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Chapter 03: Financial Analysis
3-51
Bonds payable ..................................... 150,000
Total liabilities .................................... $320,000
Stockholders’ equity
Preferred stock, $50 per value ............. 100,000
Common stock, $1 par value ............... 80,000
Capital paid in excess of par ................ 190,000
Retained earnings ................................ 210,000
Total stockholders’ equity ................ 580,000
Total liabilities and stockholders’ equity $900,000
SNIDER CORPORATION
Income statement
For the Year Ending December 31, 2010
Sales (on credit) .............................................................................
$1,980,000
Less: Cost of goods sold ............................................................
1,280,000
Gross profit ....................................................................................
700,000
Less: Selling and administrative expenses ..................................
475,000*
Operating profit (EBIT) .................................................................
225,000
Less: Interest expense ................................................................
25,000
Earnings before taxes (EBT) ..........................................................
200,000
Less: Taxes ................................................................................
80,000
Earnings after taxes (EAT) .............................................................
$ 120,000
*Includes $35,000 in lease payments.
3-36. Solution:
Snider Corporation
Profitability ratios
Profit margin = $120,000/$1,980,000 = 6.06%
Assets utilization ratios
Chapter 03: Financial Analysis
3-52
Receivable turnover = $1,980,000/$160,000 = 12.38x
Average collection period = $160,000/$5,500 = 29.09 days
Liquidity ratio
Debt utilization ratios
Debt to total assets = $320,000/$900,000 = 35.56%
37. Ratio computation and analysis (LO2) Given the financial statements for Jones
Corporation and Smith Corporation shown here:
a. To which one would you, as credit manager for a supplier, approve the extension of
(short-term) trade credit? Why? Compute all ratios before answering.
b. In which one would you buy stock? Why?
JONES CORPORATION
Current Assets
Liabilities
Cash ............................................
$ 20,000
Accounts payable ..................
$100,000
Accounts receivable ....................
80,000
Bonds payable (long-term) ....
80,000
Inventory.....................................
50,000
Long-Term Assets
Stockholders’ Equity
Fixed assets .................................
$500,000
Common stock ......................
$150,000
Less: Accumulated depreciation
(150,000)
Paid-in capital .......................
70,000
Net fixed assets* .........................
350,000
Retained earnings..................
100,000
Total assets..............................
$500,000
Total liab. and equity........
$500,000
Sales (on credit) ...................................................................................
$1,250,000
Cost of goods sold ................................................................
750,000
Gross profit ..........................................................................................
500,000
Selling and administrative expense† ...................................................
257,000
Less: Depreciation expense ................................................................
50,000
Operating profit ....................................................................................
193,000
Interest expense ....................................................................................
8,000
Earnings before taxes ................................................................
185,000
Chapter 03: Financial Analysis
3-53
Tax expense .........................................................................................
92,500
Net income ...........................................................................................
$ 92,500
*Use net fixed assets in computing fixed asset turnover.
†Includes $7,000 in lease payments.
SMITH CORPORATION
Current Assets
Liabilities
Cash ...............................
$ 35,000
Accounts payable ..................
$ 75,000
Marketable securities .....
7,500
Bonds payable (long-term) ....
210,000
Accounts receivable .......
70,000
Inventory .......................
75,000
Long-Term Assets
Stockholders’ Equity
Fixed assets ....................
$500,000
Common stock ......................
$ 75,000
Less: Accum. dep. .......
(250,000)
Paid-in capital .......................
30,000
Net fixed assets* ............
250,000
Retained earnings .................
47,500
Total assets ...............
$437,500
Total liab. and equity ..........
$437,500
*Use net fixed assets in computing fixed asset turnover.
SMITH CORPORATION
Sales (on credit) ...................................................................................
$1,000,000
Cost of goods sold ................................................................................
600,000
Gross profit ..........................................................................................
400,000
Selling and administrative expense† ...................................................
224,000
Less: Depreciation expense ...............................................................
50,000
Operating profit....................................................................................
126,000
Interest expense....................................................................................
21,000
Earnings before taxes ................................................................
105,000
Tax expense .........................................................................................
52,500
Net income...........................................................................................
$ 52,500
†Includes $7,000 in lease payments.
3-37. Solution:
Jones and Smith Comparison
One way of analyzing the situation for each company is to
compare the respective ratios for each. Examining those ratios
which would be most important to a supplier or short-term lender
and a stockholder.
