Chapter 13
Analyzing Financial Statements
ANSWERS TO QUESTIONS
1. Published financial statements are designed primarily to meet the needs of
2. The three factors are: Economy-wide factors, industry factors, and individual
company factors.
3. Under a product differentiation strategy, companies offer products with
4. The two general methods are comparing across time and comparing across
5. Component percentages express each item on a financial statement as a
percentage of a single base amount. The base amount on the income
6. Ratios express the proportionate relationship between two amounts. Ratio
analysis is useful because it may reveal critical relationships that are not
readily apparent from absolute dollar amounts.
7. Profitability ratios focus on net income and how it compares to other
amounts reported on the financial statements. Return on equity, return on
8. Turnover ratios focus on capturing how efficiently a company uses its
assets. Total asset turnover, fixed asset turnover, receivables turnover, and
9. Liquidity ratios focus on assessing a company’s ability to meet its short-term
obligations. The current ratio, quick ratio, and cash ratio are examples
discussed in Chapter 13. Formulas for these ratios are provided in Exhibit
13.3.
10. Solvency ratios focus on assessing a company’s ability to meet its long-term
11. Market ratios focus on the relationship between the current price per share
of a company’s stock and the return that accrues to stockholders.
Price/earnings and dividend yield are examples discussed in Chapter 13.
Formulas for these ratios are provided in Exhibit 13.3.
12. Accounting policy choices influence ratios This is important because different
companies rarely use exactly the same accounting policies. For example,
13. Total sales can increase as a result of a company selling more at its existing
stores, or it can increase as a result of a company opening new stores.
ANSWERS TO MULTIPLE CHOICE
Financial Accounting, 9/e 13–3
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
Alternate
Problems
Cases and
Projects
No.
No.
Time
No.
1
1
20
1
2
2
20
2
3
3
40
3
11
12
13
* Due to the nature of this project, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended
4
5
4
15
4
60
4
60
4
45
5
5
5
20
5
5
5
20
6
5
6
20
6
6
6
7
5
7
15
7
7
8
5
8
15
8
30
9
5
9
15
9
10
5
10
10
15
MINI-EXERCISES
M13–1.
Sales – Cost of Goods Sold = Gross Profit
$1,665,000 – Cost of Goods Sold = $732,600 ($1,665,000 x .44)
M13–2.
Sales – Cost of Goods Sold = Gross Profit
Sales in 2015 : $29,600 x 1.054 = $31,198
M13–3.
M13–4.
21% – 6% = 15%
M13–5.
If sales remain the same, then cost of goods sold will also remain the same.
Financial Accounting, 9/e 13–5
M13–6.
Total Assets – Noncurrent Assets = Current Assets
$1,400,000 – $480,000 = Current Assets
M13–7.
Current Ratio
=
Current Assets
Current Liabilities
=
Quick Assets
Current Liabilities
M13–8.
Times Interest Earned = (Net Income + Interest Expense + Income Tax
Expense) ÷ Interest Expense
M13–9.
Dividend Yield = Dividends per Share ÷ Market Price per Share
M13–10.
All else equal, if prices have been increasing then the most expensive
inventory is the newest inventory. Switching from FIFO to LIFO will result in
• Increase cost of goods sold on the income statement.
• Decrease inventory on the balance sheet.
The ratio effects are:
• Net Profit Margin: Numerator will decrease. Denominator will
stay the same. Overall effect is that ratio will decrease.
Financial Accounting, 9/e 13–7
EXERCISES
E13–1.
1. COMPANY 1: Car manufacturer
a. Key indicators: High inventory; high property & equipment; low
inventory turnover
2. COMPANY 2: Wholesale candy company
a. Key indicators: High property & equipment; low gross profit; low
E13–2.
1. COMPANY 1: Meat processing company
a. Key indicators: High inventory turnover; low gross profit
2. COMPANY 2: Travel agency
a. Key indicators: No cost of good sold; zero inventory turnover; high
E13–3.
