Acme Inc. is a wholesaler and distributor of electrical components. The most rec
ID: 2417571 • Letter: A
Question
Acme Inc. is a wholesaler and distributor of electrical components. The most recent draft financial statements of the business revealed the following:
Income Statement for the Year (in millions)
Sales revenue 14.2
Opening inventories 3.2
Purchases 8.4
Goods available for sale 11.6
Closing inventories (3.8)
Cost of goods sold (7.8)
Gross profit 6.4
Administration expenses (3.0)
Distribution expenses (2.1)
Operating profit 1.3
Finance costs (0.8)
Profit before taxation (0.5)
Tax (0.2)
Profit for the period 0.3
Statement of Financial Positions as at the End of the Year (in Millions)
ASSETS
Noncurrent Assets
Property, plant, and equipment
Land and buildings 4.0
Equipment 1.1
Motor vehicles 0.4
Current Assets 5.5
Inventories 3.8
Trade receivables 2.9
Cash at bank 0.2
Total Assets 12.4
EQUITY AND LIABILITIES
Equity
Share capital 2.1
Retained earning 1.6
Noncurrent Liabilities 3.7
Loan notes (secured on property) 3.9
Current Liabilities
Trade payables 2.2
Short-term borrowings 2.6
4.8
Total equity and liabilities 12.4
Additional information: Land and buildings are shown at their current market value. Equipment and motor vehicles are shown at their carrying amount (that is, cost less accumulated depreciation). No dividends have been paid to ordinary shareholders for the past three years.
In recent months, suppliers (trade payables) have been pressing for payment. The chief executive has, consequently, decided to reduce their level to an average of 40 days outstanding. To achieve this, she has decided to approach the bank with a view to increasing the overdraft (the short-term borrowings consist of only a bank overdraft). The business is currently paying 10 percent a year interest on the overdraft.
Identify four sources of finance (internal or external, but excluding a bank overdraft) that may be suitable to finance the reduction in trade payables, and state, with reasons, which of these you consider the most appropriate.
Based on the information given, complete the following tasks:
Comment on the liquidity position of the business.
Calculate the amount of finance required to reduce trade payables, from the level shown on the statement of financial position, to an average of 40 days outstanding.
State, with reasons, how you consider the bank would react to the proposal to grant an additional overdraft facility.
Explanation / Answer
Liquidity ratios measure the short term solvency or liquidity of a firm.It simply means the short term solvency.It is the ability to meet short term liability. Current ratios, quick ratio are examples.
Current ratio.
It is the oldest of all financial ratios.
=current assets/current liability
2:1 is considered as satisfactory or ideal.
Liquid ratio or quick ratio
It is the ratios of liquid assets or quick assets to current liability. Also called acid test ratio.
=liquid assets /current liability
Liquid assets are those assets which are quickly converted in to cash.
=quick assets =all current assets except inventories or stocks and prepaid expenses.
1:1 is ideal quick ratio.
Super quick ratio
Establishes relationship between super quick assets and quick liability
Super quick assets include cash in hand ,cash at bank,
Marketable securities or short term investment.
=super quick assets /current liability
0.5:1 is standard ratio
Cash burn ratio
Used in start up and growing technological companies.
=365 days ×cash raised from initial investors /projected start-up costs.
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