Nineteen measures of solvency and profitability
The comparative financial statements of Bettancort Inc. are as follows. The market price of Bettancort Inc. common stock was $71.25 on December 31, 2016.
Bettancort Inc. Comparative For the Years Ended December 31, 2016 and 2015 |
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2016 | 2015 | |||||||
Retained earnings. January 1......................................... | $2,655,000 | $2,400,000 | ||||||
Add net income for year............................................. | 300,000 | 280,000 | ||||||
Total............................................................... | $2,955,000 | $2,680,000 | ||||||
Deduct dividends: | ||||||||
On |
$ 15,000 | $ 15,000 | ||||||
On common stock................................................. | 10,000 | 10,000 | ||||||
Total........................................................... | $ 25,000 | $ 25,000 | ||||||
Retained earnings. December 31..................................... | $2,930,000 | $2,655,000 | ||||||
Bettancort Inc. Comparative Retained Earnings Statement For the Years Ended December 31, 2016 and 2015 |
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2016 | 2015 | |||||||
Sales...................... | $1,200,000 | $1,000,000 | ||||||
Cost of goods sold............ | 500,000 | 475,000 | ||||||
Gross profit............... | $ 700,000 | $ 525,000 | ||||||
Selling expenses.......... | $ 240,000 | 200,000 | ||||||
Administrative expenses...... | 180,000 | 150,000 | ||||||
Total operating expenses……….. | $ 420,000 | 350,000 | ||||||
Income from operations…….. | $ 280,000 | 175,000 | ||||||
Other income............. | 166,000 | 225,000 | ||||||
$ 446,000 | 400,000 | |||||||
Other expense (Interest)... | 66,000 | 60,000 | ||||||
Income before income tax…… | $ 380,000 | 340,000 | ||||||
Income tax expense....... | 80,000 | 60,000 | ||||||
Net income............... | $ 300,000 | 280,000 | ||||||
Bettancort Inc. Comparative Retained Earnings Statement For the Years Ended December 31, 2016 and 2015 |
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Dec.31, 2016 | Dec. 31, 2015 | |||||||
Assets | ||||||||
Current Assets: | ||||||||
Cash.................................... | $ 450,000 | $ 400,000 | ||||||
Marketable securities.................... | 300,000 | 260,000 | ||||||
Accounts receivable (net)................. | 130,000 | 110,000 | ||||||
Inventories.............................. | 67,000 | 58,000 | ||||||
Prepaid expenses........................ | 153,000 | 139,000 | ||||||
Total current assets..................... | $1,100,000 | $ 967,000 | ||||||
Long-term investments.................... | 2,350,000 | 2,200,000 | ||||||
Property, plant and equipment (net)....... | 1,320,000 | 1,118,000 | ||||||
Total assets............................... | $4,770,000 | $4,355,000 | ||||||
Liabilities | ||||||||
Current liabilities.......................... | $440,000 | $ 400,000 | ||||||
Long-term liabilities: | ||||||||
Mortgage note payable, 8.8%, due 2021... | $ 100,000 | $ 0 | ||||||
Bonds payable, 9%, due 2017............. | 1,000,000 | 1,000,000 | ||||||
Total long term liabilities............... | $1,100,000 | $1,000,000 | ||||||
Total liabilities............................ | $1,540,000 | $1,400,000 | ||||||
Stockholders' equity | ||||||||
Preferred stock $0.90, $10 par………….. | $ 200,000 | $ 200,000 | ||||||
Common stock. $5 par..................... | 100,000 | 100,000 | ||||||
Retained earnings......................... | 2,930,000 | 2,665,000 | ||||||
Total stockholders* equity............... | $3,230,000 | $2,955,000 | ||||||
Total liabilities and stockholders' equity..... | $4,770,000 | $4,355,000 |
Instructions
Determine the following measures for 2016, rounding to one decimal place:
- 1.
Working capital - 2.
Current ratio - 3. Quick ratio
- 4. Accounts receivable turnover
- 5. Number of days' sales in receivables
- 6. Inventory turnover
- 7. Number of days' sales in inventory
- 8. Ratio of fixed assets to long-term liabilities
- 9. Ratio of liabilities to
stockholders equity - 10. Number of times interest charges are earned
- 11. Number of times preferred dividends are earned
- 12. Ratio of sales to assets
- 13. Rate earned on total assets
- 14. Rate earned on stockholders' equity
- 15. Rate earned on common stockholders' equity
- 16. Earnings per share on common stock
- 17. Price-earnings ratio
- 18. Dividends per share of common stock
- 19. Dividend yield
Financial Ratios: Financial ratios are the metrics used to evaluate the capabilities, profitability, and overall performance of a company.
