P5-66B. (Learning Objectives 6, 7: Show how to speed up cash flow from receivabl
ID: 2509231 • Letter: P
Question
P5-66B. (Learning Objectives 6, 7: Show how to speed up cash flow from receivables; evaluate liquidity using ratios) The comparative financial statements of Gold Pools, Inc., for 2017, 2016, and 2015 included the following select data: (In millions) 2017 2016 2015 Balance sheet Current assets: s 70 S 60 175 50 110 Cash Investment in trading securities..150 Receivables, net of allowance for doubtful accounts of $7, $6, and $4, respectively Inventories Prepaid expenses 270 350 70 260 345 20 240 300 45 s745 650 $6,570 S,110 $5,110 s860 S 620 Income statement Net sales (all on account) Requirements 1. Compute these ratios for 2017 and 2016: a. Current ratio b. Quick (acid-test) ratio c. Days' sales outstanding 2. Which ratios improved from 2016 to 2017 and which ratios deteriorated? Is this trend fa- vorable or unfavorable? 3. Recommend two ways for Gold Pools to improve cash flow from receivables.Explanation / Answer
Answer to Part 1-a.
Current Ratio = Current Assets / Current Liabilities
Year 2016:
Current Ratio = 860 / 620
Current Ratio = 1.39 : 1
Year 2017:
Current Ratio = 910 / 560
Current Ratio = 1.63 : 1
Answer to Part 1-b.
Quick Ratio = (Current Assets – Inventories – Prepaid Expenses) / Current Liabilities
Year 2016:
Quick Ratio = (860 – 345 – 20) / 620
Quick Ratio = 495 / 620
Quick Ratio = 0.80 : 1
Year 2017:
Quick Ratio = (910 – 350 – 70) / 560
Quick Ratio = 490 / 560
Quick Ratio = 0.88 : 1
Answer to Part 1-c.
Days’ Sales Outstanding = 365 * Average Accounts Receivable / Net Sales
Year 2016:
Average Accounts Receivable = (260 + 240) / 2 = $250
Days’ Sales Outstanding = 365 * 250 / 5,110
Days’ Sales Outstanding = 17.86 or 18 days
Year 2017:
Average Accounts Receivable = (270 + 260) / 2 = $265
Days’ Sales Outstanding = 365 * 265 / 6,570
Days’ Sales Outstanding = 14.72 or 15 days
Answer to Part 2.
Current Ratio and Quick ratio has improved from 2016 to 2017 and it is favourable, as it indicates that the Company has improved in terms of Current Assets to meet its Current Liabilities.
Whereas, the Days’ Sales Outstanding ration has deteriorated from 2016 to 2017, as it indicates the Company has delayed in collecting its Accounts Receivable.
Answer to Part 3.
The Cash flow from Receivable can be improved by reducing the term take to collect the receivables i.e. Days’ Sales Outstanding or by stringent the Credit terms.
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