Answers to Questions on Accounting

¶ … balance sheet is prepared identifying the items which should be placed in this statement.

Table 1; Balance Sheet

Assets

Current

Cash

Accounts receivable

Prepaid expenses

Inventory

Total current assets

Long-term (fixed)

Equipment

Total assets

Liabilities

Current

Accounts payable

Long-Term

Mortgage

Total liabilities

Equity

Total Capital (debt + equity)

Using the figures provided, identifying the relevant inputs, the income statement, also referred to as a profit and loss statement, can be created.

Table 2; Income Statement

Revenue

Expenses

Supplies

Wages

Rent

Misc. expenses

Total expenses

Profit

20,650

Question 3

Having prepared the balance sheet and income statement, it is possible to undertake a ratio analysis to assess the condition of the firm.

Part A The current ratio is calculated by taking the current assets and dividing them by the current liabilities; this will indicate a ratio for how many times the liabilities are covered by the current assets (Elliott & Elliott, 2013).

Table 3; Current Ratio

Current assets

150,500

Current liabilities

20,650

Current ratio

7.29

It is usually recommended that firms should have a current ratio of at least 1.5, to ensure that there are 1.5 times more current assets compared to liabilities, as this will account for the failure of some assets to be realised (such as bad debts, or declines in inventory value) (Elliott & Elliott, 2013). A ratio of 7.29 shows the firm is highly liquid and does not have any cash flow problems (Elliott & Elliott, 2013). However with such a high ratio, it may be argued that there is an opportunity cost associated with holding so many assets in such as liquid form, as they may create more value being used in other ways (Nellis & Parker, 2006).

Part B

The net working capital is the current assets less the current liabilities (Elliott & Elliott, 2013).

Table 4; Net Working Capital

Current assets

150,500

Current liabilities

20,650

Net working capital

129,850

This tells us that Globus has 129,850 more in current assets than is needed to pay their current liabilities. This calculation may also be useful when assessing the level of liquid assets on hand which are either cash, or may be converted into cash, in the near future to consider further purchase and investment strategies (Drury, 2015). Here it may be seen the firm has the potential to spend up to the surplus of assets over liabilities, given time for them to be realised.

Part C

The debt to equity ratio is the total liabilities divided by equity, and also referred to as the gearing, or leverage ratio (Investopedia, 2016; Elliott & Elliott, 2013).

Table 5; Debt to Equity Ratio

Debt

93,450

Equity

112,350

Debt/equity ratio

0.83