Financial Reporting and Analysis (7th Ed.)
Chapter 5 Solutions
Essentials of Financial Statement Analysis
Exercises
Exercises
E5-1 Calculating profitability ratios
(AICPA adapted)
E5-2 Determining inventory turnover
(AICPA adapted)
E5-3 Determining receivable turnover
(AICPA adapted)
Accounts receivable turnover =
Total credit sales
Average receivables
= 5.0 and
Average receivables = ($250,000 + $300,000)/2 = $275,000. So,
Total credit sales = $275,000 x 5.0 = $1,375,000. Therefore, Total
net sales = $1,375,000 + $100,000 = $1,475,000.
E5-4 Assessing receivable and inventory turnover
(AICPA adapted)
Requirement 1:
Accounts receivable turnover
=
Net credit sales
Average trade receivables
=
$2,500,000
$462,500
= 5.41
times
where average trade receivables =
$475,000 + $450,000
2
=
$462,500
Requirement 2:
Inventory turnover =
Cost of goods sold
Average inventory
=
$2,000,000
$575,000
= 3.48
times
$600,000 + $550,000
2
E5-5 Analyzing current and quick ratios
(AICPA adapted)
The write-off of obsolete inventory would decrease Todd
Corporation’s current assets, thus decreasing the current ratio. The
E5-6 Analyzing effects on current ratio
(AICPA adapted)
Requirement 1:
The refinancing of a $30,000 long-term mortgage with a short-term
Requirement 2:
Purchasing $50,000 of inventory with a short-term account payable
would increase Gil’s current assets to $140,000, and increase the
Requirement 3:
Paying $20,000 of short-term accounts payable decreases both the
current assets and liabilities by $20,000, making the current ratio
Requirement 4:
E5-7 Calculating interest coverage
(AICPA adapted)
E5-8 Analyzing why inventory turnover increased
(AICPA adapted)
Inventory turnover is Cost of goods sold divided by Average
inventory. The inventory level was unchanged, so an increase in
(Statement 4).
E5-9 Calculating days sales outstanding
(AICPA adapted)
Requirement 1:
Gross profit equals net sales minus cost of goods sold. Net sales
Accounts receivable turnover =
Net sales
Average receivables
5 =
Net sales
$950,000
where $950,000 =
$900,000 + $1,000,000
2
Cost of goods sold can be found by using the inventory turnover ratio:
Inventory turnover =
Cost of goods sold
Average inventory
4 =
Cost of goods sold
$1,150,000
where $1,150,000 =
$1,100,000 + $1, 200,000
2
Cost of goods sold = 1,150,000 x 4 = $4,600,000
Gross profit = $4,750,000 – $4,600,000 = $150,000
Requirement 2:
Days’ sales in average receivables =
360
5
= 72 days
Days’ sales in average inventories =
360
4
= 90 days
E5-10 Hershey Company and Tootsie Roll Industries
Requirement 1:
Tootsie Roll is the smaller of the two companies as measured by
sales, and thus it should come as no surprise that Tootsie Roll also
reports smaller earnings. However, the real difference in profitability
Decomposing ROA into its profit margin and asset turnover
components shows that Hershey’s results are stronger on both
Requirement 2:
It is important to distinguish between brand familiarity and brand
value. Both companies have familiar (that is, recognizable) brands
but brand recognition does not always translate into brand value.
Companies with valuable brands are able to earn profits that exceed
E5-11 Mentor Graphics and its non-GAAP earnings
Requirement 1:
Here are the items specifically mentioned by management:
equity-based (noncash) employee compensation; severance and
related employee “rebalancing” costs; fees paid to consultants;
losses related to abandonment of excess facility space and to a
Requirement 2:
Calling attention to non-GAAP earnings can benefit analysts and
investors if it helps them to distinguish sustainable from
non-sustainable earnings. The SEC requires firms to provide a
detailed reconciliation of non-GAAP earnings to GAAP earnings so
Requirement 3:
Analysts and investors may be harmed if they naively assume that
excluded costs are non-recurring expenses of the business. Doing
E5-12 Calculating ROCE for Whole Foods Market
Requirements1 and 2:
Computation of ROCE
(Dollar amounts in millions) 2015 2012
Net income and nonrecurring items can be found in Exhibit 5.12.
Average common equity for 2015 is ($3,769 million + $3,813 million)
Requirement 3:
Financial leverage can be viewed as a multiplier that translates ROA
The company’s ROA was 9.7% in 2012 and 9.4% in 2015. Financial
leverage was beneficial in each of these years because ROCE
E5-13 Cause-of-change analysis
Requirement 1:
($ in millions)
Causes of change in net income
Net income – 2016 $1,364.0
Effect of increase in sales
Requirement 2:
Although net income grew by 5.8% ($1,443 vs. $1,364) from 2016
to 2017, sales increased by 18.2% ($6,500 vs. $5,500) over the
same period. The earnings increase did not keep pace with the
sales increase due to deteriorating margins and an increase in the
Financial Reporting and Analysis (7th Ed.)
Chapter 5 Solutions
Essentials of Financial Statement Analysis
Problems
Problems
P5-1 Comparing profitability
Requirement 1:
Following are sales growth data for the three companies. All dollar
amounts are in millions.
This analysis indicates that sales growth has been slightly stronger
Requirement 2:
Publix has had consistently higher ROA than both Kroger and Weis
P5-2 Assessing short-term liquidity
Requirement 1:
Ross Stores has the lowest current ratio of the three companies at
1.36. However, its cash conversion cycle is only 22.4 days and the
Requirement 2:
Days inventory held is computed as 365 x Average inventory / Cost
of goods sold. Including occupancy costs in cost of goods sold
reduces the value calculated for days inventory held and therefore
also reduces the reported operating and cash conversion cycles.
Requirements 3 and 4:
Ross has a very low level of receivables relative to sales,
suggesting it extends credit on only a small portion of its sales. In
P5-3 Analyzing credit risk analysis and long-term solvency
Requirement 1:
Two coverage ratios are provided. The interest coverage ratio is
computed as earnings before interest and taxes (EBIT) divided by
interest expense. The cash flow coverage ratio uses operating cash
flow before considering interest and tax payments in the numerator
rather than EBIT. Both ratios suggest the company’s ability to
Requirement 2:
Based on AK Steel’s long-term debt to assets ratio, the company
Requirement 3:
AK Steel does not have significant amounts of intangible assets.
The long-term debt to assets ratio each year is nearly equal to the