Financial Reporting and Analysis by Charles H. Gibson 13th Edition
Chapter # 6 – Liquidity of Short Term Assets
P 6-1: In this problem, compute the acid-test ratio as follows:
Current Assets -Inventory
Required: Determine the cost of sales of a firm with the following financial data.
Current ratio 2.5
Quick ratio or acid-test 2.0
Current liabilities $400,000
Inventory turnover 3 times
Hawk Company wants to determine the liquidity of its receivables. It has supplied you with the following data regarding selected accounts for December 31, 2011, and 2010:
Receivables, less allowance for losses and discounts $1,180,178 $2,200,000
Beginning of year (allowance for losses and
discounts, 2011—$12,300; 2010—$7,180) 240,360 230,180
End of year (allowance for losses and discounts,
2011—$11,180; 2010—$12,300) 220,385 240,360
a. Compute the number of days’ sales in receivables at December 31, 2011, and 2010.
b. Compute the accounts receivable turnover for 2011 and 2010. (Use year-end gross
c. Comment on the liquidity of Hawk Company receivables
a. Gross Receivables
Days’ sales in
receivables = Net Sales/365
2003: $220,385 +
$11,180 = 71.62 days
2002: $240,360 +
$12,300 = 41.92 days
C.: The Hawk Company receivables have been much less liquid in 2003 in comparison with 2002. The days’ sales in receivables at the end of the year have increased from 41.92 days in 2002 to 71.62 days in 2003. The accounts receivable turnover declined in 2003 to 4.87 from a turnover of 8.98 in 2002. These figures represent a major deterioration in the liquidation of receivables. The reasons for this deterioration should be determined. Some possible reasons are a major customer not paying its bills, a general deterioration of all receivable accounts, or a change in the Hawk Company credit terms.
Mr. Williams, the owner of Williams Produce, wants to maintain control over accounts receivable. He understands that days’ sales in receivables and accounts receivable turnover will give a good indication of how well receivables are being managed. Williams Produce does 60% of its business during June, July, and August. Mr. Williams provided the following pertinent data:
C: This company appears to have a seasonal business because of the materially different days’ sales in receivables and accounts receivable turnover when computed on the two different dates. The ratios computed will not be meaningful in an absolute sense, but they would be meaningful in a comparative sense when comparing the same dates from year to year. They would not be meaningful when comparing different dates.
L. Solomon Company would like to compare its days’ sales in receivables with that of a competitor, L. Konrath Company. Both companies have had similar sales results in the past, but L. Konrath Company has had better profit results. L. Solomon Company suspects that one reason for the better profit results is that L. Konrath Company did a better job of managing receivables. L. Solomon Company uses a calendar year that ends on December 31, while L. Konrath Company uses a fiscal year that ends on July 31. Information related to sales and receivables of the two companies follows:
a. Compute the days’ sales in receivables for both companies. (Use year-end gross receivables.)
b. Comment on the results.
b. It appears that the L. Konrath Company manages receivables better than L. Solomon Company. They have 12.6 days’ sales in receivables while the L. Solomon Company has 23.9 days’ sales in receivables. Actually, we cannot make a fair comparison between these two companies because the L. Solomon Company is using the calendar year while the L. Konrath Company appears to be using a natural business year. By using a natural business year, the L. Konrath Company has its receivables at a low point at the end of the year. This would make its liquidity overstated at the end of the year.
P 6-8: The inventory and sales data for this year for G. Rabbit Company are as follows:
Using the above data from G. Rabbit Company, compute the following:
a. The accounts receivable turnover in days
b. The inventory turnover in days
c. The operating cycle
A partial balance sheet and income statement for King Corporation follow:
Note: The trade receivables at December 31, 2010, were $280,000, net of an allowance of
$8,000, for a gross receivables figure of $288,000. The inventory at December 31, 2010, was $565,000.
Required: Compute the following:
a. Working capital
b. Current ratio
c. Acid-test ratio
d. Cash ratio
e. Days’ sales in receivables
f. Accounts receivable turnover in days
g. Days’ sales in inventory
h. Inventory turnover in days
i. Operating cycle
The following financial data were taken from the annual financial statements of Smith Corporation:
a. Based on these data, calculate the following for 2010 and 2011:
1. Working capital
2. Current ratio
3. Acid-test ratio
4. Accounts receivable turnover
5. Merchandise inventory turnover
6. Inventory turnover in days
b. Evaluate the results of your computations in regard to the short-term liquidity of the firm.
The short-term liquidity of the firm improved between 2003 and 2004. The working capital increased by $60,000, while the current ratio increased from 1.33 to 1.47. The acid-test ratio increased from .67 to .74. Using a rule of thumb of two for the current ratio and one for the acid test, this firm needs to improve its current liquidity position.
The accounts receivable turnover stayed the same, while the inventory improved from 4.25 to 4.98. The days’ sales in inventory improved from 85.88 to 73.29 days.
Much of the improvement in the current position can be attributed to the improved control of the inventory.
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