Question

Assume that Carla Harris of Morgan Stanley (MorganStanley.com) has impressed you with the company’s success and its commitment to ethical behavior. You learn of a staff opening at Morgan Stanley and decide to apply for it. Your resume is successfully screened from the thousands received and you advance to the interview process. You learn that the interview consists of analyzing the following financial facts and answering analysis questions below. (The data are taken from a small merchandiser in outdoor recreational equipment.)

	2017	2016	2015
Sales trend percents	137.0%	125.0%	100.0%
Selling expenses to sales	9.8%	13.7%	15.3%
Sales to plant assets ratio	3.5 to 1	3.3 to 1	3.0 to 1
Current ratio	2.6 to 1	2.4 to 1	2.1 to 1
Acid test ratio	0.8 to 1	1.1 to 1	1.2 to 1
Merchandise inventory turnover	7.5 times	8.7 times	9.9 times
Accounts receivable turnover	6.7 times	7.4 times	8.2 times
Total asset turnover	2.6 times	2.6 times	3.0 times
Return on total assets	8.8%	9.4%	11.1%
Return on equity	9.75%	11.50%	12.25%
Profit margin ratio	3.3%	3.5%	3.7%

Required

Use these data to answer each of the following questions with explanations.

1. Is it becoming easier for the company to meet its current liabilities on time and to take advantage of any available cash discounts? Explain.

2. Is the company collecting its accounts receivable more rapidly? Explain.

3. Is the company’s investment in accounts receivable decreasing? Explain.

4. Is the company’s investment in plant assets increasing? Explain.

5. Is the owner’s investment becoming more profitable? Explain.

6. Did the dollar amount of selling expenses decrease during the three-year period? Explain.

Short answer

1. It is not becoming easier for the company to meet its current obligations timely because the acid test ratio is decreasing.
2. The company’s ability to collect receivables has decreased.
3. The company’s investment in accounts receivables is increasing.
4. The company’s investment in plant assets has increased.
5. The profitability of the owner’s investment is decreasing.
6. The dollar amount of the selling expenses incurred by the business entity is decreasing.

Step-by-step solution

Definition of Liquidity

The liquidity of the business entity can be defined as theabilityof the business entityto convert its current assets into cash without affecting the respective assets' market value.

Step 2:Company’s ability to meet the current liabilities on time

The acid test ratio of the business entity is decreasing, reflecting that the cash and equivalent available with the entity are insufficient to meet the current liabilities on time.

Company’s ability to collect receivables

The company’s ability to collect receivables has decreased from 2015 to 2017 because the accounts receivables turnover is decreasing. In 2015 business entity collected cash from accounts receivables 8 times, and in 2017, it collected 6.7 times.

Company’s investment in accounts receivables

The company’s investment in accounts receivable is increasing because the accounts receivable turnover is decreasing, reflecting that the business entity is collecting less cash from its receivables.

Company’s investment in plant assets

Let us assume sales for 2015 are $100.

Therefore, sales for 2016 are $125, and for 2017 it is $137.

Putting this value in the formula of sales to plant asset ratio:

$\mathit{S}\mathit{a}\mathit{l}\mathit{e}\mathit{s}\mathit{t}\mathit{o}\mathit{p}\mathit{l}\mathit{a}\mathit{n}\mathit{t}\mathit{a}\mathit{s}\mathit{s}\mathit{e}\mathit{t}\mathit{s}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathbf{=}\frac{\mathbf{S}\mathbf{a}\mathbf{l}\mathbf{e}\mathbf{s}}{\mathbf{P}\mathbf{l}\mathbf{a}\mathbf{n}\mathbf{t}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}\mathbf{s}}$

We get value of plant assets as follow:

2015	$33.33
2016	$37.87
2017	$39.14

From the above figure, it can be said that investment in the plant assets has increased.

Profitability of owner’s investment

The profitability of the owner’s investment is decreasing, reflected by a decrease in the return on equity. Return on equity has decreased from 12.25% in 2015 to 9.75% in 2017. It means that income generated for equity holders has decreased from 2015 to 2017.

Decrease inthe dollar amount of selling expenses

The dollar amount of selling expenses decreased from 2015 to 2017 because the selling expenses to sales ratio decreased in 2017 compared to 2015 and 2016.