your answers to 2 decimal places.)
h. The debt-to-equity ratio. (Round your answers to 2 decimal places.)
i. The times interest earned ratio. (Round your answers to 2 decimal places.)
j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,599,000.) (Round your answers to 2 decimal places.)

	This Year		Last Year
Working capital
Current ratio
Acid-test ratio
Average collection period		days		days
Average sale period		days		days
Operating cycle		days		days
Total asset turnover
Debt-to-equity ratio
Times interest earned ratio
Equity multiplier

Answer 1

		Current Year	Calculation	Last Year	Calculation
a	Working capital(Current Assets - Current Liabilities)	$8,72,000	$1,707,000-$835,000	809000	$1,309,000-$500,000
b	Current Ratio(Current Assets/Current liabilities)	2.04	$1,707,000 / $835,000	2.62	$1,309,000 / $500,000
c	Acid-test Ratio[(Current Assets - Inventories - Prepaid expenses)/Current laibilities]	0.80	($1,707,000-$1,015,000-$26,000)/$835,000	1.23	($1,309,000-$665,000-$29,000)/$500,000
d	Average accounts receivable =(Beginning Accounts Receivable+Clsoing Accounts Receivable)/2	$4,69,000	($370,000+$568,000)/2	$3,45,000	($320,000+$370,000)/2
	Accounts receivable turnover =Net sales / Average accounts receivable	11.41	$5,350,000/$469,000	13.22	$4,560,000/$345,000
	Average collection period =365 days/Accounts receivable turnover	31.99 days	365 days / 11.41	27.61 days	365 days / 7.77
e	Average Inventory =(Opening Inventory + Closing Inventory)/2	$8,40,000	($665,000+$1,015,000)/2	$12,35,000	($570,000+$665,000)/2
	Inventory Turnover ratio =Cost of goods sold / Average Inventory	4.70	$3,945,000/$840,000	2.85	$3,520,000/$1,235,000
	Avearage Sales period =365 days / Inventory Turnover ratio	77.66 days	365 days / 4.70	128.07 days	365 days / 2.85
f	Operating Cycle =Inventory Period + Accounts receivable period	109.65 days		155.68 days
g	Average Total Assets =(Opening Total Assets + Closing Total Assets) / 2	$30,51,100	($2,709,000+3,393,200)/2	$26,69,500	($2,630,000+$2,709,000)/2
	Total Assets Turnover =Net Sales / Average Total Assets	1.75	$5,350,000/$3,051,100	1.71	$4,560,000/$14,665,000
h	Debt to equity ratio(Total Liabilities / Total Equity shareholders)	0.73	$1,435,000/$1,958,200	0.68	$1,100,000/$1,609,000
i	Times Interest earned ratio (Earning before interest & taxes / Interest expenses)	10.25	$738,000/72,000	6.64	$478,000/72,000
j	Average Shareholder's equity	$17,83,600	($1,609,000+$1,958,200)/2	$16,04,000	($1,599,000+$1,609,000)/2
	Equity Multiplier(Average Total Assets / Average Shareholder's equity)	1.71	$3,051,100/$1,783,600	1.66	$2,669,500/$1,604,000