Question

ABC Company has the following financial information for 2018:

• Total current assets: $2,200,000
• Total current liabilities: $1,200,000
• Cash: $300,000
• Inventory: $1,000,000
• Accounts Receivable: $800,000
• Accounts Payable: $500,000
• Net sales is $10,000,000
• Variable cost (VCR) is 30% of sales
• Cost of Goods Sold (COGS) at 40% of sales
• Average daily cash flow $27,000
• Standard deviation of cash flow is $40,000
• Its ROE is 25%
• Total earnings of $500,000, dividend payout of $150,000.
• Its cost of capital is 7%
• Line of credit available: $500,000
• Its credit terms from supplier is Net 35 (DPO)
• Its credit terms to customer is Net 45 (DSO)
• Expenses for credit administration and collection is 5% of sales EXP(.05/CP)
• Daily interest rate (i) is 7%/365
• Collection period for sale is 45 days (CP)

It makes the following forecast for 2019:

• Revenues increase by 10% from 2018 level;
• Receivables will be 8% of revenues;
• Inventory will equal to 10% of revenues;
• Payables are expected at 5% of revenues.

Calculate these solvency ratios:

1. WCR
2. CCE
3. DCH

Answer 1

a) WCR - Working capital requirement

the formula for WCR is = (receivables + Inventory + prepaid expenses) Less ( Accounts Payable + Accruals)

= (800000 + 1000000 + 0) - (500000 + 0)

= 1300000

b) cash coverage efficiency ratio = cash & cash equivalents / total current liabilities of the company.

= 300000 / 1200000

= 0.25

C) DCH : Days cash held

the formula for DCH is = cash & cash equivalents / (COGS/365)

= 300000 / (40% of sales/365)

= 300000/ (40% of 10000000/365)

= 300000 / 10958.9

= 27.375