Chapter 14 – Analyzing Financial Statements
14–21
P14–7.
Req. 1
.
Component Percentages 2012
Income statement:
Sales revenue (the base amount)
100
Cost of goods sold
59
Balance sheet:
Cash
4
Accounts receivable (net)
14
Inventory
Operational assets (net)
Total assets (the base amount)
(rounded)
Current liabilities
16
44
Common stock ($5 par)
29
Retained earnings
12
Total liabilities and owners’ equity (the base amount)
100
(rounded)
a.
41.0
%
b.
36.4
%
c.
d.
43.7
%
e.
Gross profit on sales
Operating expenses
Pretax income
Income taxes
Net income
8
Chapter 14 – Analyzing Financial Statements
14–22
h.
19.5
%
P14–8.
Ratio
Return on Equity
36.37
%
Return on Assets
16.86
%
Current Ratio
3.63
Quick Ratio
1.13
Receivable Turnover
3.96
times
Average Collection Period
92.17
days
Inventory Turnover
3.03
times
Average Days’ Supply
days
Times Interest Earned
5.89
Debt/Equity Ratio
1.45
Price/Earnings Ratio
12.02
Dividend Yield Ratio
1.79
%
Financial Leverage Percentage
19.51
%
Fixed Asset Turnover
4.58
Profit Margin
7.37
%
Cash Ratio
0.25
Chapter 14 – Analyzing Financial Statements
14–23
P14–9.
Analysis
The case states that both companies are exactly alike except for the impact of
the alternative methods to cost inventory. Use of LIFO (compared to FIFO),
during a period of rising prices, causes (1) lower inventory amounts on the
1. Current ratio—Company A will have a higher ratio because the inventory
amount is higher under FIFO. The cash balance for Company A is less than
2. Quick ratio—Company B will have a higher ratio because of the higher cash
3. Debt/equity ratio—Company B will have a higher ratio because of reporting a
4. Return on equity—The analyst cannot be certain which company will report
a higher ratio. The numerator of the ratio reflects differences for the current
Chapter 14 – Analyzing Financial Statements
14–24
P14–10.
Return on equity:
$311,405
=
68.4%
($318,199 + 592,922) ÷ 2
Return on assets:
$311,405 + ($97,876 x 66%*)
=
9.5%
($3,634,719 + $4,247,113) ÷ 2
*Assumed tax rate of 34%
Quality of income:
Cannot compute without the statement of cash flows.
Profit margin:
$311,405
=
6.1%
$5,132,768
$5,132,768
=
3.42
0.03
$1,270,212
Current ratio:
$1,344,945
=
1.06
$1,270,212
Quick ratio:
$492,256
=
0.39
$1,270,212
Chapter 14 – Analyzing Financial Statements
14–25
P14–10. (continued)
Receivable turnover:
$5,132,768 *
=
10.9
($455,153 + $487,285) ÷ 2
* When the amount of credit sales is not known, total sales may be used as
a rough approximation. Unfortunately, this estimate is often not meaningful.
Inventory turnover:
Cash coverage:
Cannot compute without statement of cash flows.
Debt/Equity:
$3,284,775
=
10.3
$318,199
$3,375,050
=
=
$116,056
Chapter 14 – Analyzing Financial Statements
14–26
ALTERNATE PROBLEMS
AP14–1.
1. Company A shows a high EPS but a low ROA. There are a number of
2. The low level of liquidity for Company A is a concern given its high
debt/equity ratio.
3. Despite a high EPS, Company A has a low price/earnings multiple. This
AP14–2.
2. Company A’s solvency and liquidity are potential areas of concern.
AP14–3.
Coca-Cola is the stronger company and probably is the better investment.
The biggest differences between the two companies are the P/E ratio, ROA,
Chapter 14 – Analyzing Financial Statements
14–27
AP14–4.
Req. 1
Name and Computation of the 2012 Ratio
Brief Explanation of the Ratio
Tests of profitability:
(1)
Return on equity:
Measures return earned for owners
(2)
Return on assets:
($25,200 + $4,900*) ÷ $187,500†= 16.05%.
*Bonds: $70,000 x 10% x .70 = $4,900
Measures the entity’s performance in
using total resources (total assets)
(3)
Financial leverage percentage:
The advantage to be gained by
23.12% – 16.05% = 7.07% positive
investors when the interest rate (net of
tax) is less than the return on assets.
(4)
$25,200 ÷ 20,000 shares = $1.26
outstanding.
