Brief Learning
Exercises Objectives Skills
B. Ex. 14.1 Dollar and percentage change 14-1 Analysis
B. Ex. 14.2 Trend percentages 14-1 Analysis
B. Ex. 14.3 Component percentages 14-1 Analysis
B. Ex. 14.4 Working capital and current ratio 14-4 Analysis
B. Ex. 14.5 Current and quick ratios 14-4 Analysis
B. Ex. 14.6 Debt ratio 14-4 Analysis
B. Ex. 14.7 Net income as percentage of sales 14-6 Analysis
B. Ex. 14.8 Earnings per share 14-6 Analysis
B. Ex. 14.9
Return on assets 14-7 Analysis, judgment
B. Ex. 14.10 Return on equity 14-7
Analysis, judgment
Skills
14.1 Percentages changes 14-1 Analysis
14.2 14-1
14.3 14-1
14.4 Measures of liquidity 14-3, 14-4
14.5 Multiple-step income statements 14-5 Analysis, communication
14.6 14-6
Analysis,
communication,
14.7 14-1, 14-6
14.8 Research problem 14-6
14.9
14.10 Evaluating employment opportunities 14-4, 14-6
14.11 Ratios for a retail store 14-7
14.12 Computing ratios 14-7 Analysis
14.13 14-6, 14-7 Analysis
Analysis,
communication,
Computing and interpreting rates of
change
14-3, 14-4,
14-6
CHAPTER 14
FINANCIAL STATEMENT ANALYSIS
Learning
Objectives
Trend percentages
Analysis,
communication,
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Topic
Current ratio, debt ratio, and earnings
per share
Analysis,
communication,
Analysis,
communication,
Analysis,
communication,
Analysis,
communication,
judgment, research,
Real World: CVS Health, ROI
Analysis,
communication,
Communication,
judgment, research
Real World: Home Depot
Management analysis and discussion
Topic
Exercises
Common size statements
Topic Skills
14.14 14-7
14.15 14-6, 14-7
Skills
14.1 A,B 14-1, 14-5
14.2 A,B 14-3, 14-5
14.3 A,B Measures of liquidity 14-3, 14-4
14.4 A,B
Real World: The Kroger
Company Liquidity
14-3, 14-4,
14-7
14.5 A,B
14-3, 14-4,
14.6 A,B Financial statement analysis
14.7 A,B
Basic ratio analysis
14.8 A,B 14-5, 14-7
14.9 A,B
14.1 Season’s greetings 14-1
14.2 Evaluating debt-paying ability 14-3–14-5
14.3 Strategies to improve current ratio 14-5 Communication, judgment
14.4 Real World: Calpers 14-5
Analysis, communication,
judgment, research, technology
Real World: Various Companies
14.5 14-7, 14-8
(Internet)
Analysis, communication,
judgment
Analysis, communication,
judgment
Analysis, communication,
judgment
Ratios; evaluation of two companies
14-4, 14-5,
14-7
14-5, 14-7,
14-8
Exercises
Problems
Learning
Objectives
Ratio analysis for two similar
companies
Sets A, B
Analysis, communication,
judgment
Balance sheet measures of liquidity and
credit risk
Analysis, communication,
judgment
Analysis, communication,
judgment
Real World: Johnson & Johnson.
Ratio analysis
Real World: Best Buy
Analysis to identify favorable and
unfavorable trends
Analysis, communication,
judgment
Analysis, communication,
judgment, research
Analysis, communication,
judgment
14-4, 14-5,
14-7
Analysis, communication,
judgment
Evaluating corporate governance
quality (Ethics, fraud, and corporate
governance)
Ratios; consider advisability of
incurring long-term debt
Topic
Critical Thinking Cases
Learning
Objectives
Comparing operating results with
average performance in the industry
Analysis, communication,
judgment
Analysis, communication,
judgment, research, technology
Evaluating liquidity and profitability
Analysis, communication,
judgment
Analysis, communication,
judgment
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Problems (Sets A and B)
Rogand Grocery, Inc./Glaven, Inc.
Given a list of accounts in random order, students are to prepare
the current assets and current liabilities sections of the balance
sheet, compute the current ratio and amount of working capital,
and comment upon the company’s financial position.
From “live data,” students are to evaluate the liquidity of Kroger
(for 14.4A), the world’s largest chain of supermarkets. They also
are to discuss characteristics of a supermarket’s operating cycle.
