Financial Ratio Analysis

Problem 5-A6 (Reconstructing financial statements from ratios)

Fill in the blanks in the financial statements and ratios of Ecoland Manufacturing Corp.

Ecoland Manufacturing Corporation

Balance Sheet
As of December 19x1

Cash 300,000 Accounts payable 300,000

Accounts receivable 340,000 Bank loan 100,000
Inventory 200,000 Long term loan 600,000
Net fixed assets 1,160,000 Common stock 600,000
Retained earnings 400,000
Total Asset 2,000,000 Total Liabilities & Equity 2,000,000

Solution:

1. Accounts receivable 2. Inventory

Current liabilities 400,000 Current liabilities 400,000
X Quick ratio 1.6 x Current ratio 2.1
Total quick assets 640,000 Total Current asset 840,000
Less: Cash 300,000 Less quick Asset 640,000

Accounts receivable 340,000 Inventory 200,000

3. Net Fixed assets 4. Long term liabilities 600,000

Total asset 2,000,000 Debt to equity 1:1
Less: Current asset 840,000

Net Fixed asset 1,160,000

5. Common Stock
Total Asset 2,000,000
Less: Liabilities 1,000,000
Retained earnings 400,000 1,400,000

Common stock 600,000

 Working Capital Policy and Management

9-A11 Role of Short term bank loan

Good Earth Poultry Company had sales of 4.4 million last year and current asset and liabilities as follows
(in thousand pesos):

Cash 60,000 Accounts Payable 100,000

Receivable 120,000 Bank loan 260,000
Inventory 900,000 Total 420,000
Total 1,080,000

Good Earth Poultry’s current assets and accounts payable changed in proportion to sales because of the
nature of the Poultry growing business. The company had an existing credit line with its local bank for a
maximum amount of P300, 000.

Required:
a. Calculate the net working capital and current ratio of Good Earth Poultry.
b. If sales increase to 6 million, what will happen to the current ratio? Ignore any possible effects of
profits.
c. If sales fall to 3 million, what will happen to the current ratio? Ignore any possible effects of
profits.
d. Suppose that sales increased by 20 percent and Good Poultry wanted to keeps its current ratio to
the present level. How much additional bank loan can afford? It this amount within the existing
credit limit? How was the increase in current assets financed?
e. Suppose that sales increased by 15 percent and Good Earth Poultry wanted to finance all of the
increase in current asset with a bank loan. How much additional bank loan would the company
need? What will happen to the current ratio?

Solution:
A.
1. Net working Capital = Current assets less Current Liabilities

Current assets 1,080,000

Less: Current Liabilities 420,000
Net working Capital 660,000

2. Current Ratio = Current assets/Current Liabilities

1,080,000/420,000 = 2.57

B.
1. computation of Current asset and Account payable shown below:
Current Asset = 1,080,000 x 6Million/4.4 million = 1,472,727
Accounts payable = 160,000 x 6million/4.4 million = 218,182

2. New Current Ratio = CA/CL = 1,472,727/478,182 = 3.08

  The Current ratio is increasing therefore the company margin of safety in paying short term
maturing obligation are less risky.

C.
1. computation of Current asset and Account payable shown below:
Current Asset = 1,080,000 x 3Million/4.4 million = 736,364
Accounts payable = 160,000 x 3million/4.4 million = 109,091

2. New Current Ratio = CA/CL = 736,364/369,091 = 1.99

 Current ratio is decreasing means margin of safety of firm is unfavorable in paying current
maturing obligation.

D.
1. Compute for sales increased by 20 percent
Last year sales x percent increase = 4.4million x 20% = 880,000
2. computation of Current asset and Account payable shown below:
Current Asset = 1,080,000 x 5.28Million/4.4 million = 1,296,000
Accounts payable = 160,000 x 5.28million/4.4 million = 192,000

3. If Current ratio maintained to the present level at 2.57

4. Compute for total current liabilities
Current asset/Current Ratio = 1,296,000/2.57 = 504,300
5. Compute for additional Bank loan
Total Liabilities less Accounts payable and Bank loan
504,300-452,000 = 52,300
6. If all current asset will finance by the company its will exceed the credit limit of 300,000. The
increased in current asset can only Finance thru loan up to P40,000 and any excess the company
will look for another alternative sources of fund.

