1. The two major types of financial statement analysis discussed in this chapter are common-size
analysis and ratio analysis.
2. Horizontal analysis expresses line items of financial statements as a percentage of a prior-
period amount. Vertical analysis expresses the line item as a percentage of some other line item
4. Liquidity ratios measure the ability of a firm to meet its short-term obligations. Leverage ratios
measure the ability of a firm to meet both long- and short-term obligations. Profitability ratios
measure the earning ability of a firm.
5. Two types of standards used in ratio analysis are historical and industrial standards. Historical
standards allow one to assess trends over time. Industrial standards allow one to assess a
7. It may indicate a need to modify credit and collection policies to speed up the conversion of
receivables to cash.
8.
A
high inventory turnover ratio does not necessarily provide evidence of stockouts and disgruntled
10. The purchase alternative would increase the liabilities reported on the balance sheet. Increasing
liabilities may cause the company to violate some existing debt covenants. The lease payment,
however, had an immediate impact on the income statement rather than the balance sheet.
16 FINANCIAL STATEMENT ANALYSIS
DISCUSSION QUESTIONS
16-1
12. For someone retiring, an annual income would be needed. Accordingly, companies that have
high yields and moderate payout ratios would be preferred to those that have a lower yield.
13. The price-earnings ratio can be compared with an investor’s expectation of future growth. If it is
low (high) based on this expectation, then the price is too low (high) and the price will change
based on the bidding that results.
16-2
CHAPTER 16 Financial Statement Analysis
16-1. b
16-5. d
16-6. c
MULTIPLE-CHOICE QUESTIONS
16-3
CHAPTER 16 Financial Statement Analysis
CE 16-11
Year 1 is the base year. Therefore, every dollar amount in Year 1 is 100% of itself.
Percent Year 1 Net Sales = $1,000,000/$1,000,000 = 100%
Dollars Percent Dollars Percent Dollars Percent
Net sales…………
…
$1,000,000 100% $1,100,000 110% $1,300,000 130%
Less: Cost of
…
Note: Percents are rounded to the nearest whole percent.
Dollar Amount of Line Item
CORNERSTONE EXERCISES
Year 1 Year 2 Year 3
Dollar Amount of Base Year Line Item
=Percent for a Line Item
16-4
CHAPTER 16 Financial Statement Analysis
CE 16-12
Since the analysis is based on net sales, net sales in each year equals 100% of itself.
Then, every line item on the income statement is expressed as a percent of that
year’s net sales.
Percent Year 1 Net Sales = $1,000,000/$1,000,000 = 100%
Percent Dollars Percent Dollars Percent
Net sales…………
…
100% $1,100,000 100% $1,300,000 100%
Less: Cost of
…
CE 16-13
You first need to calculate marketable securities by subtracting the specific
known current assets from the given total current assets. Therefore, marketable
$1,000,000
Dollar Amount of Line Item
Dollar Amount of Base Year Line Item
Year 2 Year 3
=Percent for a Line Item
=Current Ratio
Year 1
Dollars
=
Cash + Marketable Securities + Accounts Receivable
Current Liabilities
Current Assets
Current Liabilities
Quick Ratio
2.
1.
16-5
CHAPTER 16 Financial Statement Analysis
CE 16-14
2. Accounts Receivable Turnover
Ratio
= 14.6 times
Net Sales
Average Accounts Receivables
$2,299,500,000
$157,500,000
Beginning Receivables + Ending Receivable
s
2
=
1. Average Accounts Receivables =
=
CHAPTER 16 Financial Statement Analysis
CE 16-15
4. Nikkola’s inventory turnover ratio is 30 times, which indicates that, on average,
the company converts finished goods inventory into sales 30 times a year.
Nikkola’s inventory turnover in days is 12.2, which indicates that, on average, the
company turns over finished goods inventory about every 12 days, which is
Beginning Inventory + Ending Inventory
2
2
=
= $58,500,000
=
$54,374,200 + $62,625,800
Average Inventory
1.
CHAPTER 16 Financial Statement Analysis
CE 16-16
CE 16-17
CE 16-18
CE 16-19
Interest Expense
Income Before Taxes + Interest Expense
$875,400
$4,635,750 + $875,400
Beginning Total Assets + Ending Total Assets
2
$6,521,576 + $8,121,576
$8,281,989
2
=
=
=
= 6.3 times
= $7,321,576
=
Times-Interest-Earned Ratio
Average Total Assets
1.
16-8
CE 16-20
1. Average Common
2. Return on Stockholders’
Equity
CE 16-21
1. Preferred Dividends = $1,000,000 × 0.08 = $80,000
(Recall that the preferred shares pay a dividend of 8% as shown in
Somerville Company’s balance sheet.)
