Typical Transaction 8
Example: Payment of Fixed Assets – Change exchange rate US$/UK £ from 1.7 to 2.0
|Payment for Purchase of Fixed Assets on Commercial Credit Terms||Decrease in Cash at Bank (-)|
|Decrease in Creditors (-)|
> Double entry: Debit entry, Creditors balance decreases from 44,000 to 6,600. Credit entry, Cash at Bank balance decreases from 758,550 to 721,750
> Values in red show Balance Sheet values before and after changes
|Debtors and Prepayments||9,300||9,300|
|Other Current Assets (Stock)||0||0|
|Long Term Liabilities||0||0|
|Long Term Loan||0||0|
|TOTAL Liabilities + Equity + Retained Earnings||811,850||774,450|
An analysis of financial ratios can be seen here.
Current ratio calculations are as follows:
|Bank||Current Assets||Fixed Assets||Current Liabilities||Income Statement||Equity||Current Ratio|
|Balance Sheet Original||758,550||767,850||44,000||44,300||-32,450||767,550||767,850 / 44,300 = 17.3|
|Balance Sheet New||721,150||730,450||44,000||44,300||-32,350||767,650||730,450 / 6,900 = 104.2|
When paying fixed assets at the new exchange rate of 2.0 US$ per pound as in this example, the following changes in the Balance sheets (B/S) and the Income Statement occur:
– Creditors in Current Liabilities decrease from 44,000 in the original B/S to 6,600 in the new B/S. Thus, Current Liabilities decrease correspondingly from 44,300 to 6,900.
– Current Assets decrease, from 767,850 to 730,450, due to a lesser balance in Cash at Bank.
– Current Ratio changes significantly from 17.3 in the original B/S to 104.2 in the new B/S. Current liabilities, 6,900, are very small compared to current assets, 767,850, the reason why there is such a high current ratio, far greater than 1.0, the minimum acceptable current ratio.
– This is a highly unusual situation, for current ratios to be so high above the average ratios in a wide spectrum of economic sectors including retailing.
– The high value of current ratios reflects the policy of BIS Ltd. of paying suppliers in commercial terms, within the month of receiving delivery of the goods. This policy may be a usual one for small retailers, but in practice large retailers take more than 30 days to pay suppliers. In this case current liabilities will grow and current ratios drop close to the average benchmark values in the retailing sector, in this case.
– Efficient cash management must closely monitor the flow of revenue and expenses to be always able to pay creditors when payment is delayed, as other expenses may occur and insolvency may happen.
– There is no change in the Income statement as payment for fixed assets is neither an expense nor revenue. Thus Equity does not change either.
– There are no changes in other Liabilities, such as Long Term Loans.