Compute various measures of liquidity, and discuss the liquidity of
a company from the perspectives of different groups. Especially
interesting because the business may be excessively liquid.
45 Strong
35 Medium
Compute various measures of liquidity and profitability, and
comment upon the relationships. Includes data from the statement
of cash flows.
Sweet Tooth, Inc./Sweet as Sugar
Dickson, Inc./Hamilton Stores
14.5 A,B
14.6 A,B
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
14.1 A,B
20 Easy
The Kroger Company/Chezo, Inc.
14.4 A,B
Outdoor World, Inc./Décor, Inc.
14.2 A,B
14.3 A,B
Prepare a common size income statement and compare it with the
average for the industry. Discuss the significance of results.
Donelson, Inc./Free Time, Inc.
Designed to develop student’s awareness of percentage
relationships on an income statement. Requires preparation of a
comparative income statement, when given amounts of net income,
gross profit, and some ratios. Also calls for identification of
favorable and unfavorable trends.
25 Medium
15 Easy
25 Easy
Problems (cont’d)
Best Buy/Rochester Corporation
Harrison Electronics, Inc./Solar Systems, Inc.
Another World and Imports, Inc./ THIS Star, and THAT Star,
Inc.
25 Medium
Requires computation of the following: inventory turnover, accounts
receivable turnover, total operating expenses, gross profit percentage,
rate earned on average stockholders’ equity, and rate earned on
average assets. Also calls for a decision on advisability of the
company incurring long-term debt.
14.9 A,B
35 Medium
14.7 A,B
25 Medium
14.8 A,B
Compute the current ratio and working capital at both the beginning
and end of the year and also the returns on assets and on stockholders’
equity for the year. Evaluate whether debt-paying ability is increasing
or deteriorating and whether management appears to be using
resources efficiently.
Computation for two companies of various ratios and turnover rates
relating to liquidity. Students are asked to evaluate the companies
from the viewpoint of a short-term creditor.
Critical Thinking Cases
Holiday Greeting Cards
Third Nebraska Bank
Nashville Do-It-Yourself
Evaluating Corporate Governance Quality
Ethics, Fraud, and Corporate Governance
No time
estimate
Strong
14.5 Evaluating Liquidity and Profitability No time
Internet estimate
Strong
14.3
Students are asked to evaluate the effects of several transactions upon
the current ratio and to suggest ethical means by which management
may increase a company’s current ratio.
25 Strong
14.1
25 Medium
14.2
15 Easy
A newscaster has developed percentage-change statistics in which
fourth-quarter profits of a seasonal business are compared to those of
the third quarter, and the second year’s operations are compared to a
partial first year. Students are asked to comment on whether the
newscaster’s statistics present a realistic picture of the company’s rate
of growth.
A true “critical thinking” problem. Students are asked to evaluate two
small businesses that have applied for loans to finance expansion.
Although current ratio and working capital computations are required,
neither are important considerations. The real issue is the extent of the
owner’s personal liability.
14.4
A research problem involving the evaluation of the quality of boards
of directors.
An Internet research problem involving a company selected by the
student. Students are required to perform solvency and profitability
measures.
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1.
2.
3.
4.
5.
The purpose of classifications in financial statements is to develop useful subtotals, which help
users analyze the statements. The most commonly used classifications are:
The comparison of financial data over several time periods (over many years, second quarter of
Observation of trends is useful primarily in determining whether a situation is improving,
A ratio is a mathematical expression of the relation of one figure to another. The purpose in
computing a ratio is simply to draw attention to this relationship. The reader of a financial
Measuring the change in sales over several years would call for the use of trend percentages. The
Trend percentages are used to show the increase or decrease in an amount over a period of years
by comparing the amount in each year with the base-year amount. A component percentage is the
6.
7.
8.
9.
10.
Operating income is the difference between (1) revenue earned from customers, and (2)
expenses closely related to the production of that revenue. Items such as income taxes,
A large corporation may have thousands or even millions of individual stockholders. The
extent of each stockholder’s ownership of the business is determined by the number of
In classified financial statements, items with similar characteristics are grouped together to
Current assets are expected to be converted into cash (or substituted for cash), or used up,
within one year or an operating cycle, whichever is the longer period of time. The
Ratios and other measures used in evaluating profitability include (four required):
Percentage change in net income from the prior year (dollar amount of the change divided
by the amount in the prior year).