= $3.71, or $3.71 of earnings per share
Average Common Stockholders’ Equity
$4,316,655 + $4,949,965
Net Income – Preferred Dividends
$4,949,965.
=
CHAPTER 16 Financial Statement Analysis
CE 16-22
Before the price-earnings ratio can be computed, earnings per share must be
= 2.18329, or 2.18
CE 16-23
= 0.1108, or 11.08%
Market Price per Common Share
Dividend per Common Share
$8.10
$3.71
0.8973
$8.10
Market Price per Share
Earnings per Share
=
=
=
=
Price-Earnings Ratio
Dividend Yield2.
16-10
CHAPTER 16 Financial Statement Analysis
E 16-24
Sales…………………………………………………
…
$ 1,800,000 90.0%
Less: Cost of goods sold…………………………
…
(1,200,000) 85.7
E 16-25
1.
Sales…………………………………………………
…
$ 2,000,000 100.0%
Less: Cost of goods sold………………..………… (1,400,000) 70.0
2.
Sales…………………………………………………… $ 1,800,000 100.0%
Less: Cost of goods sold…………………………
…
(1,200,000) 66.7
Gross margin……………………………………
…
$ 600,000 33.3
EXERCISES
Year 1 Year 1 Sales
Percent o
f
Percent o
f
Y
ear 2
Y
ear 2 Sales
Year 1 AmountYear 2 Amount
Percent o
f
CHAPTER 16 Financial Statement Analysis
E 16-26
1.
Y
ear 2
Sales…………………………………..……………
…
$1,200,000 120.0%
Less: Cost of goods sold………………………
…
(700,000) 100.0
Gross margin……………………………………
…
$ 500,000 166.7
2.
Y
ear 3
Sales……………………………………………..…
…
$ 1,700,000 170.0%
Less: Cost of goods sold………………………
…
(1,000,000) 142.9
E 16-27
1.
Y
ear 1
Sales…………………………………………..……
…
$1,000,000 100.0%
Less: Cost of goods sold………………………
…
(700,000) 70.0
Percent of
Sales in Year 1
Percent of
Y
ear 1
Percent of
Y
ear 1
16-12
CHAPTER 16 Financial Statement Analysis
E 16-27 (Continued)
2.
Y
ear 2
Sales………………………………….………………
…
$1,200,000 100.0%
Less: Cost of goods sold………………………… (700,000) 58.3
Gross margin……………………………………
.
$ 500,000 41.7
3.
Y
ear 3
Sales………………………………….………………
…
$ 1,700,000 100.0%
Less: Cost of goods sold………………………… (1,000,000) 58.8
.
E 16-28
Percent of
Sales in Year 2
Percent of
Sales in Year 3
Current Assets
Current Liabilities
=
1.
Current Ratio
CHAPTER 16 Financial Statement Analysis
E 16-29
=
E 16-30
=
$408,550
+ Ending Accounts Receivables
2
=
=$419,000 + $398,100
2
Beginning Accounts Receivables
1.20
$3,000,000
$3,600,000
=
Average Accounts Receivable1.
Current Assets
Current Liabilities
Current Ratio1. =
CHAPTER 16 Financial Statement Analysis
E 16-31
=
E 16-32
=
$335,000,000 + $350,000,000
Beginning Accounts Receivable +
2
$342,500,000
2
$1,100,400 + $965,800
$1,033,100
2
=
=
Average Inventory1.
1. Average Accounts Receivable = Ending Accounts Receivable
2
=
Beginning Inventory + Ending Inventory
16-15
CHAPTER 16 Financial Statement Analysis
E 16-33
= 10.1 days
E 16-34
4. Marketable Securities = (Quick Ratio × Current Liabilities) – (Cash + Receivables)
= (2.0 × $500,000) – ($600,000 + $160,000)
= $1,000,000 – $760,000
= $240,000
365 days
36 times
Inventory Turnover Ratio
Days in a Yea
r
=
=
Inventory Turnover in Days3.
1. Average Inventory Beginning Inventory + Ending Inventory
2
$53,420 + $62,640
2 = $58,030
=
=
16-16
E 16-35
= 12.0 times
E 16-36
3. The debt ratio and debt-to-equity ratio are commonly used measures of a
company’s financial riskiness. As calculated in Requirement 1, Busch’s debt ratio
is 0.80, which indicates that for every $1.00 of assets, Busch has taken on debt
of $0.80. Stated a bit differently, Busch has chosen to finance 80% of its assets
with debt. As calculated in Requirement 2, Busch’s debt-to-equity ratio is 4.05,
which indicates that for every $1.00 of equity, Busch has taken on $4.05 of
liabilities. Taken together, it appears as though Busch has chosen to pursue a
=
Income Before Taxes + Interest Expense
Interest Expense
$5,500,000 + $500,000
=Times-Interest-Earned Ratio
$500,000
16-17