**ACCOUNTING**

Common-Size Statements and Financial Ratios for Creditors

Modern Building Supply sells various building materials to retail outlets. The company has just approached Linden Bank requesting a $300,000 loan to strengthen the Cash account and to pay certain pressing short-term obligations. The company’s financial statements for the most recent two years follow

MODERN BUILDING SUPPLY

Comparative Balance Sheet

Assets This Year Last Year

Current assets:

Cash . . . . . . . . . . . . . . . . .. $ 90,000 $ 200,000

Marketable securities . . . . . . . . . . –0– 50,000

Accounts receivable, net . . . .. . . . . 650,000 400,000

Inventory . . . . . . . . . . . . . . . 1,300,000 800,000

Prepaid expenses . . . . . . . . . . . 20,000 20,000

Total current assets . . . . . . . . . 2,060,000 1,470,000

Plant and equipment, net . . . . . . . 1,940,000 1,830,000

Total assets . . . . . . . . .. . . . . $4,000,000 $3,300,000

AND SO ON

Assume that the following ratios are typical of firms in the building supply industry:

Current ratio . . . . . . . . . . . . . . 2.5 to 1

Acid-test ratio . . . . . . . . . . . . . 1.2 to 1

Average age of receivables . . . . . 18 days

Inventory turnover in days . . . . . .. . 50 days

Debt-to-equity ratio . . . . . . . .. . . . 0.75 to 1

Times interest earned . . . . . .. . . . 6.0 times

Return on total assets . . . . . . . . . . 10%

Price-earnings ratio . . . . . . . . . . 9

Net income as a percentage of sales . . . . . 4%

Required:

1. Linden Bank is uncertain whether the loan should be made. To assist it in making a decision, you have been asked to compute the following ratios for both this year and last year:

a. The amount of working capital.

b. The current ratio.

c. The acid-test ratio.

d. The average age of receivables. (The accounts receivable at the beginning of last year totalled $350,000.)

e. The inventory turnover in days. (The inventory at the beginning of last year totalled $720,000.)

f. The debt-to-equity ratio.

g. The number of times interest was earned.

2. For both this year and last year (carry computations to one decimal place):

a. Present the balance sheet in common-size form.

b. Present the income statement in common-size form down through net income.

3. From your analysis in (1) and (2) above, what problems or strengths do you see existing in Modern Building Supply? Make a recommendation as to whether the loan should be approved.

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