Required information Problem 14-15 Comprehensive Ratio Analysis [LO14-2, LO14-3,
ID: 2339791 • Letter: R
Question
Required information
Problem 14-15 Comprehensive Ratio Analysis [LO14-2, LO14-3, LO14-4, LO14-5, LO14-6]
[The following information applies to the questions displayed below.]
You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company’s financial statements, including comparing Lydex’s performance to its major competitors. The company’s financial statements for the last two years are as follows:
To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:
Problem 14-15 Part 3
3. You decide, finally, to assess the company’s liquidity and asset management. For both this year and last year, compute:
a. Working capital.
b. The current ratio. (Round your final answers to 2 decimal places.)
c. The acid-test ratio. (Round your final answers to 2 decimal places.)
d. The average collection period. (The accounts receivable at the beginning of last year totaled $1,730,000.) (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 $2,090,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
f. The operating cycle. (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 totaled $14,670,000.) (Round your final answers to 2 decimal places.)
Lydex CompanyComparative Balance Sheet This Year Last Year Assets Current assets: Cash $ 1,020,000 $ 1,260,000 Marketable securities 0 300,000 Accounts receivable, net 2,940,000 2,040,000 Inventory 3,660,000 2,100,000 Prepaid expenses 270,000 210,000 Total current assets 7,890,000 5,910,000 Plant and equipment, net 9,640,000 9,110,000 Total assets $ 17,530,000 $ 15,020,000 Liabilities and Stockholders' Equity Liabilities: Current liabilities $ 4,070,000 $ 3,100,000 Note payable, 10% 3,700,000 3,100,000 Total liabilities 7,770,000 6,200,000 Stockholders' equity: Common stock, $75 par value 7,500,000 7,500,000 Retained earnings 2,260,000 1,320,000 Total stockholders' equity 9,760,000 8,820,000 Total liabilities and stockholders' equity $ 17,530,000 $ 15,020,000
Explanation / Answer
Answer – 3
(a) Calculation showing working capital:
Working Capital = Current Assets - Current Liabilities
Working Capital (C.Y.) = 7,890,000 - 4,070,000 = 3,820,000
Working Capital (P.Y.) = 5,910,000 – 3,100,000 = 2,810,000
Analysis - From this calculation, we have positive net working capital with which to pay short-term debt obligations before you even calculate the current ratio. You should be able to see the relationship between the company's net working capital and its current ratio.
(b) Calculation showing Current Ratio:
Current Ratio = Current Assets/Current Liabilities
Current Ratio (C.Y.) = 7,890,000/4,070,000 = 1.94
Current Ratio (P.Y.) = 5,910,000/3,100,000 = 1.91
Analysis - The current ratio shows how many times over the firm can pay its current debt obligations based on its assets. This means that the firm can meet its current (short-term) debt obligations 1.94 times over. In order to stay solvent, the firm must have a current ratio of at least 1.0, which means it can exactly meet its current debt obligations. So, this firm is solvent.
In this case, however, the firm is a little more liquid than that. It can meet its current debt obligations and have a little left over. If we look at the current ratio for the previous year, we will see that the current ratio was 1.91. So, the firm improved its liquidity in the current year which, in this case, is good since it is operating with relatively low liquidity.
(c) Calculation showing Acid Test Ration or Quick Ratio:
Acid Test Ratio or Quick Ratio = (Total Current Assets – Inventory-Prepaid Exp)/Current Liabilities
Acid Test Ratio (C.Y.) = (7,890,000 – 3,660,000 – 270,000) / 4,070,000 = 0.97
Acid Test Ratio (P.Y.) = (5,910,000 – 2,100,000 – 210,000) / 3,100,000 = 1.07
Analysis - The quick ratio is a more stringent test of liquidity than is the current ratio. It looks at how well the company can meet its short-term debt obligations without having to sell any of its inventories to do so Inventory is the least liquid of all the current assets because you have to find a buyer for your inventory. Finding a buyer, especially in a slow economy, is not always possible. Therefore, firms want to be able to meet their short-term debt obligations without having to rely on selling inventory.
The Acid test ratio for the current year is 0.97 which is less than 1.0. It means that the firm cannot meet its current (short-term) debt obligations without selling inventory. In order to stay solvent and pay its short-term debt without selling inventory, the quick ratio must be at least 1.0, which it is not.
In this case, however, the firm will have to sell inventory to pay its short-term debt.
(d) Calculation showing Average collection period:
Average collection period = 365/Account receivable turnover ratio
Average collection period (C.Y.) = 365/6.36 = 57.12 days (see further calculation below)
Average collection period (P.Y.) = 365/7.52 = 48.54 days (see further calculation below)
Calculation of Account receivable turnover ratio for current year
ARTR or Activity Ratio = Net credit sales/ Average account receivable
ARTR or Activity Ration = 15,920,000 / [(2,940,000+2,040,000)/2] = 6.39
Calculation of Account receivable turnover ratio for previous year
ARTR or Activity Ratio = Net credit sales/ Average account receivable
ARTR or Activity Ration = 14,180,000 / [(2,040,000+1,730,000)/2] = 7.52
(e) Calculation showing Average sales period:
Average sales period = 365/Inventory turnover ratio
Average sales period (C.Y.) = 365/4.52 = 82.58 days (see further calculation below)
Average sales period (P.Y.) = 365/5.08 = 71.85 days (see further calculation below)
Calculation of Inventory turnover ratio for current year
Inventory turnover ratio = Cost of goods sold / Average Inventory
Inventory turnover ratio = 12,736,000/ [(3,660,000+2,100,000)/2] = 4.42
Calculation of Inventory turnover ratio for previous year
Inventory turnover ratio = Cost of goods sold / Average Inventory
Inventory turnover ratio = 10,635,000/ [(2,100,000+2,090,000)/2] = 5.08
(f) Calculation showing operating cycle period:
Operating cycle period = Inventory Period (365/Inventory Turnover) + Account Receivable Period (365/Receivable Turnover)
Operating Cycle (C.Y.) = 82.58 days + 57.12 days = 139.70 days
Operating Cycle (P.Y.) = 71.85 days + 48.54 days = 120.39 days
(g) Calculation showing asset turnover ratio:
Total Asset Turnover Ratio = Net Sales / Average Total Assets
Total Asset Turnover Ratio (C.Y.) = 1,592,000/[(17,530,000+15,020,000)/2] = 0.98
Total Asset Turnover Ratio (P.Y.) = 14,180,000/[(15,020,000+14,670,000)/2] = 0.96
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