# Chapter 3 Analysis of Financial Statements ANSWERS TO END-OF-CHAPTER QUESTIONS

Save this PDF as:

Size: px
Start display at page:

## Transcription

1 Chapter 3 nalysis of Financial Statements NSWERS TO END-OF-CHPTER QUESTIONS 3-1 a. liquidity ratio is a ratio that shows the relationship of a firm s cash and other current assets to its current liabilities. The current ratio is found by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. The quick, or acid test, ratio is found by taking current assets less inventories and then dividing by current liabilities. b. sset management ratios are a set of ratios which measure how effectively a firm is managing its assets. The inventory turnover ratio is sales divided by inventories. Days sales outstanding is used to appraise accounts receivable and indicates the length of time the firm must wait after making a sale before receiving cash. It is found by dividing receivables by average sales per day. The fixed assets turnover ratio measures how effectively the firm uses its plant and equipment. It is the ratio of sales to net fixed assets. Total assets turnover ratio measures the turnover of all the firm s assets; it is calculated by dividing sales by total assets. c. Financial leverage ratios measure the use of debt financing. The debt ratio is the ratio of total debt to total assets, it measures the percentage of funds provided by creditors. The times-interest-earned ratio is determined by dividing earnings before interest and taxes by the interest charges. This ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs. The EBITD coverage ratio is similar to the times-interest-earned ratio, but it recognizes that many firms lease assets and also must make sinking fund payments. It is found by adding EBITD and lease payments then dividing this total by interest charges, lease payments, and sinking fund payments over one minus the tax rate. d. Profitability ratios are a group of ratios which show the combined effects of liquidity, asset management, and debt on operations. The profit margin on sales, calculated by dividing net income by sales, gives the profit per dollar of sales. Basic earning power is calculated by dividing EBIT by total assets. This ratio shows the raw earning power of the firm s assets, before the influence of taxes and leverage. Return on total assets is the ratio of net income to total assets. Return on common equity is found by dividing net income into common equity. Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-1

2 e. Market value ratios relate the firm s stock price to its earnings and book value per share. The price/earnings ratio is calculated by dividing price per share by earnings per share--this shows how much investors are willing to pay per dollar of reported profits. The price/cash flow is calculated by dividing price per share by cash flow per share. This shows how much investors are willing to pay per dollar of cash flow. Market-to-book ratio is simply the market price per share divided by the book value per share. Book value per share is common equity divided by the number of shares outstanding. f. Trend analysis is an analysis of a firm s financial ratios over time. It is used to estimate the likelihood of improvement or deterioration in its financial situation. Comparative ratio analysis is when a firm compares its ratios to other leading companies in the same industry. This technique is also known as benchmarking. g. The Du Pont chart is a chart designed to show the relationships among return on investment, asset turnover, the profit margin, and leverage. The Du Pont equation is a formula which shows that the rate of return on assets can be found as the product of the profit margin times the total assets turnover. h. Window dressing is a technique employed by firms to make their financial statements look better than they really are. Seasonal factors can distort ratio analysis. t certain times of the year a firm may have excessive inventories in preparation of a season of high demand. Therefore an inventory turnover ratio taken at this time as opposed to after the season will be radically distorted. 3-2 The emphasis of the various types of analysts is by no means uniform nor should it be. Management is interested in all types of ratios for two reasons. First, the ratios point out weaknesses that should be strengthened; second, management recognizes that the other parties are interested in all the ratios and that financial appearances must be kept up if the firm is to be regarded highly by creditors and equity investors. Equity investors are interested primarily in profitability, but they examine the other ratios to get information on the riskiness of equity commitments. Long-term creditors are more interested in the debt ratio, TIE, and fixed-charge coverage ratios, as well as the profitability ratios. Short-term creditors emphasize liquidity and look most carefully at the liquidity ratios. 3-3 The inventory turnover ratio is important to a grocery store because of the much larger inventory required and because some of that inventory is perishable. n insurance company would have no inventory to speak of since its line of business is selling insurance policies or other similar financial products--contracts written on paper and entered into between the company and the insured. This question demonstrates the fact that the student should not take a routine approach to financial analysis but rather should examine the particular business he or she is dealing with. nswers and Solutions: 3-2 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

3 3-4 Given that sales have not changed, a decrease in the total assets turnover means that the company s assets have increased. lso, the fact that the fixed assets turnover ratio remained constant implies that the company increased its current assets. Since the company s current ratio increased, and yet, its quick ratio is unchanged means that the company has increased its inventories. 3-5 Differences in the amounts of assets necessary to generate a dollar of sales cause asset turnover ratios to vary among industries. For example, a steel company needs a greater number of dollars in assets to produce a dollar in sales than does a grocery store chain. lso, profit margins and turnover ratios may vary due to differences in the amount of expenses incurred to produce sales. For example, one would expect a grocery store chain to spend more per dollar of sales than does a steel company. Often, a large turnover will be associated with a low profit margin, and vice versa. 3-6 Inflation will cause earnings to increase, even if there is no increase in sales volume. Yet, the book value of the assets that produced the sales and the annual depreciation expense remain at historic values and do not reflect the actual cost of replacing those assets. Thus, ratios that compare current flows with historic values become distorted over time. For example, RO will increase even though those assets are generating the same sales volume. When comparing different companies, the age of the assets will greatly affect the ratios. Companies whose assets were purchased earlier will reflect lower asset values than those that purchased the assets later at inflated prices. Two firms with similar physical assets and sales could have significantly different ROs. Under inflation, ratios will also reflect differences in the way firms treat inventories. s can be seen, inflation affects both income statement and balance sheet items. 3-7 ROE, using the Du Pont equation, is the return on assets multiplied by the equity multiplier. The equity multiplier, defined as total assets divided by owners equity, is a measure of debt utilization; the more debt a firm uses, the lower its equity, and the higher the equity multiplier. Thus, using more debt will increase the equity multiplier, resulting in a higher ROE. 3-8 a. Cash, receivables, and inventories, as well as current liabilities, vary over the year for firms with seasonal sales patterns. Therefore, those ratios that examine balance sheet figures will vary unless averages (monthly ones are best) are used. b. Common equity is determined at a point in time, say December 31, Profits are earned over time, say during If a firm is growing rapidly, year-end equity will be much larger than beginning-of-year equity, so the calculated rate of return on equity will be different depending on whether end-of-year, beginning-of-year, or average common equity is used as the denominator. verage common equity is conceptually the best figure to use. In public utility rate cases, people are reported to have deliberately used end-of-year or beginning- Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-3

