AFM101 Chapter Notes - Chapter 13: Inventory Turnover

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lilacmouse857

26 Jun 2018

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM101

Professor

Donna Psutka

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AFSA Education

10. Receivables Turnover Ratio: short-term liquidity and operating efficiency

= Net Credit Sales / Average Net Trade Receivables

- Collective cash from customers so it does not tie up funds in unproductive assets

- Turnover reflects how many times trade receivables was recorded and collected

- Reflects company granting and collecting activities

- Receivables turnover ratio is often converted to a time basis known as the average age

of trade receivables

Average Age of Receivables = Days in a Year / Receivables Turnover Ratio

11. Inventory Turnover Ratio: measures both liquidity and operating efficiency

= Cost of Sales / Average Inventory

- Reflects relationship between inventory to the volume of sales during the period

- Increase in ratio is usually favourable

- If ratio is too high, indication that sales were lost because items were not in stock

- Vary significantly between industries

- Inventory turnover ratio is often converted to a time basis called average days’ supply in

inventory

- Average day’s supply in inventory = days in a year / inventory turnover ratio

12. Trade Payables Turnover Ratio: evaluates the company’s effectiveness in managing

payables to trade creditors

= Cost of Sales / Average Net Trade Payables

- In reality numerator should be net credit purchases, not cost of sales

- We use cost of sales as approximation, assuming all purchases are made on credit

- Purchases = Cost of Sales + Ending Inventory – Beginning Inventory

- Converted to a time basis known as the average age of payables

- Average Age of Payables = Days in a Year / Trade Payables Turnover Ratio

Using Ratios to Analyze the Operating Cycle

- Operating cycle 3 phases: acquisition of inventory, sale of inventory, collection of cash

from customers

- 3 ratios tot analyze operations: trade payables turnover, inventory turnover, receivables

turnover

- each ratio measures the number of days it takes to complete an operating activity

Tests of Solvency

- tests of solvency: ratios that measure a company’s ability to meet its long-term

obligations

13. Times Interest Earned Ratio: shows if the company is able to pay its interest payments

= (Net Earnings + Interest Expense + Income Tax Expense) / Interest Expense

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Afsa education: receivables turnover ratio: short-term liquidity and operating efficiency. = net credit sales / average net trade receivables. Collective cash from customers so it does not tie up funds in unproductive assets. Turnover reflects how many times trade receivables was recorded and collected. Receivables turnover ratio is often converted to a time basis known as the average age of trade receivables. Average age of receivables = days in a year / receivables turnover ratio: inventory turnover ratio: measures both liquidity and operating efficiency. Reflects relationship between inventory to the volume of sales during the period. If ratio is too high, indication that sales were lost because items were not in stock. Inventory turnover ratio is often converted to a time basis called average days" supply in inventory. Average day"s supply in inventory = days in a year / inventory turnover ratio: trade payables turnover ratio: evaluates the company"s effectiveness in managing payables to trade creditors.

Related Questions

1. Use the attached balance sheet and income statement to compute the required financial ratios for 2012. Use 360 for the number of days in a year. The computations for 2011 are already done for you.

Current ratio_________________________

Quick ratio__________________________

Inventor turnover____________________

Average Collection Period_____________

Total asset turnover__________________

Net profit margin____________________

Operating profit margin_______________

Times Interest Earned_________________

Debt/Net Worth Ratio_________________

Return on Equity ratio__________________

2. Using the computed financial ratios from question 1, compare Grounds Keeperâs performance from 2011 to 2012. Address what areas the company has improved and what areas it has not

A.)Liquidity

B.) Activity / turnover / efficiency

C.) Profitability

D.) Leverage / use of debt / solvency

3. If you were the CEO of Grounds Keeper, what area(s) would you concentrate on to improve the performance of the company?

4. Define the terms capital structure, cost of capital, and working capital. Focus on how they are different from each other and impact both profitability and risk.

5. Determine Grounds Keeperâs capital structure and working capital.

6. If Grounds Keeper has a required rate of return on its long-term debt of 9% (before taxes) and a required rate of return on its common stock, a tax rate of 40%, what is its weighted average cost of capital (WACC) for 2012? How could Grounds Keeper lower its WACC? (HINT: you will need to look at the balance sheet to determine the weight of debt to equity.

