Management of Working Capital Accounting ratios Primary Types

Management of Working Capital Accounting ratios

Primary Types of Financial Statements Balance Sheet • A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity. Income Statement • A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.

Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2007 a Cash $ 90 Acct. Rec. c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assetse $1, 195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g (329) Net Fix. Assets $ 701 Investment, LT 50 Other Assets, LT 223 Total Assetsb $2, 169 a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear.

Basket Wonders’ Balance Sheet (Liability Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2007 Notes Payable Acct. Payablec Accrued Taxes d Other Accrued Liab. d Current Liab. e Long-Term Debt f Shareholders’ Equity Com. Stock ($1 par) g Add Pd in Capital g Retained Earnings h Total Equity Total Liab/Equitya, b $ 290 94 16 100 $ 500 530 200 729 210 $1, 139 $2, 169 a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, salaries, etc. e. Debts payable < 1 year. f. Debts payable > 1 year. g. Original investment. h. Earnings reinvested.

Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2007 a Net Sales Cost of Goods Sold b Gross Profit SG&A Expenses c EBITd Interest Expensee EBT f Income Taxes EATg Cash Dividends Increase in RE $ 2, 211 1, 599 $ 612 402 $ 210 59 $ 151 60 $ 91 38 $ 53 a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm. , advertising, officers’ salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders.

Liquidity Ratios Balance Sheet Ratios Liquidity Ratios Shows a firm’s ability to cover its current liabilities with its current assets. Current Assets Current Liabilities For Basket Wonders December 31, 2007 $1, 195 = 2. 39 $500

Liquidity Ratio Comparisons Current Ratio Year 2007 2006 2005 BW 2. 39 2. 26 1. 91 Industry 2. 15 2. 09 2. 01 Ratio is stronger than the industry average.

Liquidity Ratios Balance Sheet Ratios Liquidity Ratios Shows a firm’s ability to meet current liabilities with its most liquid assets. Acid-Test (Quick) Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2007 $1, 195 – $696 = 1. 00 $500

Liquidity Ratio Comparisons Acid-Test Ratio Year 2007 2006 2005 BW 1. 00 1. 04 1. 11 Industry 1. 25 1. 23 1. 25 Ratio is weaker than the industry average.

Summary of the Liquidity Ratio Comparisons Ratio Current Acid-Test BW 2. 39 1. 00 Industry 2. 15 1. 25 • Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account. • Note that this industry has a relatively high level of inventories.

Current Ratio – Trend Analysis Comparison Trend Analysis of Current Ratio Value 2. 5 2. 3 2. 1 BW Industry 1. 9 1. 7 1. 5 2006 Analysis Year 2007

Acid-Test Ratio – Trend Analysis Comparison Trend Analysis of Acid-Test Ratio Value 1. 5 1. 3 BW Industry 1. 0 0. 8 0. 5 2006 Analysis Year 2007

Summary of the Liquidity Trend Analyses • The current ratio for BW has been rising at the same time the acid-test ratio has been declining. • The current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. • This indicates that inventories are a significant problem for BW. BW

Activity Ratios Income Statement/ Balance Sheet Ratios Activity Ratios Indicates quality of receivables and how successful the firm is in its collections. Receivable Turnover (Assume all sales are credit sales. ) Annual Net Credit Sales Receivables For Basket Wonders December 31, 2007 $2, 211 = 5. 61 $394

Activity Ratios Income Statement/ Balance Sheet Ratios Activity Ratios Average number of days that receivables are outstanding. (or RT in days) Avg Collection Period Days in the Year Receivable Turnover For Basket Wonders December 31, 2007 365 5. 61 = 65 days

Activity Ratio Comparisons Average Collection Period Year 2007 2006 2005 BW 65. 0 71. 1 83. 6 Industry 65. 7 66. 3 69. 2 BW has improved the average collection period to that of the industry average.

Activity Ratios Income Statement/ Balance Sheet Ratios Activity Ratios Indicates the promptness of payment to suppliers by the firm. Payable Turnover (PT) (Assume annual credit purchases = $1, 551. ) Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2007 $1551 = 16. 5 $94

Activity Ratios Income Statement/ Balance Sheet Ratios Activity Ratios Average number of days that payables are outstanding. PT in Days in the Year Payable Turnover For Basket Wonders December 31, 2007 365 16. 5 = 22. 1 days

Activity Ratio Comparisons Payable Turnover in Days Year 2007 2006 2005 BW 22. 1 25. 4 43. 5 Industry 46. 7 51. 1 48. 5 BW has improved the PT in Days. Is this good?

Activity Ratios Income Statement/ Balance Sheet Ratios Inventory Turnover Activity Ratios For Basket Wonders December 31, 2007 Indicates the effectiveness of the inventory management practices of the firm. Cost of Goods Sold Inventory $1, 599 = 2. 30 $696

Activity Ratio Comparisons Inventory Turnover Ratio Year 2007 2006 2005 BW 2. 30 2. 44 2. 64 Industry 3. 45 3. 76 3. 69 BW has a very poor inventory turnover ratio.