Question

The comparative financial statements of Newton Cosmetic Supply for 2018, 2017,

and 2016 include the data shown here:

2018 2017 2016

Balance sheet—partial

Current Assets:

Cash \( 80,000 \) 50,000 $ 30,000

Short-term investment 150,000 170,000 125,000

Accounts Receivable, Net 310,000 260,000 220,000

Merchandise Inventory 360,000 335,000 330,000

Prepaid Expenses 50,000 30,000 35,000

Total Current Assets 950,000 845,000 740,000

Total Current Liabilities 530,000 630,000 670,000

Income statement—partial

Net Sales (all on account) 5,850,000 5,110,000 425,000

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

(1) The ratios are calculated as follows:

Ratios	Year 2017	Year 2018
Acid-test ratio	0.76	1.02
Accounts receivable turnover	21.30	20.53
Accounts receivable turnover	17 Days	18 Days

(2)Acid test ratio of company is improved, accounts receivable turnover is deteriorated, and day’s sales in receivables deteriorated. All these show unfavourable trend, as company is able to receive cash late, as compared to previous year. In other hand, company is able to increase the liquidity as well.

Step-by-step solution

Definition of the acid-test ratio

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

Ratio for 2018

a.Acid-test Ratio-

$\begin{array}{rcl}& & \text{Acid - test} \text{Ratio =} \frac{\text{Quick} \text{Asset}}{\text{Current} \text{Liabilities}}\\ & & \text{=}\frac{\text{\$ 540,000}}{\text{\$ 530,000}}\\ & & \text{=} \text{1.02}\\ & & \end{array}$

b. Accounts receivable turnover:

$\begin{array}{rcl}& & \text{Accounts} \text{Receivable} \text{Turnover =}\frac{\text{Sales}}{ \text{Average} \text{Accounts} \text{Receivable}}\\ & & \text{=}\frac{\text{\$ 5,850,000}}{\text{\$ 285,000}}\\ & & \text{= 20.53}\\ & & \end{array}$

c. Day’s Sale

$$\begin{gathered} \text{Day's} \text{Sale =}\frac{\text{365}}{\text{Accounts} \text{Receivable} \text{Turnover} \text{Ratio}} \\ \text{=}\frac{\text{365}}{\text{20.53}} \\ \text{=} 18 \text{days} \end{gathered}$$

Ratios for 2017

a. Acid-test Ratio

$$\begin{gathered} \text{Acid - test} \text{Ratio =}\frac{\text{Quick} \text{Asset}}{\text{Current} \text{Liabilities}} \\ =\frac{\text{\$ 480,000}}{\text{\$ 630,000}} \\ \text{= 0.76} \end{gathered}$$

b. Accounts receivable turnover:

$$\begin{gathered} \text{Accounts} \text{Receivable} \text{turnover =} \frac{\text{Sales}}{\text{Average} \text{Accounts} \text{Receivable}} \\ \text{=}\frac{\text{\$ 5,110,000}}{\text{\$ 240,000}} \\ \text{= 21.30} \end{gathered}$$

c. Day’s Sale:

$$\begin{gathered} \text{Day's} \text{Sale =}\frac{\text{365}}{\text{Accounts} \text{Receivable} \text{Turnover} \text{Ratio}} \\ =\frac{365}{21.30} \\ \text{=} \text{17} \text{days} \end{gathered}$$

Analysis of the ratios

Company is able to increase its liquidity from 0.76 to1.01. In terms of increasing the efficiency of credit and collecting it, the performance has deteriorated from 21.30 to 20.53. Now company is able to collect cash from the accounts receivable within 18 days which is more as compared to 17 days in previous year.