Q49. Example II-B

Using the information presented below, calculate the solvency and activity ratios.

[Financial information]

Cash = $370,000

Accounts receivable = $780,000

Inventory = $970,000

Current assets = $2,120,000

Property, plant and equipment = $4,380,000

Total assets = $6,500,000

Accounts payable = $650,000

Short-term borrowings = $830,000

Current liabilities = $1,480,000

Long-term liabilities = $1,620,000

Total liabilities = $3,100,000

Total stockholders’ equity = $3,400,000

Total liabilities and stockholders’ equity = $6,500,000

Average accounts receivable = $740,000

Average inventory = $960,000

Average total assets = $6,250,000

Average accounts payable = $625,000

Average stockholders’ equity = $3,260,000

Cash sales = $1,150,000

Credit sales = $6,400,000

Sales = $7,550,000

Cost of goods sold = $4,830,000

Credit purchases = $4,720,000

Gross profit = $2,720,000

Earnings before interest and taxes (EBIT) = $1,550,000

Interest expense = $250,000

Tax expense = $410,000

Net income = $890,000

[Financial ratios to be calculated]

(1) 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

(2) Activity ratios

a. Assets turnover ratio

b. Inventory turnover ratio

c. Accounts receivable turnover ratio

d. Accounts payable turnover ratio

A49.

(1) Solvency ratios

a. Debt to equity ratio = 0.91

b. Debt to assets ratio = 0.48

c. Long-term debt to assets ratio = 0.25

d. Times interest earned ratio = 6.20

e. Assets to equity ratio = 1.92

(2) Activity ratios

a. Assets turnover ratio = 1.21

b. Inventory turnover ratio = 5.03

c. Accounts receivable turnover ratio = 8.65

d. Accounts payable turnover ratio = 7.55

[Note]

(1) Solvency ratios

a. Debt to equity ratio

= Total liabilities / Total stockholders’ equity

= $3,100,000 / $3,400,000 = 0.91

b. Debt to assets ratio

= Total liabilities / Total assets

= $3,100,000 / $6,500,000 = 0.48

c. Long-term debt to assets ratio

= Long-term liabilities / Total assets

= $1,620,000 / $6,500,000 = 0.25

d. Times interest earned ratio

= Earnings before interest and taxes (EBIT) / Interest expense

= (Net income + Interest expense + Tax expense) / Interest expense

= ($890,000 + $250,000 + $410,000) / $250,000

= $1,550,000 / $250,000 = 6.20

e. Assets to equity ratio

= Average total assets / Average stockholders’ equity

= $6,250,000 / $3,260,000 = 1.92

(2) Activity ratios

a. Assets turnover ratio

= Sales / Average total assets

= $7,550,000 / $6,250,000 = 1.21

b. Inventory turnover ratio

= Cost of goods sold / Average inventory

= $4,830,000 / $960,000 = 5.03

c. Accounts receivable turnover ratio

= Credit sales / Average accounts receivable

= $6,400,000 / $740,000 = 8.65

d. Accounts payable turnover ratio

= Credit purchases / Average accounts payable

= $4,720,000 / $625,000 = 7.55

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