Solution for Business Analysis and Valuation: Text and Cases 1st Edition Chapter 3, Problem 1

by Paul M., Palepu, Krishna G., Peek, Erik Healy
179 Solutions 11 Chapters 55682 Studied ISBN: 9781408056424 Accounting 5 (1)

Chapter 3, Problem 1 : 1. Many firms recognize revenues at the point...

1. Many firms recognize revenues at the point of shipment. This provides an incentive to accelerate revenues by shipping goods at the end of the quarter. Consider two companies, one of which ships its product evenly throughout the quarter, and the second of which ships all its products in the last two weeks of the quarter. Each company’s customers pay thirty days after receiving shipment. How can you distinguish these companies, using accounting ratios?

Step-By-Step Solution

1. There is no difference between the two companies in their income statements. Both companies have the same amount of revenues and expenses. However, the two companies are different in their balance sheets. Assuming that all other things are equal, the company that sells product evenly has a higher cash and a lower trade receivables balance at the quarter-end than the company which ships all products in the last two weeks. The following accounting ratios can be used to differentiate the two companies:


Trade Receivables Turnover =  Trade Receivables

The company with even sales will have a higher receivable turnover ratio.

Trade Receivables

Days’ Receivables = Average Sales per Day

The company with even sales will show lower days’ receivable.

Cash + Marketable Securities

Cash Ratio = Current Liabilities

The company with even sales will have a higher cash ratio.

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