Chapter 03: Financial Analysis
3-54
JONES CORPORATION
Profit margin = $92,500/$1,250,000 = 7.40%
Return on assets (investment) = $92,500/$500,000 = 18.50%
Return on equity = $92,500/$320,000 = 28.91%
SMITH CORPORATION
Profit margin = $52,500/$1,000,000 = 5.25%
Return on assets (investment) = $52,500/$437,500 = 12.0%
Return on equity = $52,500/$152,500 = 34.43%
3-37. (Continued)
a. Since suppliers and short-term lenders are most concerned with
liquidity ratios, Smith Corporation would get the nod as having
Chapter 03: Financial Analysis
3-55
the best ratios in this category. One could argue, however, that
Smith had benefited from having its debt primarily long term
rather than short term. Nevertheless, it appears to have better
liquidity ratios.
b. Stockholders are most concerned with profitability. In this
category, Jones has much better ratios than Smith. Smith does
Smith and its lower liquidity ratios could reflect better short-term
asset management, and that point was covered in part a.
Note: Remember that to make actual financial decisions more than
one year’s comparative data is usually required. Industry
comparisons should also be made.
SMITH CORPORATION
Sales (on credit) .........................................
$1,000,000
Cost of goods sold ......................................
600,000
Gross profit.................................................
400,000
Selling and administrative expense .........
224,000
Less: Depreciation expense ......................
50,000
Operating profit ..........................................
126,000
Interest expense ..........................................
21,000
Earnings before taxes .................................
105,000
Tax expense ................................................
52,500
Net income .................................................
$ 52,500
Includes $7,000 in lease payments.
Chapter 03: Financial Analysis
3-56
COMPREHENSIVE PROBLEM
Comprehensive Problem 1.
Lamar Swimwear (trend analysis and industry comparisons)(LO3) Bob Adkins has recently
been approached by his first cousin, Ed Lamar, with a proposal to buy a 15 percent interest in
Lamar Swimwear. The firm manufactures stylish bathing suits and sunscreen products.
Mr. Lamar is quick to point out the increase in sales that has taken place over the last three years
as indicated in the income statement, Exhibit 1. The annual growth rate is 25 percent. A balance
sheet for a similar time period is shown in Exhibit 2, and selected industry ratios are presented in
Exhibit 3. Note the industry growth rate in sales is only 10 to 12 percent per year.
There was a steady real growth of 3 to 4 percent in gross domestic product during the period
under study.
Comprehensive Problem 1 (Continued)
Exhibit 1
LAMAR SWIMWEAR
Income Sheet
201X
201Y
201Z
Sales (all on credit) ...........................................
$1,200,000
$1,500,000
$1,875,000
Cost of goods sold .............................................
800,000
1,040,000
1,310,000
Gross profit .......................................................
$ 400,000
$ 460,000
$ 565,000
Selling and administrative expense* ..................
239,900
274,000
304,700
Operating profit (EBIT).....................................
$ 160,100
$ 186,000
$ 260,300
Interest expense .................................................
35,000
45,000
85,000
Net income before taxes ....................................
$ 125,100
$ 141,000
$ 175,300
Taxes ................................................................
36,900
49,200
55,600
Net income ........................................................
$ 88,200
$ 91,800
$ 119,700
Shares ...............................................................
30,000
30,000
38,000
Earnings per share .............................................
$ 2.94
$ 3.06
$ 3.15
*Includes $15,000 in lease payments for each year.
Exhibit 2
LAMAR SWIMWEAR
Balance Sheet
Assets
201X
201Y
201Z
Cash ..................................................................
$ 30,000
$ 40,000
$ 30,000
Marketable securities ........................................
20,000
25,000
30,000
Accounts receivable ..........................................
170,000
259,000
360,000
Inventory...........................................................
230,000
261,000
290,000
Total current assets ........................................
$ 450,000
$ 585,000
$ 710,000
Chapter 03: Financial Analysis
3-57
Net plant and equipment....................................
650,000
765,000
1,390,000
Total assets .......................................................
$1,100,000
$1,350,000
$ 2,100,000
Liabilities and Stockholders’ Equity
Accounts payable ..............................................
$ 200,000
$ 310,000
$ 505,000
Accrued expenses ..............................................
20,400
30,000
35,000
Total current liabilities ..................................
$ 220,400
$ 340,000
$ 540,000
Long-term liabilities ..........................................
325,000
363,600
703,900
Total liabilities ..............................................
$ 545,400
$ 703,600
$ 1,243,900
Common stock ($2 par) .....................................
60,000
60,000
76,000
Capital paid in excess of par ..............................
190,000
190,000
264,000
Retained earnings ..............................................
304,600
396,400
516,100
Total stockholders’ equity .............................
