Common-Size Statements and Financial Ratios for Creditors [LO1, LO3, LO4]

Modern Building Supply sells various building materials to retail outlets. The company has just approached Linden State Bank requesting a $300,000 loan to strengthen the Cash account and to pay certain pressing short-term obligations. The company’s financial statements for the most recent two years follow:

Modern Building Supply Comparative Balance Sheet This Year Last Year Assets Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 $ 200,000 Marketable securities . . . . . . . . . . . . . . . . 0 50,000 Accounts receivable, net . . . . . . . . . . . . . . 650,000 400,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300,000 800,000 Prepaid expenses . . . . . . . . . . . . . . . . . . . 20,000 20,000 Total current assets . . . . . . . . . . . . . . . . . . . 2,060,000 1,470,000 Plant and equipment, net . . . . . . . . . . . . . . . 1,940,000 1,830,000 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . $4,000,000 $3,300,000 Liabilities and Stockholders’ Equity Liabilities:

Current liabilities . . . . . . . . . . . . . . . . . . . . $1,100,000 $ 600,000 Bonds payable, 12% . . . . . . . . . . . . . . . . . 750,000 750,000 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 1,350,000 Stockholders’ equity:

Preferred stock, $50 par, 8% . . . . . . . . . . . 200,000 200,000 Common stock, $10 par . . . . . . . . . . . . . . 500,000 500,000 Retained earnings . . . . . . . . . . . . . . . . . . . 1,450,000 1,250,000 Total stockholders’ equity . . . . . . . . . . . . . . . 2,150,000 1,950,000 Total liabilities and stockholder’s equity . . . . $4,000,000 $3,300,000 Modern Building Supply Comparative Income Statement and Reconciliation This Year Last Year Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,000,000 $6,000,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . 5,400,000 4,800,000 Gross margin . . . . . . . . . . . . . . . . . . . . . . . . 1,600,000 1,200,000 Selling and administrative expenses . . . . . . 970,000 710,000 Net operating income . . . . . . . . . . . . . . . . . . 630,000 490,000 Interest expense . . . . . . . . . . . . . . . . . . . . . . 90,000 90,000 Net income before taxes . . . . . . . . . . . . . . . . 540,000 400,000 Income taxes (40%) . . . . . . . . . . . . . . . . . . . 216,000 160,000 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . 324,000 240,000 Dividends paid:

Preferred dividends . . . . . . . . . . . . . . . . . . 16,000 16,000 Common dividends . . . . . . . . . . . . . . . . . . 108,000 60,000 Total dividends paid . . . . . . . . . . . . . . . . . . . 124,000 76,000 Net income retained . . . . . . . . . . . . . . . . . . . 200,000 164,000 Retained earnings, beginning of year . . . . . . 1,250,000 1,086,000 Retained earnings, end of year . . . . . . . . . . $1,450,000 $1,250,000 During the past year, the company has expanded the number of lines that it carries in order to stimulate sales and increase profits. It has also moved aggressively to acquire new customers. Sales terms are 2/10, n/30. All sales are on account.
Assume that the following ratios are typical of companies in the building supply industry:
Current ratio . . . . . . . . . . . . . . . . . 2.5 Acid-test ratio . . . . . . . . . . . . . . . . 1.2 Average collection period . . . . . . . 18 days Average sale period . . . . . . . . . . . 50 days Debt-to-equity ratio . . . . . . . . . . . . 0.75 Times interest earned . . . . . . . . . . 6.0 Return on total assets . . . . . . . . . 10%
Price-earnings ratio . . . . . . . . . . . 9 Required:
1. Linden State Bank is uncertain whether the loan should be made. To assist it in making a decision, you have been asked to compute the following amounts and ratios for both this year and last year:

a. Working c apital.

b. Current ratio.

c. Acid-test r atio.

d. Average collection period. (The accounts receivable at the beginning of last year totaled $350,000.)

e. Average sale period. (The inventory at the beginning of last year totaled $720,000.)

f. Debt-to-equity r atio.
g. Times interest earned.
2. For both this year and last year (carry computations to one decimal place):

a. Present the balance sheet in common-size form.

b. Present the income statement in common-size form down through net income.
3. From your analysis in (1) and (2) above, what problems or strengths do you see for Modern Building Supply? Make a recommendation as to whether the loan should be approved.