10. The effect of transactions on ratios You've been asked to tutor Luis, finance student who doesn't feel comfortable about his understanding of the relationship between a company's better appreciate these relationships, you've created the following business activities, its financial accounts, and the company's financial ratios. exercises for Luis to complete. The purpose of these exercises is to help Luis (1) understand the effect of business transactions financial statement -such as balance sheet and Income statement-accounts and (2) how these changes in the numerators and denominators of financial ratios affect the the following two ratios' values. However, before using these exercises in vour tutoring session later today, vou'll want to run the calculations o ... business transactions, to verify the accuracy of your answers. To provide a consistent frame of reference for the company's financial statements and ratios, assume that the following balance sheet and income statement reflect the company's pretransaction condition and performance. National Transmissions Inc.'s Pretransaction Statement of Financial Condition Cash $15.000 Accounts payable $20,000 Marketable securities 20,000 10,000 Wages payable Taxes payable Accounts receivable 10.000 470,000 Notes payable 50,000 Inventory 500,000 Total current liabilities Prepaid expenses 5,000 100,000 Total current assets Long-term debt 1,000,000 500,000 Total liabilities 600,000 Common stock Gross plant and equipment .500,000 150,000 Capital paid in excess of par Accumulated depreciation 500,000 350,000 Net plant and equipment 1,000,000 Retained earnings 900.000 Total equity 1,400,000 Total debt and equity Total assets $2,000,000 $2,000,000 National Transmissions Inc.'s Pretransaction Statement of Financial Performance Sales $5.000,000 Less: Cost of goods sold ,000,000 Gross profit 3,000,000 Less: Operating expenses 600,000 Operating profit (EBIT) 2,400,000 Less: Interest expense 33,000 Earnings before taxes (EBT) 2,367,000 Less: Tax expense 828,450 $1.538.550 Net income Cost of goods sold equals 40 % f sales. 2Interest expense equals 6% of the combined notes payable and lona-term debt balances. The average federal and state tax rate is 35% . Indicate if any of the listed financial statement accounts affected by the following business transactions and whether the listed ratios will increase, decrease, or remain unchanged as a result of the transaction. (Hint: Assume that the business transaction occurs exactly as stated without Interpreting it further. Do not consider any related transactions that may occur before or after the specified transaction. Assume there are 365 days in Business Transaction 1 National Transmissions Inc. (NTI) sells $165,000 of merchandise on credit. Financial Account Check if the Account Is Affected by the Specified Transaction Inventory Accounts payable Cash Accounts receivable Sales Financial Ratio Ratio's Behavior Cost of goods sold Times interest earned Price-to-earnings ratio Market-to-book ratio Quick ratio Inventory turnover ratio Business Transaction 2 National Transmissions Inc. (NTI) switches from holding an available inventory to a just-in-time inventory system, thereby reducing its inventory by 80.00%. Financial Account Check if the Account Is Affected by the Specified Transaction Inventory Accounts payable Prepaid expenses Total assets Common stock Financial Ratio Ratio's Behavior Average collection period Inventory turover No change Fixed assets turnover Quick ratio Decreases Return on assets Increases Debt ratio
