Question 1 (25 marks)
Hi-Tech Computer Ltd. is a company selling computers. After studying the companys financial statements that were published on December 31, 2020, the General Manager, Rex, has arranged a meeting with the Sales Manager, John. Rex: According to the recent financial analysis, the inventory turnover has decreased from 5.1 to 2.7, while the accounts receivables turnover has decreased from 11 to 7. I was wondering if you could explain this change in operations. John: There is little need for concern. The inventory represents computers that we were unable to sell during the holiday buying session. We are confident that we will be able to sell these computers as we move into the next fiscal year. Rex: What gives you that confidence? John: We will increase our advertising and provide very attractive price concessions to move these machines. We have no choice. Newer technology is already out there, and we have to unload this inventory. Rex: How about the receivables? John: As you may be aware, the company is under tremendous pressure to expand sales and profits. As a result, we lowered our credit standards to our commercial customers so that we would be able to sell products to a broader customer base. As a result of this policy change, we have been able to expand sales by 35%. Rex: Your responses have not been reassuring to me. John: Im a little bit confused. Assets are good, right? Why dont you look at our current ratio? It has improved, hasnt it? I would think that you would view that very favourably.
REQUIRED:
Examine the concerns and responses of John.
Examine the concerns and responses of Rex.
If you were Rex, how would you respond to Johns comments that assets are good and current ratio has improved?