Analysis
We will first calculate some accounting ratios
and see what light these ratios can shed on their
respective financial status. Only the liquidity
ratios namely the current ratio and the acid test
ratios can be calculated as unfortunately we do
not have the Profit and Loss Statement because
that would have enabled us to calculate the profitability
ratios. We do not have comparative (prior years)
balance sheets either to enable us to calculate
efficiency ratios like ‘inventory turnover
ratio’ or ‘debtors to sales’
or ‘creditors to purchase’ ratios.
Current Ratio
This is derived by dividing the current assets
by current liabilities.
Current ratio = Current assets
Current liabilities
The ratio may be expressed as either a ratio to
1, with current liabilities being set to 1, or
as a ‘number of times’, representing
the relative size of the amount of the amount
of total current assets compared to total current
liabilities. The resultant figure shows how much
of current assets are available with the firm
to pay off the current liabilities.
L.L. Sams Company
Current Ratio $108500/$30000= 3.62
Melinda Garcia Career Services
Current Ratio = $19000/$174000 = 0.11
We see that the current ratio in the case of L.L.
Sams Company is a healthy 3.62 which means there
is an ample safety cover or margin of over three
and a half times to pay off each one dollar worth
of liabilities.
In the case of Melinda Garcia Career Services
the current ratio is a miserable 0.11 which means
it will not be able to meet its current liability
commitments.
This is in the main owing to the huge figure of
$168,000 under Notes payable which is generally
regarded as a current liability. The interest
accrued on this liability is however taken as
a long term liability.
Acid Test Ratio
This ratio shows that, provided creditors and
debtors are paid at approximately the same time,
a view might be made as to whether the business
has sufficient liquid resources to meet its current
liabilities.
Acid test ratio = Current assets – inventory
Current liabilities
L.L. Sams Company
= $23500-$85000
$30000
= -$61500
$30000
= -2.05
Melinda Garcia Career Services
Acid test ratio cannot be calculated as no inventory
figure is available.
In the case of L.L. Sams Company the ratio shows
an adverse status of not being able to meet liability
obligations under an ‘acid test’ situation/formula.
Conclusions/Summary
Neither of the two companies are prime candidates
for advancing a loan. However, because of a favorable
current ratio a lender would be more inclined
to make a loan to L.L. Sams Company.
Further this company is better placed to do business
as it has a merchandise inventory of $85,000.
It has the opportunity to sell this stock for
a profit, several times in a year if the business
activities are managed well. Such trading can
on the one hand generate liquidity, profits and
on the other hand build for itself a valuable
credit worthiness.
In the case of Melinda Garcia Career Services
we do not have any idea of what, if any, has been
its revenues from the career services. Whether
the services have commenced and the ball has been
set rolling is also not known. To be sure this
is not known even in the case of L.L. Sams Company
as simply having an inventory figure of $85,000
does not show us whether the business has commenced
and if it has whether the revenues have produced
a profit margin. But in the absence of any other
information it is fair to assume that some trading
activity, at some profit margin, can be a distinct
possibility.
What is more Melinda Garcia Career Services has
a huge amount of liability under Notes Payable.
It has financed the purchase of ‘Land’
by using this money. Now it is an established
maxim that long term assets cannot be financed
from current liabilities. This firm is poorly
placed in that if the Notes payable liability
is to be discharged it will have to sell the land
and close the business.
In view of the forgoing discussion it will be
safer to lend to L.L. Sams Company.
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