7. What are the advantages to Grounds Keeper in using money market instruments as financing? How does this related to financing net working capital?

8. Explain what Grounds Keeper should consider when deciding whether to issue stocks or bonds? Answer using at least 3 different characteristics comparing and contrasting stocks and bonds.

9. Define money market instruments; list at least one type of security that would be considered a money market instrument. What are the advantages to Grounds Keeper in using money market instruments as financing? What are the disadvantages?

	Grounds Keeper
	Consolidated Balance Sheets
	(Dollars in thousands)
	2012	2011
Assets
Current assets:
Cash and cash equivalents	78,240	44,395
Receivables	399,891	340,062
Inventories	844,737	736,677
Total current assets	1,322,868	1,121,133

Fixed assets, net	1,244,384	889,613
Other long-term assets	1,048,537	1,187,141
Total assets	3,615,789	3,197,887

Liabilities and Stockholdersâ Equity
Current liabilities:
Accounts payable	309,222	319,465
Accruals	201,017	145,240
Notes payable	9,748	6,669
Total current liabilities	519987	471374
Long-term debt	834574	814298
Total liabilities	1,354,561	1,285,672
Stockholdersâ equity:
Common stock, $0.10 par value:	15,268	15,447
Additional paid-in capital	1,464,560	1,499,616
Retained earnings	781400	397152
Total stockholdersâ equity	2,261,228	1,912,215
Total liabilities and stockholdersâ equity	3,615,789	3,197,887

Grounds Keeper

Consolidated Statements of Operations

(Dollars in thousands except per share data)

2012

2011

Net sales

3,889,426

2,642,390

Cost of sales

2,589,799

1,746,274

Gross profit

1,299,627

896,116

Selling and operating expenses

481,493

348,696

General and administrative expenses

219,010

187,016

Operating income

599,124

360,404

Interest expense

22,983

57,657

Income before income taxes

576,141

302,747

Income tax expense

212,641

101,699

Net Income

363,500

201,048

Basic income per share:

Average shares outstanding

154,933,948

146,214,860

Earnings per common share

2.35

1.38

Current Ratio	Current assets/ Current liabilities
Quick Ratio	Current assets â inventory/ Current liabilities
Inventory Turnover	Cost of goods sold/ Inventory
Receivables Turnover	Sales/ Accounts receivables
Average Collection Period	Receivables/ Sales per day
Fixed Asset Turnover	Sales/ Fixed assets
Total Asset Turnover	Sales/ Total Assets
Gross Profit Margin	Revenues - Cost of goods sold/ Sales
Operating Profit Margin	Earnings before interest and taxes/ Sales
Net Profit Margin	Net income/ Sales
Return on Total Assets	Net income/ Total assets
Debt/Net Worth Ratio	Total Debt/ Total Equity
Times-Interest-Earned	Operating Income/ Interest expense
Return on Equity	Net income/ Total equity

