Financial Ratios Example I-B



Q47. Example I-B
Using the information presented below, calculate the liquidity and solvency ratios.

[Financial information]

Cash = $120,000
Accounts receivable = $260,000
Inventory = $350,000
Current assets = $730,000
Property, plant and equipment = $1,520,000
Total assets = $2,250,000

Accounts payable = $210,000
Short-term borrowings = $260,000
Current liabilities = $470,000
Long-term liabilities = $580,000
Total liabilities = $1,050,000

Total stockholders’ equity = $1,200,000
Total liabilities and stockholders’ equity = $2,250,000

Average accounts receivable = $250,000
Average inventory = $300,000
Average total assets = $2,000,000

Average accounts payable = $200,000
Average stockholders’ equity = $1,250,000

Cash sales = $750,000
Credit sales = $1,750,000
Sales = $2,500,000
Cost of goods sold = $1,500,000
Credit purchases = $1,350,000
Gross profit = $1,000,000

Earnings before interest and taxes (EBIT) = $525,000
Interest expense = $100,000
Tax expense = $125,000
Net income = $300,000

[Financial ratios to be calculated]

(1) Liquidity ratios
a. Current ratio
b. Quick ratio
c. Working capital ratio

(2) Solvency ratios
a. Debt to equity ratio
b. Debt to assets ratio
c. Long-term debt to assets ratio
d. Times interest earned ratio
e. Assets to equity ratio

A47.
(1) Liquidity ratios
a. Current ratio = 1.55
b. Quick ratio = 0.81
c. Working capital ratio = 0.12

(2) Solvency ratios
a. Debt to equity ratio = 0.88
b. Debt to assets ratio = 0.47
c. Long-term debt to assets ratio = 0.26
d. Times interest earned ratio = 5.25
e. Assets to equity ratio = 1.60

[Note]
(1) Liquidity ratios

a. Current ratio
= Current assets / Current liabilities
= $730,000 / $470,000 = 1.55

b. Quick ratio
= Quick assets / Current liabilities
= (Cash + Accounts receivable) / Current liabilities
= ($120,000 + $260,000) / $470,000
= $380,000 / $470,000 = 0.81

Inventory is not a quick asset.

c. Working capital ratio
= Working capital / Total assets
= (Current assets – Current liabilities) / Total assets
= ($730,000 – $470,000) / $2,250,000
= $260,000 / $2,250,000 = 0.12

(2) Solvency ratios

a. Debt to equity ratio
= Total liabilities / Total stockholders’ equity
= $1,050,000 / $1,200,000 = 0.88

b. Debt to assets ratio
= Total liabilities / Total assets
= $1,050,000 / $2,250,000 = 0.47

c. Long-term debt to assets ratio
= Long-term liabilities / Total assets
= $580,000 / $2,250,000 = 0.26

d. Times interest earned ratio
= Earnings before interest and taxes (EBIT) / Interest expense
= (Net income + Interest expense + Tax expense) / Interest expense
= ($300,000 + $100,000 + $125,000) / $100,000
= $525,000 / $100,000 = 5.25

e. Assets to equity ratio
= Average total assets / Average stockholders’ equity
= $2,000,000 / $1,250,000 = 1.60