Question
Jim Connor is the owner of Wave Riders, a surf shop located in West Palm Beach, Florida. Jim has just received his end of the
Jim Connor is the owner of Wave Riders, a surf shop located in West Palm Beach, Florida. Jim has just received his end of the year financial statements from his accountant. When he sees his gross and net income he is dismayed. With almost $250,000 in gross profit he just doesn't understand why he is always short on cash to pay his employees and suppliers. One of his largest suppliers of surf boards notified him just last month that they would no longer extend him credit and he would have to pre-pay all of his orders. He put a call into his accountant to set up a meeting with her to discuss the financial health of his business.
Part 1
- Using the financial statements provided, calculate the 12 ratios discussed in your text using the financial information that is provided below for Wave Riders.
- Looking at these ratios, are there any of them that look suspicious? If so, which ratios are they and what about them do you believe is cause for concern?
Part 2
- Using the industry ratios that have been provided, compare Wave Riders' ratios with those for the industry. What "red flags" do you see when making this comparison?
- What do you think might be causing the deviations that you see between Wave Riders ratios and the industry ratios?
Part 3
- What recommendations would you make to Jim to help him improve the financial performance of Wave Riders in the future? Draw a memo to Jim outlining your recommendations, make certain to include your reasons for the recommendation (i.e. ratio and/or comparison to industry ratios).
Wave Riders
Income Statement
For the year ended December 31, 20XX
Merchandise Sales $500,000
Cost of Goods Sold $255,000
Gross Profit $245,000
Wage Expense $140,000
Rent Expense $45,000
General and
Administrative $45,000
Total Expenses $230,000
Earnings Before Interest & Taxes
(EBIT) $15,000
Interest $5,000
Income before Tax $10,000
Tax (@25% rate) $2,500
Net Income/(Loss) $7,500
Wave Riders
Statement of Owner's Equity
For the year ended December 31, 20XX
Beginning Capital $0
Owner Contributions $5,000
Net Income/(Loss) $7,500
$12,500
Owner Withdrawals $0
Ending Capital $12,500
Wave Riders
Balance Sheet
As of December 31, 20XX
Assets
Current Assets
Cash and Cash
Equivalents $29,500
Accounts Receivable $10,000
Merchandise Inventory $100,000
Prepaid Expenses $7,000
Total Current
Assets $147,000
Property, Plant, and
Equipment $5,000
Total Assets $152,000
Liabilities
Current Liabilities
Accounts Payable $74,250
Wages Payable $10,250
Total Current
Liabilities $84,500
Long-Term Debt $55,000
Total Liabilities $139,500
Owner's Equity $12,500
Total Liabilities and Owner's
Equity $152,000
Wave Riders
Statement of Cash Flows
For the year ended December 31, 20XX
Cash provided by operating activities
Net Income (loss) $7,500
Changes in operating assets &
liabilities
Inventories ($100,000)
Accounts Receivables ($10,000)
Accounts Payable $10,250
Accrued Expenses $7,500
Cash provided by (used by
operations $85,000
Cash provided by investing activities
Purchases of fixed assets ($5,000)
Cash provided by (used by)
investing ($5,000)
Cash provided by financing
Long-term borrowing $55,000
Owner contribution $5,000
Payment of Debt and Financing
Costs ($5,000)
Cash provided by (used by)
financing $55, 000
Change in cash $35,000
Beginning cash balance $0
Ending cash balance ($35,000)
Industry Ratios
Liquidity & Solvency Ratios
Current Ratio 2.1
Quick Ratio 0.95
Debt Ratio 1.05
Debt to Net Worth Ratio 8.5
Times Interest Earned Ratio 4.2
Return on Equity (ROE) 5.25
Operating Ratios
Average Inventory Turnover Ratio 6.85
Average Receivables Turnover Ratio 10
Average Collection Period Ratio 36.5
Payables Turnover Ratio 5.8
Average Payable Period Ratio 62.9
Net Sales to Total Assets Ratio 3.3
Profitability Ratios
Net Profit on Sales Ratio 4.8%
Net Profit to Assets Ratio 4.55%
Net Profit to Equity Ratio 1.8
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