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P5-14 Explaining changes in financial ratios
(AICPA adapted)
1) a,b,d Inventory turnover is defined as the cost of goods sold
divided by average inventory. A lower inventory would cause the
inventory turnover ratio to increase, as would a higher cost of
goods sold. Consignment items should still be included in
2) a,b,e Accounts receivable turnover is net credit sales divided by
average accounts receivable. Recording goods shipped on
consignment before they are actually sold overstates accounts
3) a,b,e If the allowance for doubtful accounts increased in dollars,
but the allowance decreased as a percentage of accounts
receivable, then accounts receivable must have increased by a
4) p The refinancing of short-term debt as long-term debt at a
higher interest rate would cause the long-term debt to increase,
5) l,p Net income for the year can be found from operating income
less interest expenses and federal income taxes. If operating
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6) h Gross margin percentage is defined as gross margin divided
by sales. If the gross margin percentage remained constant
while the gross margin increased, then sales must have
P5-15 EBITDA and revenue recognition
Requirement 1:
Requirement 2:
Sales at G&L grew at 8.4% in 2013 and almost 18% in 2014 while
Requirement 3:
GG&L’s sales growth is accompanied by a longer receivables
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Receivable Composition 2012 2013
One reason for the increase in days accounts receivable
Requirement 4:
G&L uses percentage-of-completion to record revenue on its
long-term construction projects. (Note that the dates in the problem
pre-date the new revenue recognition standard.) This approach
assigns revenue to the period when G&L does the work—i.e., when
the revenue is “earned”. However, the exact amount of “work done”
each year, and thus the amount of revenue earned that year, is a
judgment call made by management. One way a company can
make it look like sales are growing (and profits are holding steady)
Under the new revenue recognition standard, effective in 2017 for
calendar-year companies, revenue may still be recognized over
P5-16 Analyzing ratios: Alpine Chemical
(CFA adapted)
Requirement 1:
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a) EBIT/interest expense =
1, 629 + 318
318
= 6.12
b) Long-term debt/total capitalization =
1,491
(1,491 + 3,075)
= 33%
Note: Some students may include the $1,900 note payable as
c) Funds from operations/total debt:
(Net income + Depreciation expense)/(Long-term debt + Notes
payable)
=
(1,479 + 511) =59%
(1,491 + 1,900)
d) Operating income/sales =
2,458 =13%
19,460
Requirement 2:
a) EBIT/interest expense measures Alpine Chemical’s ability to
make its interest payments from pre-tax earnings. A ratio of less
b) Long-term debt/total capitalization measures Alpine’s financial
leverage. A highly leveraged company can find that issuing new
c) Funds from operations/total debt measures Alpine’s ability to
d) Operating income/sales measures Alpine’s profitability.
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increased, or costs reduced, to generate the same level of operating
Requirement 3:
a) EBIT/interest expense. With the exception of 2013, interest
coverage has been consistently above 4.00. The year 2017 shows
b) Long-term debt/total capitalization. This leverage measure has
been stable in the past three years. During the six-year period,
c) Funds from operations/total debt. The cash flow ratio has been
d) Operating income/sales. Operating margins remain stable but
Financial Reporting and Analysis (7th Ed.)
Chapter 5 Solutions
Essentials of Financial Statement Analysis
Cases
Cases
C5-1 McDonald’s and Buffalo Wild Wings: Comparing two restaurant
chains
Requirements 1 and 2:
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Buffalo Wild Wings’ sales per company-owned store have grown
substantially in the last several years, and now exceed that of
McDonald’s ($3.08 million versus $2.70 million). However,
franchise fees per store are significantly greater at McDonald’s
suggesting McDonald’s is able to charge a larger franchise fee rate.
Requirements 3, 4 and 5:
2011 versus 2008
Sales at company-owned Buffalo Wild Wings stores grew from
$379.7 million in 2008 to $717.4 million in 2011. That growth
resulted from both an increase in the number of stores open ($233.2
million) and growth in sales per store ($104.0 million). In contrast,
Similarly, more of Buffalo Wild Wings’ franchise fee growth is due to
2014 versus 2011
From 2011 to 2014, sales at company-owned Buffalo Wild Wings
stores again grew due to both factors, with more of the growth
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$880.7 million. However, this increase was more than offset by
falling sales per store ($2.70 million per store versus $2.85 million),
Buffalo Wild Wings’ franchise fee revenue grew as a result of both
more store and greater fees per store. Like its results for
Summary
These analyses illustrate the two different strategies these
companies employ, probably due where each is in its life cycle.
McDonald’s is much more mature and therefore has fewer growth
In contrast, Buffalo Wild Wings is still getting a substantial amount
of growth from new locations, both company-owned and franchised.
From 2008 to 2014, it has more than doubled the number of
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C5-2. Crocs and Deckers Outdoor: Comparing footwear manufacturers
Requirement 1:
Requirement 2:
The superior ROA earned in 2014 by Deckers Outdoor can be traced to a
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Requirement 3:
In 2012, Crocs reported a strong ROA of 25.5%. It fell substantially the next
year, suggesting either a decline in profitability or that the quality of 2012
Requirement 4:
Deckers had a greater number of days receivables outstanding and inventory
held until 2014, when it cut both substantially. This decrease coincides with
strong sales growth (16.7% in 2014 versus 2013), suggesting Deckers was
Requirement 5:
Days receivables outstanding and days inventory held could be affected by
the year-end, as they are based on balance sheet amounts. When a
company’s operations have a seasonal component to it, certain balance
C5-3. Argenti Corporation: Evaluating credit risk
Requirement 1:
Operating cash flows for 2016 ($356) million
The company’s operating cash flows are described in the case exhibit. The
long-term debt repayment is the account balance decrease (from $423 million
to $87 million).
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Property, plant, and equipment, and investments declined during 2016, which
suggests that these items provided cash rather than consumed it. There
Thus, two factors seem responsible for the increased short-term borrowing:
repayment of the company’s existing long-term debt and the negative cash
There are several aspects of the financial statements that point to a company
Requirement 2:
By almost any measure, Argenti’s credit risk has increased substantially
since 2012: sales have declined, losses are being recorded, operating cash
flows are negative, and the company has already violated its existing loan
Under normal circumstances, this would not be the time for a lender to
expand its credit position with the company from $165 million to $1.5 billion.
But circumstances are not normal since GE Capital is also Argenti’s largest
What happened?
This case is drawn from the experience of Montgomery Ward & Company,
which was taken private in a $3.8 billion leveraged buyout by GE Capital and
the then CEO, Bernard Brennan, in 1988. Shortly after releasing its first-
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