Financial Accounting
Financial Accounting
14th Edition
ISBN: 9781305088436
Author: Carl Warren, Jim Reeve, Jonathan Duchac
Publisher: Cengage Learning
Question
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Chapter 17, Problem 4PB
To determine

Determine the following ratios measures for 2016.

  1. 1. Working capital
  2. 2. Current ratio
  3. 3. Quick ratio
  4. 4. Accounts receivable turnover
  5. 5. Number of days' sales in receivables
  6. 6. Inventory turnover ratio
  7. 7. Number of days' sales in inventory
  8. 8. Ratio of fixed assets to long-term liabilities
  9. 9. Ratio of liabilities to stockholders’ equity
  10. 10. Number of times interest charges are earned
  11. 11. Number of times preferred dividends are earned
  12. 12. Ratio of sales to assets
  13. 13. Rate earned on total assets
  14. 14. Rate earned on stockholders' equity
  15. 15. Return on common stockholders' equity
  16. 16. Earnings per share on common stock
  17. 17. Price earnings ratio
  18. 18. Dividends per share of common stock
  19. 19. Dividend yield

Expert Solution & Answer
Check Mark

Explanation of Solution

Financial Ratios: Financial ratios are the metrics used to evaluate the capabilities, profitability, and overall performance of a company.

1.  Working capital

Working capital  = Current assets – Current liabilities = $3,690,000 – $900,000= $2,790,000

Note:

Working capital is determined as the difference between current assets and current liabilities.

Formula:

Working capital = Current assets – Current liabilities 

2. Current ratio

Current ratio=Current assetsCurrentliabilities=$3,690,000$900,000=4.1

 Note:

Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.  Current assets include cash and cash equivalents, short-term investments, net, accounts and notes receivables, net, inventories, and prepaid expenses and other current assets. Current liabilities include short-term obligations and accounts payable.  

Formula:

Current ratio=Current assetsCurrentliabilities

3. Quick ratio

Quick ratio =Quick assets Currentliabilities=$2,250,000$900,000=2.5

Note:

Acid-Test Ratio is the ratio denotes that this ratio is a more rigorous test of solvency than the current ratio. It is determined by dividing quick assets and current liabilities. The acceptable acid-test ratio is 0.90 to 1.00. It is referred as quick ratio. Use the following formula to determine the acid-test ratio:

Acid Ratio=Quick assetsCurrentliabilities

4. Accounts receivable turnover

Accounts receivables turnover ratio}=Net credit salesAverage accounts receivables=$10,000,000$625,000=16.0

Note:

Accounts receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. Main purpose of accounts receivable turnover ratio is to manage the working capital of the company. This ratio is determined by dividing credit sales and sales return.

Formula:

Accounts receivables turnover ratio}=Net credit salesAverage accounts receivables

Average accounts receivable is determined as follows:

Average accounts receivables }(Opening accounts receivables + Closing accounts receivables )2=$740,000+$510,0002=$625,000

5. Number of days’ sales in receivables

 Number of days’ sales in receivable }=Average accounts receivable Average daily sales=$625,00027,397.26=22.8days

Note:

Number of days’ sales in receivables is used to determine the number of days a particular company takes to collect accounts receivables.

Formula:

 Number of days’ sales in receivable=Average accounts receivable Average daily sales

Average daily sales are determined by dividing sales by 365 days.

Average daily sales = Sales365days=$10,000,000365days=$27,397.26

6. Inventory turnover ratio

Inventory turnover ratio =Cost of goods soldAverage inventory=$5,350,000$1,070,000=5times

Note:

Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

Formula:

Inventory turnover=Cost of goods soldAverage inventory

Average inventory is determined as below:

 Average inventory = (Opening inventory + Closing inventory )2=$1,190,000+$950,0002=$1,070,000

7.  Number of days sales in inventory ratio

 Number of days’ sales in inventory }=Average inventory Average daily cost of goods sold=$1,070,000$14,657.53=73.0days

Note:

Number of days’ sales in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

Formula:

Number of days’ sales in invenotry=Average inventory Average daily cost of goods sold

Average daily cost of goods sold are determined by dividing cost of goods sold by 365 days. Thus, average daily cost of goods sold are determined as follows:

Average daily cost of goods sold= Cost of goods sold365days=$5,350,000365days=$14,657.53

8. Ratio of fixed assets to long-term liabilities

Ratio of fixed assets to long-term liabilities=Fixed assets Long-term liabilities =$3,740,000$1,700,000=2.2

Note:

Ratio of fixed assets to long-term liabilities is determined by dividing fixed assets and long-term liabilities.

Formula:

Ratio of fixed assets to long-term liabilities=Fixed assets Long-term liabilities 

9. Ratio of liabilities to stockholders’ equity

 Ratio of liabilities to stockholders' equity }=Total liabilitiesStockholders' equity=$2,600,000$7,180,000=0.4

Note:

Ratio of liabilities to stockholders’ equity is determined by dividing liabilities and stockholders’ equity.

