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Chapter 24: Question P24-3_b (page 1451)

(Ratio Computations and Additional Analysis) Bradburn Corporation was formed 5 years ago through a public subscription of common stock. Daniel Brown, who owns 15% of the common stock, was one of the organizers of Bradburn and is its current president. The company has been successful, but it currently is experiencing a shortage of funds. On June 10, 2018, Daniel Brown approached the Topeka National Bank, asking for a 24-month extension on two 35,000notes,whicharedueonJune30,2018,andSeptember30,2018.Anothernoteof6,000 is due on March 31, 2019, but he expects no difficulty in paying this note on its due date. Brown explained that Bradburnโ€™s cash flow problems are due primarily to the companyโ€™s desire to finance a \(300,000 plant expansion over the next 2 fiscal years through internally generated funds. The commercial loan officer of Topeka National Bank requested the following financial reports for the last 2 fiscal years

BRADBURN CORPORATION

BALANCE SHEET

MARCH 31

Assets

2018

2017

Cash

\) 18,200

\( 12,500

Notes receivable

148,000

132,000

Accounts receivable (net)

131,800

125,500

Inventories (at cost)

105,000

50,000

Plant & Equipment (net of depreciation)

1,449,000

1,420,500

Total assets

\)1,852,000

\(1,740,500

Liabilities and Stockholdersโ€™ Equity

Accounts payable

\) 79,000

\( 91,000

Notes payable

76,000

61,500

Accrued liabilities

9,000

6,000

Common stock (130,000 shares, \)10 par)

1,300,000

1,300,000

Retained earnings*

388,000

282,000

Total liabilities and stockholdersโ€™ equity

\(1,852,000

\)1,740,500

*Cash dividends were paid at the rate of 1pershareinthefiscalyear2017and2 per share in the fiscal year 2018.

BRADBURN CORPORATION

INCOME STATEMENT

FOR THE FISCAL YEARS ENDED MARCH 31

2018

2017

Sales revenue

\(3,000,000

\)2,700,000

Cost of goods sold*

1,530,000

1,425,000

Gross margin

1,470,000

1,275,000

Operating expenses

860,000

780,000

Income before income taxes

610,000

495,000

Income taxes (40%)

244,000

198,000

Net income

\( 366,000

\) 297,000

Depreciation charges on the plant and equipment of 100,000and102,500 for fiscal years ended March 31, 2017, and 2018, respectively, are included in the cost of goods sold.

Instructions

b)Identify and explain what other financial reports and/or financial analyses might be helpful to the commercial loan officer of Topeka National Bank in evaluating Daniel Brownโ€™s request for a time extension on Bradburnโ€™s notes.

Short Answer

Expert verified

Bradburn's liquidity can be tested by day to day sales in accounts receivable turnover and day to day sales in inventory.

Step by step solution

01

Meaning of Liquidity Ratio

The liquidity ratio indicates a person's capacity to pay off debtswhen they become due. To put it another way, this ratio indicates how rapidly a corporation can turn its present assets into cash in order to pay down its liabilities on time. Liquidity and short-term solvency are frequently used simultaneously.

02

Explaining other financial reports and financial analyses which might be helpful

The following are the other financial reports and financial analyses which might be helpful to the commercial loan officer of Topeka National Bank:

  1. The amount of cash provided by operating operations, other sources of cash, and the use of cash to meet long-term resources and long-term credit needs will be highlighted in the statement of cash flows.
  2. Forecasted financial statements for 2019, including a forecasted statement of cash flows. An investigation into Bradburn's entire budget would also be beneficial. These items will be used to present management's operational forecast for the coming year.
  3. Additional ratios such as day sales in receivables, account receivable turnover, and day sales in inventory are used to test Bradburn's liquidity.
  4. Bradburn is being investigated to see how much leverage he is using.

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Most popular questions from this chapter

The following comment appeared in the financial press: โ€œInadequate financial disclosure, particularly with respect to how management views the future and its role in the marketplace, has always been a stone in the shoe. After all, if you donโ€™t know how a company views the future, how can you judge the worth of its corporate strategy?โ€ What are some arguments for reporting earnings forecasts?

What is the fair value option? Explain how use of the fair value option reflects application of the fair value principle.

What is a performance obligation, and how is it used to determine when revenue should be recognized?

Edna Millay Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of similar size are presented below.

Edna Millay

2017 Industry

2015

2016

2017

Averages

Current ratio

2.09

2.27

2.51

2.24

Quick ratio

1.15

1.12

1.19

1.22

Inventory turnover

2.40

2.18

2.02

3.50

Net sales to stockholdersโ€™ equity

2.71

2.80

2.99

2.85

Return on common stockholdersโ€™ equity

0.14

0.15

0.17

0.11

Total liabilities to stockholdersโ€™ equity

1.41

1.37

1.44

0.95

Millay is being reviewed by several entities whose interests vary, and the companyโ€™s financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Millayโ€™s financial position.

Archibald MacLeish Bank. The bank is processing Millayโ€™s application for a new 5-year term note. Archibald MacLeish has been Millayโ€™s banker for several years but must reevaluate the companyโ€™s financial position for each major transaction.

Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established for sale to Robert Penn Warrenโ€™s clients.

Working Capital Management Committee. This is a committee of Millayโ€™s management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the companyโ€™s working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.

Instructions

a) Describe the analytical use of each of the six ratios presented above.

โ€œThe financial statements of a company are managementโ€™s, not the accountantโ€™s.โ€ Discuss the implications of this statement.

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