7. (12.5 points) Use the following simplified 2013 balance sheet to show, in gen

Question

7. (12.5 points) Use the following simplified 2013 balance sheet to show, in general terms, how an improvement in the DSO would tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change "ripple through" the financial statements (shown in thousands below) and influence the stock price? $878 1,802 817 $3,497 Debt $1,545 Accounts receivable Other current assets Net fixed assets Total assets Equity Liabilities plus equity 1,952 $3,497 First, we need to calculate XYZ's daily sales Daily sales Sales Daily sales$7,035,600 / Daily sales$19,275.62 365 365 Target A/RDaily sales Target A/R-$19,276 Target A/R$616,820 Target DSo 32 Freed-up cash old A/R Freed-up cash -$878,000 Freed-up cash =$261,180 new A/R $616,820 8. (12.5 points) Provide a brief summary or rationale of how these ratios are used, and why they are important

Explanation / Answer

7) When DSO is improved to 32 days. from the exising 46 days [878000/19275= 46 days), cash to the extent of 261,180 is freed. This will save interest cost on working capital finance, as only lesser amount would have to be borrowed. Supposing that the cost of working capital finance is 10%, the freeing up of the above amount would reduce financing costs (before tax) by $26,118. This would improve profits and total assets and equity would go up by this amount. As the stockholders' wealth is improved the stock price would go up. 8) DSO (Days sales outstanding) tells us how many days sales is blocked in receivables. It is calculated as: Accounts receivables/Net credit sales per day. This ratio can be compared with the credit term of the firm to evaluate whether the credit policy is properly implemented. For instance, if the credit period is 30 days and the DSO is 40, it means that the credit appraisal and credit collecton is not as it was planned. This ratio can be compared with the figures of the same firm over the years to see whether there is improvement or deterioration over the years. Necessary action can be taken to to improve the ratio. The firm's ratio should also be compared with the industry average as the ratio tends to be different for different industries.

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