Question

Given the financial statements for Jones Corporation and Smith Corporation shown here:

a. To which one would you, as credit manager for a supplier, approve the extension of (short-term) trade credit? Why? Compute all ratios before answering.

JONES CORPORATION
Current assets		Liabilities
Cash	\(20,000	Accounts payable	\)100,000
Accounts receivable	80,000	Bonds payable (long term)	80,000
Inventory	50,000
Long Term Assets		Stockholder’s Equity
Fixeed assets	\(500,000	Common Stock	\)150,000
Less: Accumulated Depreciation	(150,000)	Paid in capital	70,000
Net fixed assets*	350,000	Retained earnings	100,000
Total assets	\(500,000	Total Liab. And equity	\)500,000

JONES CORPORATION
Sales (on credit)	\(1,250,000
Cost of goods sold	750,000
Gross profit	\)500,000
Selling and administrative expenses	257,000
Less: depreciation expenses	50,000
Operating profits	\(193,000
Interest expenses	8,000
Earning before taxes	\)185,000
Tax expenses	92,500
Net income	\(92,500

*Use net fixed assets in computing fixed asset turnover.

†Includes \)7,000 in lease payments.

SMITH CORPORATION
Current assets		Liabilities
Cash	\(35,000	Accounts payable	\)75,000
Marketable securities	7,500	Bonds payable (long term)	210,000
Accounts receivable	70,000
Inventory	75,000
Long term assets		Stockholder’s equity
Fixed assets	\(500,000	Common stock	\)75,000
Less: accumulated depreciation	250,000	Paid in capital	30,000
Net fixed assets*	250,000	Retained earnings	47,500
Total assets	\(437,500	Total liab. And equity	\)437,500

*use net fixed assets in computing fixed assets turnover.

SMITH CORPORATION
Sales (on credit)	\(1,000,000
Cost of goods sold	600,000
Gross profit	\)400,000
Selling and administrative expenses	224,000
Less: depreciation expenses	50,000
Operating profits	\(126,000
Interest expenses	21,000
Earning before taxes	\)105,000
Tax expenses	52,500
Net income	\(52,500

Includes \)7,000 in lease payments

Short answer

The suppliers and the short term lenders are most concerned with the liquidity ratios. Smith corporation’s liquidity ratios are better than the jones corporation. As a credit manager for the supplier, extension of trade credit is approved for smith corporation because of the improved liquidity ratios.

Step-by-step solution

Calculation of ratios of Jones corporation

	Formula	Computation	Ratios
Profit margin	Net income/Sales	$92,500/$1,250,000	7.40%
Return on assets	Net income/Total assets	$92,500/$500,000	18.50%
Return on equity	Net income/Stockholder Equity	$92,500/$320,000	28.91%
Receivable turnover ratio	Sales/Average accout receivable	$1,250,000/$80,000	15.63 times
Average collection period	365/Receivable turnover	365 days/15.63 time	23.35 days
Inventory turnover	Sales/Average inventory	$1,250,000/$50,000	25 times
Fixed assets turnover	Sales/Average fixed assets	$1,250,000/$350,000	3.57 times
Total assets turnover ratio	Sales/Total assets	$1,250,000/$500,000	2.5 times
Current ratio	Current assets/Current liabilities	$150,000/$100,000	1.5 times
Quick ratio	Liquid assets/Current liabilities	$100,000/$100,000	1.0 times
Debt to total assets	Debts/Total assets	$80,000/$500,000	16%
Times interest earned	EBITDA/Interest expense	$243,000/$8,000	30.37 times
Fixed charge coverage ratio	(EBIT+ Fixed charges)/(Fixed charges + Interest)	(($193,000+$7,000)/($8,000+$7,000)	13.33 times

Calculation of ratios of Smilth corporation

	Formula	Computation	Ratios
Profit margin	Net income/Sales	$52,500/$1,000,000	5.25%
Return on assets	Net income/Total assets	$52,500/$437,500	12%
Return on equity	Net income/Stockholder Equity	$52,500/$152,500	34.4%
Receivable turnover ratio	Sales/Average accout receivable	$1,000,000/$70,000	14.29 time0073
Average collection period	365/Receivable turnover	365 days/14.29 times	25.54 days
Inventory turnover	Sales/Average inventory	$1,000,000/$75,000	13.3 times
Fixed assets turnover	Sales/Average fixed assets	$1,000,000/$250,000	4 times
Total assets turnover ratio	Sales/Total assets	$1,000,000/$437,500	2.29 times
Current ratio	Current assets/Current liabilities	$187,500/$75,000	2.5 times
Quick ratio	Lquid assets/Current liabilities	$112,500/$75,000	1.5 times
Debt to total assets	Debts/Total assets	$210,000/$437,500	48%
Times interest earned	EBITDA/Interest expense	$176,000/$21,000	8.38 times
Fixed charge coverage ratio	(EBIT+Fixed charges)/(Fixed charges + Interest)	($126,000+$7,000)/($21,000+$7,000)	4.75 times