1. COMPANY 1: Cable TV Company
a. Key indicators: No cost of goods sold; zero inventory turnover; high
property & equipment
2. COMPANY 2: Accounting firm
E13–4.
COMPANY 1: Restaurant
Key indicators: High inventory turnover; high property & equipment
COMPANY 2: Full-line department store
Key indicators: High inventory; low inventory turnover
E13–5.
Lowe’s Companies, Inc.
Consolidated Statements of Earnings
(In millions, except per share and percentage data)
Fiscal years ended on
January 30,
2015
% Sales
January 31,
2014
% Sales
February 1,
2013
% Sales
Net sales $ 56,223
100.00%
$ 53,417
100.00%
$ 50,521
100.00%
Cost of sales 36,665
65.21
34,941
65.41
33,194
65.70
Gross margin 19,558
34.79
18,476
34.59
17,327
34.30
Expenses:
— — — — —
E13–6.
1.
A
Net profit margin
2.
H
Inventory turnover ratio
3.
B
Average days to collect
4.
Dividend yield ratio
5.
C
Return on equity
6.
G
Current ratio
7.
K
Debt/equity ratio
8.
M
Price/earnings ratio
9.
E
Financial leverage percentage
10.
I
Receivable turnover ratio
11.
Average days to sell inventory
12.
D
Earnings per share
13.
N
Return on assets
14.
F
Quick ratio
15.
Times interest earned
16.
Cash coverage ratio
17.
Fixed asset turnover ratio
E13–7.
Turnover Ratios:
Receivable: $74,756* ÷ [($6,386 + $6,508) ÷ 2]
=
11.60
Inventory: $40,700** ÷ [($6,759 + $6,909) ÷ 2]
=
5.96
*$83,062 x .90 = $74,756
**$83,062 x .49 = $40,700
Days:
=
31.47 days
=
61.24 days
E13–8.
Turnover Ratios:
Receivable: $700,000* ÷ [($60,000 + $45,000) ÷ 2]
=
13.33
Inventory: $600,000** ÷ [($25,000 + $70,000) ÷ 2]
=
12.63
*$1,000,000 x .70 = $700,000
**$1,000,000 x .60 = $600,000
=
27.38 days
E13–9.
Current Assets
(1)
Current Liabilities
(2)
Current
Ratio
(1 ÷ 2)
Before
transactions
$120,000
($120,000 ÷ 1.5)
$80,000
1.50
Transaction (1)
Inventory
Accts. Pay.
New
balances
1.33
Transaction (2)*
Cash
$157,000
$120,000
1.31
E13–10.
Effect on Current Ratio:
1.
Increase: Current assets increase. Current liabilities stay the same.
2.
Decrease: Current assets stay the same. Current liabilities increase.
3.
Decrease: Current assets decrease. Current liabilities stay the same.
4.
Increase: Current assets increase. Current liabilities stay the same.
E13–11.
Inventory turnover ratio = Cost of Goods Sold ÷ Average Inventory
8.0 = Cost of Goods Sold ÷ $1,668 million
Cost of Goods Sold = $13,344 million
E13–12.
Receivable Turnover
$4,552 ÷ $506.50*
*($508 + $505) ÷ 2
=
8.99
Inventory Turnover
$2,637 ÷ $245.50*
*($251 + $240) ÷ 2
=
10.74
E13–13.
Dividend Yield = Dividends per Share ÷ Market Price per Share
PROBLEMS
P13–1.
Based on the ratios provided, Company Y appears to be the better
investment. Company Y has a higher gross profit margin, which means that
they make more gross profit on each dollar of sales than does Company X.
P13–2.
Company A dominates Company B on all ratios. It is important to note that
Financial Accounting, 9/e 13–13
P13–3.