Earnings per share
A measure of the return earned on
(5)
Profit margin
$25,200 ÷ $453,000 = 5.56%
Indicates percent of each sales dollar
that was represented by income.
(6)
3.62
Fixed asset turnover
$453,000 ÷ [($130,000 + $120,000) ÷ 2] =
An indication of how efficiently
management is using fixed assets.
*($116,000 + $102,000) ÷ 2 = $109,000
Chapter 14 – Analyzing Financial Statements
14–28
AP14–4. (continued)
Req. 1 (continued)
Name and Computation of the 2012 Ratio
Brief Explanation of the Ratio
Tests of liquidity:
(1)
Cash ratio
The most stringent test of liquidity; it
(2)
Current ratio
Measures the adequacy of working
A severe test of liquidity by relating
quick assets to total current liabilities.
(4)
2
Receivable turnover
A measure of the effectiveness of
= 5.10 times
365 ÷ 5.10 = 71.57 days
Average number of days to collect an
account receivable.
(5)
Inventory turnover
An indication of the velocity with which
merchandise flows through the
business.
$250,000 ÷ [$25,000 + $18,000]
2
= 11.63 times
Indicates, as a days of supply figure,
the velocity with which merchandise
flows through the business.
measures the amount of cash
available to pay current liabilities.
Chapter 14 – Analyzing Financial Statements
14–29
AP14–4. (continued)
Req. 1 (continued)
Name and Computation of the 2012 Ratio
Brief Explanation of the Ratio
Tests of solvency and equity position:
6.14
(2)
Market tests:
Debt/equity ratio
Measures relationship between
(1)
Price/earnings ratio
$18 ÷ $1.26 = 14.29 to 1
A measure of the earnings of a
company that may benefit the investor
directly or indirectly. It is the ratio of
current market price of the stock to the
EPS.
(2)
Dividend yield ratio
$0.45 ÷ $18 = 2.5%
Measures cash return to the
stockholder from dividends in
relationship to the current market price
of the stock.
Req. 2
(a) The financial leverage percentage indicates that an advantage was earned
for the stockholders because the company earned a higher return on total
resources used compared to the interest paid on debt (after tax).
(c) The current ratio is high and is more than the quick ratio because the latter
ratio is a much more severe test of liquidity (it omits inventory and prepaid
expenses). Each of these ratios probably would be “good” when compared
with some standard (such as those listed in (b) above). However, there
appears to be a severe liquidity problem that these two ratios do not divulge;
that is, the extremely low amount of cash.
A measure of the amount of earnings
available to cover interest expense.
Chapter 14 – Analyzing Financial Statements
14–30
AP14–5.
Req. 1
a. Tests of profitability*:
(1) Return on equity: $12,600 ÷ $120,500 = 10.46%.
(2) Return on assets: [$12,600 + ($4,000 x .70)] ÷ $199,750 = 7.71%.
*These ratios usually are computed on income before extraordinary items. After–
tax ratio: 1.00 – .30 = .70. Investment amounts are based on the average of the
2011 and 2012 balances.
b. Tests of liquidity:
(7) Cash ratio: $49,500 ÷ $43,000 = 1.15
(10)
Receivable turnover: $55,000 ÷
$32,000 + $37,000
=
1.59 times
2
Average days to collect: 365 ÷ 1.59 = 230 days.
(11)
Inventory turnover: $52,000 ÷
$38,000 + $25,000
=
1.65 times
2
Days’ supply in inventory: 365 ÷ 1.65 = 221 days.
c. Tests of solvency:
(12) Times interest earned: ($12,600 + $4,000 + $5,400) ÷ $4,000 = 5.50
Chapter 14 – Analyzing Financial Statements
AP14–5. (continued)
Req. 2
a.
Sales revenue
($110,000 – $99,000) ÷ $99,000 = 11.11%
Income before extraordinary items
($12,600 – $9,800) ÷ $9,800 = 28.57%
Net income
($11,200 – $11,900) ÷ $11,900 = (5.88%)
Cash
($49,500 – $18,000) ÷ $18,000 = 175%
Inventory
($25,000 – $38,000) ÷ $38,000 = (34.21%)
Debt
($83,000 – $75,500) ÷ $75,500 = 9.93%
b. Pretax interest rate on the long-term note: $4,000 ÷ $40,000 = 10%.
Req. 3
Potential problems are:
1. Average collection period of 230 days—long compared with the 30-day
credit period.