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:

1. 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.

c. The acid-test ratio.

d. The average collection period. (The accounts receivable at the beginning of last year totaled $320,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $570,000.)

Answer 1

		Current Year	Previous Year
a	Working capital(Current Assets - Current Liabilities)	$8,72,000	$8,09,000
b	Current Ratio(Current Assets/Current liabilities)	2.04	2.62
c	Acid-test Ratio[(Current Assets - Inventories - Prepaid expenses)/Current laibilities]	0.80	1.23
	Average accounts receivable =(Beginning Accounts Receivable+Clsoing Accounts Receivable)/2	469000	345000
	Accounts receivable turnover =Net sales / Average accounts receivable	11.41	13.22
d	Average collection period =365 days/Accounts receivable turnover	32	28
	Average Inventory =(Opening Inventory + Closing Inventory)/2	840000	617500
	Inventory Turnover ratio =Cost of goods sold / Average Inventory	4.70	5.70
e	Avearage Sales period =365 days / Inventory Turnover ratio	78	64