Question

The comparative financial statements of Norfolk Cosmetic Supply for 2018, 2017, and

2016 include the data shown here:

2018 2017 2016

Balance sheet—partial

Current Assets:

Cash

Short-term investments

Accounts Receivable, Net

Merchandise Inventory

Prepaid Expenses

Total Current Assets

Total Current Liabilities

Income statement—partial

Net Sales (all on account)

\( 70,000

140,000

280,000

355,000

70,000

915,000

560,000

5,890,000

\) 60,000

170,000

240,000

330,000

35,000

835,000

630,000

5,130,000

$ 50,000

120,000

260,000

310,000

35,000

775,000

640,000

4,210,000

Requirements

1. Compute these ratios for 2018 and 2017:

a. Acid-test ratio (Round to two decimals.)

b. Accounts receivable turnover (Round to two decimals.)

c. Days’ sales in receivables (Round to the nearest whole day.)

2. Considering each ratio individually, which ratios improved from 2017 to 2018 and

which ratios deteriorated? Is the trend favorable or unfavorable for the company?

Short answer

Answer:

(1) The ratios are calculated as follows:

Ratios	Year 2017	Year 2018
Acid-test ratio	0.75	0.88
Accounts receivable turnover	20.52	22.65
Accounts receivable turnover	18 Days	16 Days

(2) All the company’s ratios are improved, which is a good trend.

Step-by-step solution

Definition of the acid-test ratio

Acid-test ratio is the ratio that calculates the ability of the company to pay its current liabilities.

Ratio for 2018

1. Acid-test Ratio-$$\begin{gathered} Acid-testRatio=\frac{QuickAsset}{CurrentLiabilities} \\ =\frac{\$490,000}{\$56,000} \\ =0.85 \end{gathered}$$

1. Accounts receivable turnover:$$\begin{gathered} AccountReceivableTurnover=\frac{Sales}{AverageAccountReceivable} \\ =\frac{\$5,890,00}{\left(\frac{\$240,600+\$280,000}{2}\right)} \end{gathered}$$

1. Day’s Sale$$\begin{gathered} PaysScale=\frac{365}{AccountReceivableTurnoverRatio} \\ =\frac{365}{20.65} \\ =16days \end{gathered}$$

Ratios for 2017

1. Acid-test Ratio$$\begin{gathered} Acid-TestRatio=\frac{QuickRest}{CurrentLiabilities} \\ =\frac{\$470,000}{\$630,000} \\ =0.75 \end{gathered}$$

1. Accounts receivable turnover:$$\begin{gathered} AccountReceivableTurnover=\frac{Sales}{AverageAccountsReceivables} \\ =\frac{\$5,130,000}{\left({\displaystyle \frac{\$260,00+\$240,000}{2}}\right)} \\ =20.52 \end{gathered}$$

1. Day’s Sale:$$\begin{gathered} Day\text{'}sScale=\frac{365}{AccountReceivableTurnoverRatio} \\ =\frac{365}{20.52} \\ =18days \end{gathered}$$

Analysis of the ratios

Company is able to increase its liquidity from 0.75 to 0.88. In terms of increasing the efficiency of credit and collecting it, the performance has improved from 20.52 to 22.65. Now company is able to collect cash from the accounts receivable within 16 days which is less as compared to 18 days in previous year.