Question

Picasso Company is a wholesale distributor of packaging equipment and supplies. The company’s sales have averaged about \(900,000 annually for the 3-year period 2015–2017. The firm’s total assets at the end of 2017 amounted to \)850,000.

The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past 3 years. This report will be presented to the board of directors at their next meeting.

In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the 3-year period 2015–2017.

	2015	2016	2017
Current ratio	1.80	1.89	1.96
Acid-test (quick) ratio	1.04	0.99	0.87
Accounts receivable turnover	8.75	7.71	6.42
Inventory turnover	4.91	4.32	3.42
Debt to assets ratio	51.0%	46.0%	41.0%
Long-term debt to assets ratio	31.0%	27.0%	24.0%
Sales to fixed assets (fixed asset turnover)	1.58	1.69	1.79
Sales as a percent of 2015 sales	1.00	1.03	1.07
Gross margin percentage	36.0%	35.1%	34.6%
Net income to sales	6.9%	7.0%	7.2%
Return on assets	7.7%	7.7%	7.8%
Return on common stockholders’ equity	13.6%	13.1%	12.7%

In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.

Instructions

a) The current ratio is increasing while the acid-test (quick) ratio is decreasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend.

Short answer

Inventory turnover has decreased considerably during the previous three years, falling from 4.91 to 3.42.

Step-by-step solution

Meaning of Financial Statements

Financial management is the department interior and organization or trade that's concerned with cash flow, profitability, credits, costs, etc. in order to guarantee that the company has the resources essential to realize its trade targets and objectives.

Explaining the contributing factors for apparently divergent trend

The acid-test ratio is the current ratio with the subtraction of stock and prepaid costs(by and large inconsequential relative to stock) from current assets. Any disparity in drift between these two ratios would subsequently be subordinate to the inventory account.

Inventory turnover has declined strongly within the three-year period, from 4.91 to 3.42. Amid the same period, deals to settled resources have expanded, and total deals have expanded 7 percent.

The decline within the inventory turnover is subsequently not due to a decline in sales. The clear cause is that venture in stock has expanded at a quicker rate than deals, and this has accounted for the uniqueness between the acid-test and current ratios.