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The accounting scenario of Tex Slong and his cattle.

1. Using the knowledge of ratios, look at the numbers above and see if you can identify Tex's problems. Assume all sales are credit Net 30 sales. What advice would you offer Tex in order to help out the situation. Should Tex liquidate some of his investments to pay his bills until something changes? How is he going to get the money to pay his creditors?

2. Now that you have solved Tex's issues, what would you suggest he plan for the next fiscal year? Should Tex wait until December 31st every year to see his numbers? What would you advise Tex to do? Why? Would your ideas change if Tex sold oil, or cars, or ladies handbags? What types of budgets is your analysis going to focus on? What budget should you start with first?

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The first problem is that his balance sheet is wrong, and if he is working with an incorrect balance sheet, we can assume that he is not substituting the correct numbers when he does any type of his own analysis. For example, 2,500 + 1,000,000 + 500,000 doesn't equal 150,500, it equals 1,502,500. We see the same incorrect calculations with liabilities. We see incorrect calculations in the previous year as well. Depreciation doesn't get added back to cattle expense, as what is shown here. In addition, he's trying to evaluate what's going on and his net income is incorrect. His net sales are calculated correctly. He then had 650,000 in expenses, so his net income is 50,000, not 500,000, although in the previous year, the calculation for net income is correct. Because of the errors, we need to focus on the actual numbers on the balance sheet and we cannot use the totals, because he prepared the balance sheet incorrectly.

When we look at the main sources of cash that Tex has available, we see that he has a very small amount of actual cash, whereas the previous year he had a much larger amount. We also see that his investments have grown considerably. This shows us that he has taken the majority of the company's cash and purchased investments. It is interesting to note that AR increased while sales actually decreased. This tells us that his ARs are outstanding way too long and he's not effectively collecting from his customers on the outstanding ARs.

Let's look at a few ratios to see what exactly is going on with cash and where he stands. Our most basic and most useful ratio is our liquidity ratio, which is current assets divided by current liabilities.
502500 / 100000 = 5.025 (We are going to assume that the investments are not market securities that can be turned into cash very quickly, and that they are long term assets.) While the current ratio is healthy, the current ratio makes certain assumptions. One of the assumptions is that the AR accounts are being effectively collected, and from the scenario, we see that customers have 30 days to pay. It's also interesting to note that the liabilities don't include an allowance for doubtful accounts, which means that there could be AR accounts within that 500,000 that are several years old which Tex never wrote off.

We need to look at the AR turnover. We want to use this formula:
Annual credit sales / AR

We are going ...

Solution Summary

1. Using the knowledge of ratios, look at the numbers above and see if you can identify Tex's problems. Assume all sales are credit Net 30 sales. What advice would you offer Tex in order to help out the situation. Should Tex liquidate some of his investments to pay his bills until something changes? How is he going to get the money to pay his creditors?

2. Now that you have solved Tex's issues, what would you suggest he plan for the next fiscal year? Should Tex wait until December 31st every year to see his numbers? What would you advise Tex to do? Why? Would your ideas change if Tex sold oil, or cars, or ladies handbags? What types of budgets is your analysis going to focus on? What budget should you start with first?

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