The following ratios measures for 2016.
- 1. Working capital
- 2. Current ratio
- 3. Quick ratio
- 4. Accounts receivable turnover
- 5. Number of days' sales in receivables
- 6. Inventory turnover ratio
- 7. Number of days' sales in inventory
- 8. Ratio of fixed assets to long-term liabilities
- 9. Ratio of liabilities to stockholders’ equity
- 10. Number of times interest charges are earned
- 11. Number of times preferred dividends are earned
- 12. Ratio of sales to assets
- 13. Rate earned on total assets
- 14. Rate earned on stockholders' equity
- 15. Return on common stockholders' equity
- 16. Earnings per share on common stock
- 17. Price earnings ratio
- 18. Dividends per share of common stock
- 19. Dividend yield
Explanation of Solution
1. Working capital
Working capital is determined as the difference between current assets and current liabilities.
Formula:
2. Current ratio
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:
3. Quick ratio
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:
4. Accounts receivable turnover
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:
Average accounts receivable is determined as follows:
5. Number of days’ sales in receivables
Number of days’ sales in receivables is used to determine the number of days a particular company takes to collect accounts receivables.
Formula:
Average daily sales are determined by dividing sales by 365 days.
6. Inventory turnover ratio
Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.
Formula:
Average inventory is determined as below:
7. Number of days sales in inventory ratio
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:
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:
8. Ratio of fixed assets to long-term liabilities
Ratio of fixed assets to long-term liabilities is determined by dividing fixed assets and long-term liabilities.
Formula:
9.Ratio of liabilities to stockholders’ equity
Ratio of liabilities to stockholders’ equity is determined by dividing liabilities and stockholders’ equity.
Formula:
10.Number of times interest charges are earned
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:
11. Number of times preferred dividends are earned
Number of times preferred dividends are determined by dividing net income and preferred dividends.
Formula:
12. Ratio of sales to assets
Ratio of sales to assets is used to determine the asset’s efficiency (excluding long-term investments) towards sales.
Formula:
Working notes for average total assets are as follows:
13. Rate earned on total assets
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:
Working notes for average total assets are as follows:
14. Rate earned on stockholders’ equity
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:
Average stockholders’ equity is determined as follows:
15. Rate earned on common stockholders’ equity
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:
Average common stockholders’ equity is determined as follows:
16. Earnings per share on common stock
A portion of profit that an individual earns from each share is referred to earnings per share.
Formula:
17. Price earnings ratio
Price/earnings ratio is used to determine the profitability of a company. This ratio is abbreviated as P/E.
Formula:
18.Dividend per share of common stock
Dividend per share of commons stock is determined by dividing dividend per common stock and shares of common stock.
Formula:
19.Dividend yield ratio
Dividend yield ratio is determined to evaluate the relationship between the annual dividend per share and the market price per share.
Formula:
Thus, summary table of determined ratios are below:
S.No | Particulars | Ratios |
1. | Working capital | $660,000 |
2. | Current ratio | 2.5 |
3. | Acid test ratio | 2.0 |
4. | Accounts receivable turnover ratio | 10.0 |
5. | Number of days’ sales in receivables | 36.5 |
6. | Inventory turnover ratio | 8.0 |
7. | Number of days sales in inventory | 45.6 |
8. | Ratio of fixed assets to long-term liabilities | 1.2 |
9. | Ratio of liabilities to stockholders’ equity | 0.5 |
10. | Number of times interest charges are earned | 6.8 |
11. | Number of times preferred dividends are earned | 20.0 |
12. | Ratio of sales to assets | 0.5 or 52.5% |
13. | Rate earned on total assets | 8.0% |
14. | Rate earned on stockholders’ equity | 9.7% |
15. | Rate earned on common stockholders’ equity | 9.9% |
16. | Earnings per share | $28.50 |
17. | Price earnings ratio | 2.5 |
18. | Dividend per share of common stock | $1.00 |
19. | Dividend yield | 1.4% |
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Chapter 15 Solutions
Financial & Managerial Accounting
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