Current ratio Current assets 159,485 Current liabilities 21,600 Current ratio 7.4 The ability of a company to pay its short-term dues using the current assets is determined through the current ratio. A value of 1 to 2 is an acceptable range and, therefore, Smith Ltd. Company’s ratio is too high, at 7.4. Even though the company does not have any problem paying its short-term creditors since there is an ample current asset, there is a possibility that the company is operating a very strict credit policy, which could put off some customers (Marshall, 2002).
Quick ratio Current assets - inventory 147485 Current liabilities 21,600 Current ratio 6.8 Quick ratio, just like current ratio, is a measure of the company’s liquidity level, only that Quick ratio excludes inventory. This ratio is almost at the same range with the current ratio meaning that inventory does not make much difference. The ratio is too high indicating that the company could be missing investment opportunities since it is maintaining too low current liabilities. Accounts receivable turnover Net credit sales 100,000 Average accounts receivable 20,000 Accounts receivable turnover 5 times This ratio also shows a company’s liquidity level. It is a strong indicator of how the management has efficiently employed the accounts receivable.
A ratio of 5 times is remarkably high, meaning that collection of accounts receivable and extension of credit to customers was operated efficiently. Alternatively, this may indicate that the company operated, chiefly, on a cash basis (Marshall, 2002). Average Collection period Days * average accounts receivable 7,300,000 (20,000*365) Credit sales 100,000 73 days The company’s average collection period is 73 days, meaning that it takes about 73 days for debtors to clear their dues. This is a good duration since the customers do not take too long to pay and hence the company is able to maintain some good cash flow to pay to finance its operations. Inventory turnover Sales 180,000 Inventory 12,000 15 Times An inventory turnover of 15 is an indication that the company’s stock is selling very fast. This, however, could be a sign that the company is maintaining very low inventory.
Total asset turnover Sales 180,000 Total Assets 455,918 Total asset turnover 0.4 This ratio is somewhat high, indicating that the management has invested the assets efficiently to generate income. The management should seek ways of boosting sales to ensure this ratio is maintained at a high level (Lee, 2008). Debt to total assets Debt 146,600 Assets 455,918 Debt to total assets 0.32 This ratio shows the company’s leverage level.
A ratio of 0.32 is balanced because the debts are neither too low nor too high. The company should avoid a situation where this ratio gets too high because this can lead to bankruptcy. Also, the company should avoid a situation whereby this ratio drops too low because this could mean that some important investment opportunities are foregone (Marshall, 2002). Debt to Equity Debt 146,600 Equity 276951 Debt To Equity 0.53 Debt to equity is also a measure of the company’s leverage level.
A ratio of 0.53 is balanced because it means that the company is not overburdened with interest expenses yet it has invested in a substantial amount of borrowed capital to generate income (Lee, 2008). I can invest in this company Analysis of these ratios has revealed that Smith Ltd is enjoying a very stable financial position, and it would be prudent to invest in it. Overall, the company liquidity is healthy, and it is very unlikely for to be declared bankrupt.
Also, the company’s capital structure is an ideal one as it shows that most of its capital is funded by owners rather than creditors. Furthermore, the company’s trading activities are very healthy; with very good credit policies whereby the debtors pay their dues on time hence making the company enjoy very healthy cash flows to help finance its activities (Karen and Knight, 2005). References Karen, B., & Knight, J., 2005. Liquidity ratios: Can we pay our bills? Boston, MA: Harvard Business School Press. Lee, S., 2008.
Ownership Structure and Financial Performance: Evidence from Panel Data of South Korea. Utah: University of Utah. Marshall, D.H. et al. , 2002. Accounting: What the Numbers Mean, Fifth Edition with Selected Material from Accounting: Text and Cases, Tenth Edition. Boston: McGraw-Hill Primus. APPENDICES Appendix 1: Statement of financial position as at 31 December 2012 Assets Current assets: Cash From cash flow statement 89243 Inventories From income statement 12,000 Accounts receivable [5,000+100,000-60,000-10,000] 35,000 Pre-paid rates [375+500] 875 Total current assets 137,118 Fixed assets: Freehold land and buildings [220,000-2%] 215,600 Furniture 5,000-10% 4,500 Vehicle I 15,000-20% 12,000 Vehicle II 8,00- [8,000/3] 7,333 Total fixed assets 239,433 Other assets: Goodwill 30,000-(30,000/6) 25,000 brand 15000-5000 10,000 patent 20,000-(5%*20,000) 19,000 Total other assets 54,000 Total assets 430,551 Liabilities and owners equity Current liabilities: Interest payable [12,500-5,500-800] 6,200 Trade payables [5,000+45,000-45,000] 5,000 Wages payable 400 Income taxes payable [10,000-5,000+5,000] 10,000 Total current liabilities 21,600 Long-term liabilities: Mortgage payable 145,000-20,000 125,000 Total long-term liabilities 125,000 Owners equity: Ordinary shares [100,000+20,000*£1.4] 128,000 Preference shares [10,000+20,000*£1] 30,000 Accumulated retained earnings From income statements 125951 Total owners equity 283,951 Total liabilities and owners equity 430,551 - Appendix 2: Statement of Changes in Equity for the financial year ended 31 December 2012 Preferred Stock Common Stock Additional Paid-in Capital Retained Earnings (Accumulated Deficit) Total Beginning balance 100,000 10,000 110,000 Issuance of stock 28,000 20,000 48,000 Net income (net loss) 132,651 132,651 Dividends 12,800 900 (13,700) Ending balance 276,951 Appendix 3: Cash flow statement For the financial year ended 31 December 2012 Cash on Hand (beginning of Year) 35,000 CASH RECEIPTS Cash Sales 80,000 Collections from accounts receivable 60,000 Ordinary shares [20,000*1.4] 28,000 Preference shares [20,000*1] 20,000 TOTAL CASH RECEIPTS 180,000 Total Cash Available (before cash out) 223,000 CASH PAID OUT Purchases (merchandise) 50,000 Wages 5,000 Van running expenses 600 Rates (Land & Building) 1,500 Electricity bills 2,090 Taxes (corporation tax) 5,000 Interest (Mortgage) 5,500 SUBTOTAL 69,690 Loan principal payment (mortgage) 20,000 Capital purchase (Vehicle II) 8,000 Dividends 13,700 TOTAL CASH PAID OUT 89243 Cash Position (end of year) 89,243 Appendix 4: Income statement for the year ended 31 December 2012