E.
1. Compute for sales increased by 15 percent
Last year sales x percent increase = 4.4million x 15% = 660,000
2. computation of Current asset and Account payable shown below:
Current Asset = 1,080,000 x 5.06 Million/4.4 million = 1,242,000
Accounts payable = 160,000 x 5.06 million/4.4 million = 184,000
3. Current Company additional loan would be 162,000 the asset increased.
4. Current ratio = 1,242,000/606,000 = 2.05
 Current ratio is decreasing and company margin of safety in paying the short term obligation
is also unfavorable.
 Cash Management

10-A8 Fund generation and cash cycles

Malasimbo Crafts, Inc., manufactured handicrafts for export. Since it bought materials from nearby farms,
it did not have any account payable. Its total cash requirement per year came to 4.8 million. Malasimbo
crafts had 48 days of inventory and an average days collection period seventeen days.

Malasimbo Crafts took out a short term bank loan for 300,000 that was payable in 60 days. While the
company could generate cash from an income of 80,000 in the next two months, it had no other sources of
funds to pay for the loan.

The company manager, Rey Tria, thought about reducing the average days’ inventory to 30 days and
tightening the collection period to thee regular term of one week. He wondered whether these measures
would be sufficient and whether be he could generate enough cash on time to pay the loan.

Required:
a. Calculate the average cash operating cycle and annual cash turnover of the company.
b. Estimate the average amount of cash tiep up as working capital of the company
c. How much cash can be generated from:
 The reduction in inventory?
 Stricker collection of customer accounts?
d. Can Tria generate sufficient cash to repay the loan on time?

Solution:

a.)
1. Average cash operating cycle = Age of inventory + collection period
48 days + 17 days = 65 days
2. Annual cash turnover = Annual revenue/cash balance
4,800,000/173,333.33 = 27.69
b.)
Computation of Daily sales
Assumption average sales 400,000 per month = 400,000/30days = 13,333.33

Solution:
Daily sales 13,333.33
X Collection days (30 days – 17 Days) 13 Days

Monthly Collection 173,333.33

c.) If Average day’s inventory are 30 days and one week collection period
Computation of Daily sales
Assumption average cash sales 400,000 per month = 400,000/30days = 13,333.33
 Solution:
Daily sales 13,333.33
X Collection days (30 days – 7 Days) 23 Days

Monthly Collection 306,666.67

d.) Can Tria generate sufficient cash to repay the loan on time?
 Yes, the company can repay based on the above analysis and computation.

Proof:

Collection from the 60 days period 306,666.67

Less: Short term loan 300,000.00
Excess cash 6,666.67

Time Value, uneven cash flows.

Max Bok was in the business of mining graphic rocks in the hill sides of Bukidnon. Due to
erratic weather, the condition of the equipment and limited availability of skilled labor, he
expected the flowing the following pattern of net cash flows from his business.
YEAR NET CASH FLOWS (Pesos)
0 (40,000)
1 25,000
2 40,000
3 (10,000)
4 30,000
Bok would like to know whether the cash flows justified his going on with the business.
Alternatively, he could invest the P40,000 he held more in a time deposit account to yield 12
percent after tax. Bok was hoping to retire with a tidy sum of money at the end of four years.
1. What is the present value of the business cash flows?
2. How much is the “tidy sum of money” that awaits Bok at the end of four years?
3. Determine the equal amount of annual cash flows that is equivalent to the above cash
flows.
4. Should Bok pursue the business or deposit his money in the bank?
A. PV = FVn {1/(1+i)n}

YEAR
0 PV = (40,000) {1/(1 + 12%)0} = P(40,000.00)
1 PV = 25,000 {1/(1 + 12%)1} = 22,321.43
2 PV = 40,000 {1/(1 + 12%)2} = 31,887.76
3 PV = (10,000) {1/(1 + 12%)3} = ( 7,117.80)
4 PV = 30,000 {1/(1 + 12%)4} = 19,065.54
45,000
Total Present Value P 26,156.93
B. FV4 = PV(1+i)n
= P40,000 (1+.12)4
=P40,000 (1.12)4
FV =P62,940.77
C. PV = PMT {1-(1+i)-n)/i}
PMT = PVi / [1-(1+i) –n]
= P26,156.93(12%) / [1-(1+12%) –4]
= P3,138.8316 / 0.36448
PMT = P8,611.81
D. Bok should put his money on business because it will give him higher investment income.

Bank investment income = P62,940.77 – P40,000 = P 22,940.77

Business investment income = P26,156.93