Earnings per share (in the simplest case, net income divided by the number of shares of
capital stock outstanding).
11.
12.
13.
14.
15.
The investor is calculating the rate of return by dividing the dividend by the purchase price of the
From the viewpoint of Moffett’s stockholders, this situation represents a favorable use of leverage.
It is probable that little interest, if any, is paid for the use of funds supplied by current creditors, and
The length of the operating cycle of the two companies cannot be determined from the fact that one
P/e ratios reflect investors’ expectations concerning future profits. If Congress announced an
intention to limit the prices and profits of pharmaceutical companies, these expectations would
If the company’s earnings are very low, they may become almost insignificant in relation to stock
price. While this means that the p/e ratio becomes very high, it does not necessarily mean that
B.Ex. 14.1
B.Ex. 14.3
Sales 100.0%
B.Ex. 14.5
B.Ex. 14.6
B.Ex. 14.7
B.Ex. 14.8
B.Ex. 14.9
SOLUTIONS TO BRIEF EXERCISES
B.Ex. 14.4
Current ratio: $470,000 ÷ $267,000 = 1.76
$189,500 – $150,000 = $39,500
B.Ex. 14.10
$45,500 ÷ $450,000 = 10.1%
EPS: $215,000 ÷ 10,000 shares = $21.50
($50,000 + $160,000) ÷ $457,000 = 46.0%
$475,000 ÷ $3,500,000 = 13.6%
$39,500/$150,000 = 26.3%
c.
e.
Ex. 14.2 2018 2017 2016 2015 2014
163% 148% 123% 118% 100%
195% 160% 135% 123% 100%
Cost of goods sold …….
Ex. 14.3
Year 2 Year 1
Net income …………………………………………………..
Sales …………………………………………………………. 100% 100%
The changes from Year 1 to Year 2 are favorable. Sales increased and the gross
SOLUTIONS TO EXERCISES
Sales …………………….
Common size income statements for Year 2 and Year 1.
A percentage change cannot be calculated because retained earnings showed a
Notes payable increased 11.3% ($90,000 increase ÷ $800,000 = 11.3%
Ex. 14.4
a. (1)
$ 47.3
b. (1)
$ 207.0
130.1
$ 311.3
130.1
$ 311.3
130.1
$ 181.2
Total current assets (part a) …………………………….
Current liabilities …………………………………………..
Working capital:
Total current assets (part a) ……………………………..
Less: Current liabilities ………………………………….
c.
By traditional standards, Roy’s Toys seems to be quite liquid. Both its quick ratio
and current ratio appear satisfactory, and its working capital balance is
Quick ratio:
Total quick assets (part a) ………………………………..
Current liabilities ………………………………………..
(Dollars in
Millions)
Quick assets:
Cash and short-term investments ………………………
159.7
$ 207.0
$ 207.0
72.3
32.0
$ 311.3
Inventories ………………………………………………….
Prepaid expenses and other current assets ……………..
Quick assets [part a (1) ] …………………………………
Receivables ……………………………………………….
Current assets:
Ex. 14.5
4,395,253$
2,821,455
b.
Return on assets ($569,402 ÷ $2,575,000) ……………………..
(4)
Return on equity:
Net income ……………………………………………………………….
Average equity …………………………………………………………
Return on equity ($380,379 ÷ $1,917,000) ……………………….
Operating income ………………………………………………………….
Return on assets:
($380,379 ÷ $4,395,253) ……………………………………………..
(3)
Average total assets …………………………………………………….
Net sales ……………………………………………………………….
Gross profit rate ($1,573,798 ÷ $4,395,253) ……………………
Net sales ……………………………………………………………….
Net income ………………………………………………………………………..
Net income as a percentage of net sales:
(2)
1,573,798$
c.
The net sales figure represents the company’s primary source of revenue from
operations. Interest revenue is a nonoperating source of revenue. To include interest
Gross profit …………………………………………………………….
(Dollars in thousands, except per share amounts)
Net sales ……………………………………………………………….
Less: Cost of goods sold …………………………………………………….
a.
SPINX, INC
Statement of Earnings
For the Year Ended December 31, Current Year
(1)
Gross profit rate:
Income tax expense ……………………………………………………..
Earnings per share
Operating income ………………………………………………………………
Gross profit ……………………………………………………………………….
