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

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