magentalouse290

Tivoli Home Furnishings Mini Case Anders Jensen founded TivoliHome Furnishings as a corporation during mid-2015. Sales during thefirst full year (2016) of operation reached $1.3 million. Salesincreased by 15% in 2017 and another 20% in 2018. However, profits,after increasing in 2017 over 2016, fell sharply in 2018, causingAnders to wonder what was happening to his âpride-and-joyâ businessventure. After all, Anders has continued to work as closely aspossible to a 24/7 pace beginning with the startup of Tivoli andthrough the first three full years of operation. Tivoli HomeFurnishings, located in eastern North Carolina, designs,manufactures, and sells Scandinavian-designed furniture andaccessories to home furnishings retailers. The modern Scandinaviandesign has a streamlined and uncluttered look. While this furniturestyle is primarily associated with Denmark, both Norwegian andSwedish designers have contributed to the allure of Scandinavianhome furnishings. Some say that the inspiration for theScandinavian design can be traced to the elegant curves of artnouveau from which designers were able to produce aestheticallypleasing, structurally strong modern furniture. Danish furnishingsand the home furnishings produced by the other ScandinaviancountriesââSweden, Norway, and Finlandââ are made using wood(primarily oak, maple, and ash), aluminum, steel, and high-gradeplastics. Anders grew up in Copenhagen, Denmark, and received anundergraduate degree from a technical university in Sweden. As istypical in Europe, Anders began his business career as anapprentice at a major home furnishings manufacturer in Copenhagen.After learning the trade, he quickly moved into a managementposition in the firm. However, after a few years, Anders realizedthat what he really wanted to do was to start and operate his ownScandinavian home furnishings business. At the same time, aftertraveling throughout the world, including the United States, he wassure that he wanted to be an entrepreneur in the United States.Anders moved to the U.S. in early 2015. With $140,000 of hispersonal assets and $210,000 from venture investors, he beganoperations in mid-2015. Anders, with 40% ownership interest andindustry-related management expertise, was allowed to operate theventure in a way that he thought was best for Tivoli. Four yearslater, Anders is sure he did the right thing. Following are thethree years of income statements and balance sheets for Tivoli HomeFurnishings. Anders felt that in order to maintain a competitiveadvantage, he would need to continue to expand sales. After firstconcentrating on selling Scandinavian home furnishings in thenortheast in 2016 and 2017, he decided to enter the west coastmarket. An increase in expenses occurred associated withidentifying, contacting, and selling to home furnishings retailersin California, Oregon, and Washington. Anders Jensen hopes that youcan help him better understand what has been happening to TivoliHome Furnishings from both operating and financial standpoints. âTivoli Home Furnishings, Inc. Income Statements 2016 2017 2018 Netsales $ 1,300,000 $ 1,500,000 $ 1,800,000 Cost of goods sold780,000 900,000 1,260,000 Gross profit 520,000 600,000 540,000Marketing expenses 130,000 150,000 200,000 General andadministrative 150,000 150,000 200,000 Depreciation expense 40,00053,000 60,000 EBIT 200,000 247,000 80,000 Interest expense 45,00057,000 70,000 Earnings before taxes 155,000 190,000 10,000 Incometaxes (40%) 62,000 76,000 4,000 Net income $ 93,000 $ 114,000 $6,000 Tivoli Home Furnishings, Inc. Balance Sheets 2016 2017 2018Cash $ 50,000 $ 40,000 $ 10,000 Accounts receivable 200,000 260,000360,000 Inventories 450,000 500,000 600,000 Total current assets700,000 800,000 970,000 Fixed assets, net 300,000 400,000 500,000Total assets $1,000,000 $1,200,000 $1,470,000 Accounts payable $130,000 $ 170,000 $ 180,000 Accruals 50,000 70,000 80,000 Bank loan90,000 90,000 184,000 Total current liabilities 270,000 330,000444,000 Long-term debt 300,000 400,000 550,000 Common stock ($10par)* 300,000 300,000 300,000 Capital surplus 50,000 50,000 50,000Retained earnings 80,000 120,000 126,000 Total liabilities andequity $1,000,000 $1,200,000 $1,470,000 * 30,000 shares of commonstock were issued to Anders Jensen and the venture investors whenTivoli Home Furnishings was incorporated in mid-2015. â A.Calculate the current ratio and the quick ratio for each of theyears. What has happened to Tivoliâs liquidity position? CurrentRatio: Quick Ratio: B. Calculate the inventory turnover, days salesin inventory, receivables turnover, and days sales in receivablesfor each of the years and interpret the results. InventoryTurnover: Day Sales in Inventory: Receivables Turnover: Days Salesin Receivables: C. Creditors as well as management are alsoconcerned about the ability of the venture to meet its debtobligations as they come due. For each year, calculate total debt,debt to equity, equity multiplier, and the times interest earnedratios. Interpret your results and explain what has happened toTivoli. Total Debt: Debt to Equity: Equity Multiplier: Total Assets/Total Equity (Assets â Liabilities) Times Interest Earned Ratios:D. Of importance to Anders and the venture investors is theprofitability of the venture. Calculate the profit margin, ROA, andROE for each year and describe what is happening to theprofitability of Tivoli Home Furnishings. E. Anders and the ventureinvestors are also interested in how efficiently Tivoli is able toconvert the firmâs total assets into sales. Calculate the totalasset turnover ratio for each year and interpret. F. Perform a DuPont decomposition for each year and provide an interpretation ofyour findings. G. Trade association data show an average profitmargin of 6.5 percent, a sales to asset ratio of 1.3 times, and atotal debt ratio of 55 percent over the 2016-2018 period. Comparethe components of the Du Pont analysis with the industry averages âcompare each component, as well as the product of the components.How does Tivoli compare with the rest of the industry? H. What isgoing on with Tivoli and what is the likely solution?