$ 554,600
$ 646,400
$ 856,100
Total liabilities and stockholders’ equity ...........
$1,100,000
$1,350,000
$2, 100,000
Exhibit 3
Selected Industry Ratios
201X
201Y
201Z
Growth in sales .................................
—
10.00%
12.00%
Profit margin .....................................
7.71%
7.82%
7.96%
Return on assets (investment) ............
7.94%
8.86%
8.95%
Return on equity ................................
14.31%
15.26%
16.01%
Receivable turnover ..........................
9.02X
8.86X
9.31X
Average collection period..................
39.9 days
40.6 days
38.7 days
Inventory turnover.............................
4.24X
5.10X
5.11X
Fixed asset turnover ..........................
1.60X
1.64X
1.75X
Total asset turnover ...........................
1.05X
1.10X
1.12X
Current ratio ......................................
1.96X
2.25X
2.40X
Quick ratio ........................................
1.37X
1.41X
1.38X
Debt to total assets ............................
43.47%
43.11%
44.10%
Times interest earned ........................
6.50X
5.99X
6.61X
Fixed charge coverage .......................
4.70X
4.69X
4.73X
Growth in EPS ..................................
—
10.10%
13.30%
The stock in the corporation has become available due to the ill health of a current stockholder,
who is in need of cash. The issue here is not to determine the exact price for the stock, but rather
whether Lamar Swimwear represents an attractive investment situation. Although Mr. Adkins
has a primary interest in the profitability ratios, he will take a close look at all the ratios. He has
no fast and firm rules about required return on investment, but rather wishes to analyze the
overall condition of the firm. The firm does not currently pay a cash dividend, and return to the
investor must come from selling the stock in the future. After doing a thorough analysis
(including ratios for each year and comparisons to the industry), what comments and
recommendations do you offer to Mr. Adkins?
Chapter 03: Financial Analysis
3-58
CP 3-1. Solution: Lamar Swimwear
201X
201Y
201Z
Growth in sales
(Company)
25%
25%
(Industry)
10%
12%
Profit margin
(Company)
7.35%
6.12%
6.38%
(Industry)
7.71%
7.82%
7.96%
Return on assets
(Company)
8.02%
6.80%
5.70%
(Industry)
7.94%
8.68%
8.95%
Return on equity
(Company)
15.90%
14.20%
13.98%
(Industry)
14.31%
15.26%
16.01%
Receivable turnover
(Company)
7.06x
5.79x
5.21x
(Industry)
9.02x
8.86x
9.31x
Average collection
period
(Company)
51.0 days
62.2 days
69.1 days
(Industry)
39.9 days
40.6 days
38.7 days
Inventory turnover
(Company)
5.22x
5.75x
6.47x
(Industry)
4.24x
5.10x
5.11x
Fixed asset turnover
(Company)
1.85x
1.96x
1.35x
(Industry)
1.60x
1.64
1.75x
Total asset turnover
(Company)
1.09x
1.11x
0.89x
(Industry)
1.05x
1.10x
1.12x
Current ratio
(Company)
2.04x
1.72x
1.31x
(Industry)
1.96x
2.25x
2.40x
Quick ratio
(Company)
1.00x
.95x
0.78x
(Industry)
1.37x
1.41x
1.38x
Debt to total assets
(Company)
49.58%
52.12%
59.23%
(Industry)
43.47%
43.11%
44.10%
Times interest
earned
(Company)
4.57x
4.13x
3.06x
(Industry)
6.50x
5.99x
6.61x
Fixed charge
coverage
(Company)
3.50x
3.35x
2.75x
(Industry)
4.70x
4.69x
4.73x
Growth in E.P.S.
(Company)
----
4.1%
2.9%
(Industry)
----
10.1%
13.3%
Chapter 03: Financial Analysis
3-59
CP 3-1. (Continued)
Discussion of Ratios
(25 percent per year). There obviously are no economies of scale for this
firm. Higher costs of goods sold and interest expense appear to be
causing the problem. The return-on-asset ratio starts out in 201X above
the industry average (8.02 percent versus 7.94 percent) and ends up well
of the progressively larger debt that the firm is using. High debt
utilization tends to contribute to high return on equity, but not in this
case. There is simply too much deterioration in return on assets
translating into low return on equity.
asset turnover. A decline from 1.85x to 1.35x was caused by an increase
in 113.8 percent in fixed assets (representing $740,000).
We can summarize the discussion of the turnover ratios by saying that
despite a 56.25 percent increase in sales, assets grew even more rapidly
