Question

Diane Corporation is preparing its 2012 balance sheet. The company records show the following selected amounts at the end of the accounting period, December 31, 2012.Total assets $530,000Total noncurrent assets $362,000Liabilities:Notes payable (8%, due in 5 years) $15,000Accounts payable $56,000Income taxes payable $14,000Liability for withholding taxes $3,000Rent revenue collected in advance $7,000Bonds payable (due in 15 years) $90,000Wages payable $7,000Property taxes payable $3,000Note payable (10%, due in 6 months) $12,000Interest payable $400Common stock $100,000Required:1. Compute (a) working capital and (b) the quick ratio (quick assets are $70,000). Why is working capital important to management? How do financial analysts use the quick ratio?2. Would your computations be different if the company reported $250,000 worth of contingent liabilities in the notes to the statements? Explain.

Answer 1

Answer:

Answer= Net working capital  = $65,600

 

Explanation:

The formula for calculating the working capital ratio is

Net working capital = Total current assets - Total current liabilities

Total current assets :

Total current assets = Total assets - Total non current assets

= $530,000 - $362,000

= $168,000

Total current liabilities = Accounts payable + Income taxes payable + Wages payable + Property taxes payable + Notes payable (Due in 6months) + Interest payable + Rent revenue collected in advance + Liability for withholding taxes

= $56,000 + $14,000 + $7,000 + $3,000 + $12,000 + $400 + $7,000 + $3,000

= $102,400

Substituting the values in the above formula;

Net working capital = $168,000 - $102,400

= $65,600

b) Quick ratio = Total quick assets / Total current liabilities

= $70,000 / $102,400

= 0.68 times

Importance of working capital to financial management of a business;

It shows the ability to pay its debts or short-term liabilities, when they fall due.

It represents the funds available with the company for successful day-to-day operations.

Companies cannot survive with negative working capital as it shows the company has no funds for day-to-day operations.

The effective management of working capital is necessary for achieving long-term and short-term goals.

The quick ratio is a form of liquidity ratio. It is a measure of liquidity. It is sometimes referred to as "Acid-test ratio". This ratio measures the firms ability in meeting its short-term obligations and goals with its most liquid assets. It excludes inventory as inventory is most liquid asset which is difficult to liquidate.

Therefore, the survival of a business can be estimated in the short-term in case of short-fall in the sales revenue.

2) Contingent liabilities are those liabilities that may occur in the future events. If they are probable and can be estimated, then they should be reported as a real liability and if they are not probable and cannot be estimated, then they should not be reported in the balance sheet.

The Contingent liabilities are disclosed in the form of notes to financial statements. There would be no effect on the balance sheet, because they are usually reported as notes to financial statements and the effect is found only when the contingent liabilities turns to a liability.

Answer 2

Answer:

a. The working capital is $65,600

b. The quick ratio is 68%

The Working capital is important to financial management of a business, becuase it indicates the ability to pay its debts ot short-term liabilities

The quick ratio is a form of liquidity ratio, and this ratio is important to financial analysts becuase it measures the firms ability in meeting its short-term obligations and responsibilities with its most liquid assets.

if the company reported $250,000 worth of contingent liabilities in the notes to the statements the computations would not be different becuase there would be no effect on the balance sheet, as they are reported as notes to financial statements and the effect is found only when the contingent liabilities turns to a liability

Explanation:

a. In order to calculate working capital we would have to use the following formula:

Net working capital = Total current assets - Total current liabilities

Total current assets = Total assets - Total non current assets

= $530,000 - $362,000

= $168,000

Total current liabilities = Accounts payable + Income taxes payable + Wages payable + Property taxes payable + Notes payable (Due in 6months) + Interest payable + Rent revenue collected in advance + Liability for withholding taxes

Total current liabilities= $56,000 + $14,000 + $7,000 + $3,000 + $12,000 + $400 + $7,000 + $3,000

= $102,400

Therefore, working capital = $168,000 - $102,400

= $65,600

b) In order to calculate the quick ratio we would have to use the following formula:

Quick ratio = Total quick assets / Total current liabilities

= $70,000 / $102,400

= 0.68

The Working capital is important to financial management of a business, becuase it indicates the ability to pay its debts ot short-term liabilities

The quick ratio is a form of liquidity ratio, and this ratio is important to financial analysts becuase it measures the firms ability in meeting its short-term obligations and responsibilities with its most liquid assets.

if the company reported $250,000 worth of contingent liabilities in the notes to the statements the computations would not be different becuase there would be no effect on the balance sheet, as they are reported as notes to financial statements and the effect is found only when the contingent liabilities turns to a liability