Formula:

 Ratio of liabilities to stockholders' equity=Total liabilitiesStockholders' equity

10. Number of times interest charges are earned

Number of times interest charges are earned }=Income before income tax+Interest expenseInterest expense=$1,130,000+$170,000$170,000=7.6%

Note:

Number of times interest charges are earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

Formula:

Number of times interest charges are earned }=Income before income tax+Interest expenseInterest expense

11. Number of times preferred dividends are earned

Number of times preferred dividends are earned  }=Net incomePreferred dividends=$300,000$15,000=20.0

Note:

Number of times preferred dividends are determined by dividing net income and preferred dividends.

Formula: Number of times preferred dividends are earned  }=Net incomePreferred dividends

12. Ratio of sales to assets

Ratio of sales to assets=SalesAverage total assets=$10,000,000$6,942,500=1.4

Note:

Ratio of sales to assets is used to determine the asset’s efficiency towards sales.

Formula: Ratio of sales to assets=SalesAverage total assets

Working notes for average total assets are as follows:

Average total assets =Beginning total assets + Ending total assets 2=$7,430,000+$6,455,0002=$6,942,500

13. Rate earned on total assets

Rate earned on total assets=Netincome + Interest expenseAverage total assets=$900,000+$170,000$9,267,500=11.5%

Note:

Rate earned on total assets determines the particular company’s overall earning power. It is determined by dividing sum of net income and interest expense and average total assets.

Formula: Rate earned on total assets=Netincome + Interest expenseAverage total assets

14. Rate earned on stockholders’ equity

 Rate earned on stockholders' equity}= Net income  Average stockholder’s equity=$900,000$6,777,500=13.3%

Note:

Rate earned on stockholders’ equity is used to determine the relationship between the net income and the average equity that are invested in the company.

Formula: Rate earned on stockholders' equtiy = Net incomeAverage  stockholder’s equity

Average stockholders’ equity is determined as follows:

Average  stockholders' equity =(Beginning  stockholders' equity  + Ending  stockholders' equity  2)=$7,180,000+$6,375,0002=$6,777,500

15. Rate earned on common stockholders’ equity

 Rate earned on common stockholders' equity}= Net income – Preferred dividends Average stockholder’s equity=$900,000$45,000$6,277,500=13.6%

Note:

Rate earned on stockholders’ equity is used to determine the relationship between the net income and the average common equity that are invested in the company.

Formula: Rate earned on common stockholders' equtiy} = Net income – Preferred dividends Average  common stockholder’s equity

Average common stockholders’ equity is determined as follows:

Average  stockholders' equity =(Beginning common stockholders' equity  + Ending  common stockholders' equity  2)=$6,680,000+$5,875,0002=$6,277,500

16. Earnings per share on common stock

Earnings per share=(Net income  PreferreddividendsWeighted-average common shares outstanding)=$900,000$45,000100,000=$8.55

A portion of profit that an individual earns from each share is referred to earnings per share.

Formula:

Earnings per share}=Net income Preferred dividendsWeighted average number of common shares outstanding

17. Price earnings ratio

Price earnings ratio =Market price per shareEarning per share=$119.70$8.55=14.0 times

Price/earnings ratio is used to determine the profitability of a company. This ratio is abbreviated as P/E.

Formula:

Price/earnings ratio= Market price per share of common stockEarnings per share

18. Dividend per share of common stock

Dividend per share of common stock}= Dividend per Common stockShares of common stock×100=$50,000100,000shares=$0.50

Note:

Dividend per share of commons stock is determined by dividing dividend per common stock and shares of common stock. 

Formula:

Dividend per share of common stock}= Dividend per Common stockShares of common stock×100

19. Dividend yield ratio

Dividend yield = Annual dividend per ShareMarket price per Share×100=$0.50$119.70=0.4%

Note:

Dividend yield ratio is determined to evaluate the relationship between the annual dividend per share and the market price per share.  

Formula:

Dividend yield = Annual dividend per ShareMarket price per Share×100

Conclusion

Thus, summary table of determined ratios are below:

S.NoParticularsRatios
1.       Working capital$2,790,000
2.       Current ratio4.1
3.       Acid test ratio2.5
4.       Accounts receivable turnover ratio16.0
5.       Number of days’ sales in receivables22.8
6.       Inventory turnover ratio5.0
7.       Number of days sales in inventory73.0
8.       Ratio of fixed assets to  long-term liabilities 2.2
9.       Ratio of liabilities to stockholders’ equity0.4
10.   Number of times interest charges are earned7.6
11.   Number of times preferred dividends are earned20.0
12.   Ratio of sales to assets 1.4
13.   Rate earned on total assets11.5%
14.   Rate earned  on stockholders’ equity 13.3%
15.   Rate earned on common stockholders’ equity13.6%
16.   Earnings per share $8.55
17.   Price earnings ratio14.0
18.   Dividend  per share of common stock $0.50
19.   Dividend yield 0.4%

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