Return on equity
$6,345 ÷ $10,922*
*($9,322 + $12,522) ÷ 2
=
58.09%
Return on assets
$6,345 ÷ $40,232*
*($39,946 + $40,518) ÷ 2
=
15.77%
Total asset turnover
$83,176 ÷ $40,232**
*($39,946 + $40,518) ÷ 2
=
2.07
Inventory turnover
=
4.90
P13–4.
Req. 1
Ratio
Blue Water Company
Prime Fish Company
Profitability ratios:
1.
Return on equity
$45,000 ÷ $238,000* = 18.91%
*($148,000 + $29,000 + $61,000)
$91,000 ÷ $689,000* = 13.21%
*($512,000 + $106,000 + $71,000)
2.
Return on assets
$45,000 ÷ $402,000 = 11.19%
$91,000 ÷ $798,000 = 11.40%
3.
Financial leverage percentage
13.21% – 11.40% = 1.81%
Net profit margin
$45,000 ÷ $447,000 = 10.07%
$91,000 ÷ $802,000 = 11.35%
*$148,000 / $10
*$512,000 ÷ $10
Turnover ratios:
7.
Total asset turnover
$447,000 ÷ $402,000 = 1.11
$802,000 ÷ $798,000 = 1.01
8.
Fixed asset turnover
$447,000 ÷ $140,000 = 3.19
$802,000 ÷ $401,000 = 2.00
9.
Receivable turnover
$267,333* ÷ $31,000= 8.62
Inventory turnover
$241,000 ÷ $99,000 = 2.43
Liquidity ratios:
11.
Current ratio
$178,000* ÷ $99,000 = 1.80
*$41,000 + $38,000 + $99,000
$92,000* ÷ $49,000 = 1.88
*$21,000 + $31,000 + $40,000
12.
Quick ratio
$79,000* ÷ $99,000 = .80
$52,000* ÷ $49,000 = 1.06
Cash ratio
$21,000 ÷ $49,000 = .43
Solvency ratios:
16.
Debt/equity ratio
$164,000* ÷ $238,000** = .69
*$99,000 + $65,000
**$148,000 + $29,000 + $61,000
$109,000* ÷ $689,000** = .16
*49,000 + $60,000
**$512,000 + $106,000 + $71,000
Price/earnings ratio
*$45,000 ÷ 14,800 shares
$15 ÷ $1.78* = 8.43
*$91,000 ÷ 51,200 shares
Dividend yield ratio
$2.23* ÷ $22 = 10.14%
$2.89 ÷ $15 = 19.27%
Req. 2
On average, Prime Fish collects its accounts receivable balance 8.62 times a
year and turns over its inventory 10.00 times a year. Blue Waters collects its
accounts receivable balance 3.92 times a year and turns over its inventory
Financial Accounting, 9/e 13–15
P13–5.
Req. 1
Increase (Decrease)
from Year 1 to Year 2
Income Statement
Year 2
Year 1
Amount
Percent
Sales revenue
$190,000
$167,000
$ 23,000
13.77
Cost of goods sold
112,000
100,000
12,000
12.00
Net income
14,000
10,000
$ 4,000
40.00
Balance Sheet
Cash
$4,000
$7,000
$ -3,000
-42.86
Accounts receivable (net)
14,000
18,000
-4,000
-22.22
Inventory
40,000
34,000
6,000
17.65
Property & equipment (net)
45,000
38,000
7,000
18.42
Total assets
$ 6,000
Current liabilities (no interest)
$16,000
$17,000
$ -1,000
-5.88
45,000
45,000
Common stock ($5 par value)
30,000
30,000
Retained earnings
12,000
7,000
140.00
Total liabilities & equity
103,000
97,000
$ 6,000
6.19
Year 2 current ratio: ($4,000 + $14,000 + $40,000) ÷ $16,000 = 3.63
Gross profit
78,000
67,000
11,000
16.42
Operating expenses and interest expense
56,000
53,000
3,000
Pretax income
22,000
14,000
8,000
57.14
Income tax
4,000
100.00