Less: Operating expenses …………………………………………………..
Net earnings
Nonoperating items:
c.
Ex. 14.7 a.
(1)
Ex. 14.8 a.
b.
c.
Investment recommendations will vary depending upon the companies students
The financial measures computed by the students will vary depending upon the
Based on their findings, students should comment on the price volatility of their
Net sales increased 10% ($200,000 increase ÷ $2,000,000 = 10% increase).
Computation of percentage changes:
There are several explanations for why a company’s stockholders’ equity might
decrease during a year. The most common are:
-Net loss (decreases retained earnings, an element of stockholders’ equity)
Ex. 14.9
a.
b.
c.
The number of Home Depot stores has modestly increased each year from 2011 to
The trend in the relationship of net earning to sales is strongly favorable, from 2011
As measured by the current ratio, liquidity has decreased. The current ratio has
Ex. 14.10
Note to instructor: Students should be cautioned not to rely completely upon financial information
in the decisions they make. In deciding which job offer to accept, for example, one should take into
consideration the people, fringe benefits, career growth opportunities, geographic location, potential
long-term stability of each firm, and intangible characteristics important to the student.
Accepting the job offer from Alpha Research might be justified in terms of the
company’s liquidity, profitability, and the growth potential of its common stock.
Liquidity: At first glance, the high current and quick ratios of Omega Scientific make
it appear to be more liquid than Alpha Research. However, these figures may also
Ex. 14.11 a. (1)
b.
Ex. 14.12 a.
b.
Quick ratio: 1.7 to 1 ($250,000 ÷ $150,000)
Working capital: $430,000 ($580,000 − $150,000)
Inventory turnover: 6.8 times ($1,834,000 ÷ $270,000)
Gross profit percentage:
Current ratio: 3.9 to 1 ($580,000 ÷ $150,000)
There are three favorable trends. First, the growth in net sales from $610,000 to
Inventory turnover:
Year 1: 4 times ($408,000 ÷ $102,000 average inventory)
Year 2: 4.5 times ($495,000 ÷ $110,000 average inventory)
Accounts receivable turnover:
Year 1: 6.1 times ($610,000 ÷ $100,000 average accounts receivable)
Year 2: 5 times ($750,000 ÷ $150,000 average accounts receivable)
Ex. 14.13
a.
1.3 to 1 ($130,000 ÷ $100,000)
Year 2
Current ratio: 2.0 to 1 ($160,000 ÷ $80,000)
Year 1
Italian
Brazil
Stone
Marble Co. Products
a. 54,000$
Ex. 14.15
(i.e., no change).
Inventory turnover is higher
Accounts receivable turnover is higher
Brazil Stone Products is stronger on all four financial measures:
Gross profit rate
Net income is a higher percentage of sales
Current ratio
Net income as a percentage of sales
Ex. 14.14
Net income ($1,800,000 x .03)……………………………………….
($1,200,000 ÷ $100,000) ……………………….
Inventory turnover*
Accounts receivable turnover
($60,000 ÷ $300,000) ………………………….
($1,800,000 ÷ $200,000) ……………………….
20 Minutes, Easy
a. Common size income statement:
Outdoor World
Industry
Inc. Average
Sales (net) 100% 100%
Cost of goods sold 49 58
Gross profit on sales 51% 42%
b.
SOLUTIONS TO PROBLEMS SET A
Outdoor World, Inc.’s operating results are significantly better than the average
performance within the industry. As a percentage of sales revenue, operating income and
net income are over twice the average for the industry. As a percentage of total assets,
profits equal an impressive 23%, as compared to 14% for the industry.
PROBLEM 14.1A
OUTDOOR WORLD INC.
Operating expenses:
Operating income 13% 6%
Net income 7% 3%
25 Minutes, Medium
2018 2017
a. Net sales: ($172,800 ÷ .06) 2,880,000$
($189,000 ÷ .075) 2,520,000$
b. Cost of goods sold in dollars:
d.
2018 2017
Net sales 2,880,000$ 2,520,000$
Cost of goods sold 1,872,000 1,386,000
Gross profit 1,008,000$ 1,134,000$
Net income 172,800$ 189,000$
For the Year Ended December 31, 2018 and December 31, 2017
PROBLEM 14.2A
DONELSON, INC
DONELSON, INC.
Condensed Comparative Income Statement