In this exercise, you will discuss the impact of cash payment against the accoun
ID: 2655469 • Letter: I
Question
In this exercise, you will discuss the impact of cash payment against the accounts payable on the current ratio of a company. In addition, you will perform a vertical analysis against the entries listed on the financial statement.
Task 1: A company has a current ratio of two. The CFO decides to pay off a portion of its accounts payable with cash. Explain whether the current ratio will increase, decrease, or remain unchanged. Support your answer with appropriate rationale.
Task 2: Based on the attached financial information, perform a vertical analysis, list the steps performed, and provide an explanation for your analysis.
Year-2010
Year-2009
Amount in Dollars
Amount in Dollars
Sales
1,00,000
79,900
Cost of goods sold
47,500
39,950
Operating expenses
750
500
Selling expenses
9,500
9,000
Administrative expenses
12,000
12,000
Net income
30,250
18,450
Year-2010
Year-2009
Amount in Dollars
Amount in Dollars
Sales
1,00,000
79,900
Cost of goods sold
47,500
39,950
Operating expenses
750
500
Selling expenses
9,500
9,000
Administrative expenses
12,000
12,000
Net income
30,250
18,450
Explanation / Answer
TASK - 1
A part of Accounts Payable is paid off with cash. So, cash (Current asset) decreases, and Accounts payable (Current Liabilities) decreases.
So, in the current ratio, the numerator & denominator both decrease by the same amount. Therefore, Current ratio increases.
Here, let initial current asset = 350, current liabilities = 175, so current ratio = 2
Assume, both cash & payables decrease by 50.
Revised current assets = 300, current liabilities = 125, so current ratio = 2.4 > 2
TASK - 2
A vertical analsysis expresses each line item as a percent of another line item. For income statements, the line items are normally expressed as a % of Sales Revenue.
Accordingly, the vertical analyses for both the years are as follows.
As is seen from the analysis, while Sales revenue has increased, COGS has decreased more than proportionately - from 50% in 2009 to 47.5% in 2010. Excepting a slight increase in operating expenses as % of sales, all other cost components have decreased as % of sales in 2010, vis-a-vis 2009.
The net effect of these comparative changes is an increase in net income as % of sales, from 23% to 30%.
Therefore, both in dollar terms as well as in relative terms, financial performance has improved in 2010.
2010 2009 $ % of Sales $ % of Sales Sales 1,00,000 100.00% 79,900 100.00% Cost of Goods Sold 47,500 47.50% 39,950 50.00% Operating Expenses 750 0.75% 500 0.63% Selling Expenses 9,500 9.50% 9,000 11.26% Admin Expenses 12,000 12.00% 12,000 15.02% Net Income 30,250 30.25% 18,450 23.09%Related Questions
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