pearwasp6

Balance Sheet

2015

2016

2017

Assets

Cash

807,000

628,000

612,000

Accounts Receivables

2,582,000

2,896,000

4,605,000

Inventories

2,870,000

5,181,000

7,319,000

Total Current Assets

6,259,000

8,705,000

12,536,000

Net Fixed Assets

2,216,000

2,423,000

5,538,000

Total Assets

8,475,000

11,128,000

15,074,000

Liabilities and Equity

Accounts Payable

961,000

1,648,000

3,137,000

Notes Payable

400,000

800,000

2,860,000

Accruals

440,000

800,000

1,150,000

Total Current Liabilities

1,801,000

3,248,000

7,147,000

Long Term Debt

1,350,000

1,908,000

1,867,000

Common Stock

3,650,000

Retained Earnings

1,674,000

2,322,000

2,410,000

Total Equity

5,324,000

5,972,000

6,060,000

Total Liabilities and Equity

8,475,000

11,128,000

15,074,000

Income Statement

2015

2016

2017

Sales

26,820,000

28,966,000

30,703,000

Cost of Sales

21,216,000

23,550,000

26,140,000

Gross Profit

5,604,000

5,416,000

4,563,000

Operating Expenses

2,574,000

3,225,000

3,866,000

Operating Profit

3,030,000

2,191,000

697,000

Interest

91,000

275,000

469,000

Earnings Before Taxes

2,939,000

1,916,000

228,000

Taxes (48%)

1,411,000

919,000

110,000

Net Income

1,528,000

997,000

118,000

Liquidity	2015	2016	2017	Average
Current Ratio	3.475	2.68	1.754	2.5x
Quick Ratio	1.882	1.085	0.73	1.0x

Asset Management
Average Collection Period	35.139	36.492	54.745	32.0 (days)
Inventory Turnover	7.392	4.545	3.572	7.0x Fixed
Asset Turnover	3.165	2.603	2.037	12

Debt Management
Total Debt to Total Assets	0.372	0.463	0.598	50.00%
Times Interest Earned	33.297	7.967	1.486	7.7x

Profitability
Profit Margin	0.057	0.034	0.004	2.90%
Return on Equity (ROE)	0.287	0.167	0.019	17.50%

ABC Company, a toy manufacturer, believes the coming holiday season (between Thanksgiving in late November and Christmas on the 25^thof December) will be a very good one, expecting an increase of 20% in its sales. Outside economic analysts believe the effects of the recent recession are over. Consumer confidence is high. To meet that 20% increase, however, inventories must be built up so, to finance that expansion, ABC wants to borrow $1,000,000 from its bank.

You are the loan officer who must make the decision as to whether or not to give ABC the money. You are going to prepare ratios for 3 years, the Cash Conversion Cycle for the same period and operating cash flow for the years for which you have figures.

Review the Balance Sheets and Income Statements for ABC over the 3 years and answer the following questions (20 points each).

3) Operating Cash Flow is the first of the 3 parts to the Statement of Cash Flows.

a) Define operating cash flow. What does it tell us?
b) Calculate ABCâs operating cash flows for those years for which figures are available.
c) Does your analysis of ABCâs operating cash flows change your conclusions listed in 1) and 2) above?

4) Do you believe ABCâs cash position and its management of cash needs improvement? If so, how would you recommend they do it?

Answer Questions in Bold!

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AFM101 Chapter Notes - Chapter 13: Inventory Turnover

AFM101 Full Course Notes

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