4 of-year equity to make returns on equity appear excessive or inadequate. Similar problems can arise when a firm is being evaluated. 3-9 Firms within the same industry may employ different accounting techniques which make it difficult to compare financial ratios. More fundamentally, comparisons may be misleading if firms in the same industry differ in their other investments. For example, comparing Pepsico and Coca-Cola may be misleading because apart from their soft drink business, Pepsi also owns other businesses such as Frito-Lay, Pizza Hut, Taco Bell, and KFC Total Effect Current Current on Net ssets Ratio Income a. Cash is acquired through issuance of additional common stock b. Merchandise is sold for cash c. Federal income tax due for the previous year is paid d. fixed asset is sold for less than book value e. fixed asset is sold for more than book value f. Merchandise is sold on credit g. Payment is made to trade creditors for previous purchases h. cash dividend is declared and paid i. Cash is obtained through short-term bank loans j. Short-term notes receivable are sold at a discount k. Marketable securities are sold below cost l. dvances are made to employees m. Current operating expenses are paid nswers and Solutions: 3-4 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

5 Total Effect Current Current on Net ssets Ratio Income n. Short-term promissory notes are issued to trade creditors in exchange for past due accounts payable o. Ten-year notes are issued to pay off accounts payable p. fully depreciated asset is retired q. ccounts receivable are collected r. Equipment is purchased with short-term notes. 0-0 s. Merchandise is purchased on credit t. The estimated taxes payable are increased Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-5

6 SOLUTIONS TO END-OF-CHPTER PROBLEMS C C - I 3-1 C \$3,000,000; 1.5; CL CL 1.0; CL?; I? C 1.5 CL \$3,000, CL 1.5 CL \$3,000,000 CL \$2,000,000. C - I 1.0 CL \$3,000,000 - I 1.0 \$2,000,000 \$3,000,000 - I \$2,000,000 I \$1,000, DSO 40 days; DS \$20,000; R? 40 DSO R S 360 R \$20,000 R \$800, /E 2.4; D/? D D 1 - D 1 E %. nswers and Solutions: 3-6 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

7 3-4 RO 10%; PM 2%; ROE 15%; S/T?; /E? RO NI/; PM NI/S; ROE NI/E RO PM S/T NI/ NI/S S/T 10% 2% S/T S/T 5. ROE PM S/T T/E NI/E NI/S S/T T/E 15% 2% 5 T/E 15% 10% T/E T/E We are given RO 3% and /Total assets 1.5. From Du Pont equation: RO Profit margin Total assets turnover 3% Profit margin (1.5) Profit margin 3%/1.5 2%. We can also calculate the company s debt ratio in a similar manner, given the facts of the problem. We are given RO(NI/) and ROE(NI/E); if we use the reciprocal of ROE we have the following equation: E E E D NI E _ and NI 1 3% _ 0.05 D 60% E 1-40%.,so lternatively, ROE RO EM 5% 3% EM EM 5%/3% 5/3 T/E. Take reciprocal: E/T 3/5 60%; therefore, D/ %. Thus, the firm s profit margin 2% and its debt ratio 40%. Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-7

8 \$1,312, Present current ratio 2.5. \$525,000 Minimum current ratio \$1,312,500 + NP \$525,000 + NP 2.0. \$1,312,500 + NP \$1,050, NP NP \$262,500. Short-term debt can increase by a maximum of \$262,500 without violating a 2 to 1 current ratio, assuming that the entire increase in notes payable is used to increase current assets. Since we assumed that the additional funds would be used to increase inventory, the inventory account will increase to \$637,500, and current assets will total \$1,575,000. Quick ratio (\$1,575,000 - \$637,500)/\$787,500 \$937,500/\$787, Current assets Current liabilities 3.0 \$810,000 Current liabilities 3.0 Current liabilities \$270, Current assets - Inventories Current liabilities 1.4 \$810,000 - Inventories \$270, Inventories \$432,000. Current Marketable ccounts 3. assets Cash + Securities + receivable + Inventories \$810,000 \$120,000 + ccounts receivable + \$432,000 ccounts receivable \$258, Inventory 6.0 \$432, \$2,592, DSO ccounts receivable /360 \$258,000 \$2,592,000/ days. 3-8 TIE EBIT/INT, so find EBIT and INT. Interest \$500, \$50,000. Net income \$2,000, \$100,000. Pre-tax income \$100,000/(1 - T) \$100,000/0.7 \$142,857. EBIT \$142,857 + \$50,000 \$192,857. TIE \$192,857/\$50, nswers and Solutions: 3-8 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

9 3-9 ROE Profit margin T turnover Equity multiplier NI/ /T T/Equity. Now we need to determine the inputs for the equation from the data that were given. On the left we set up an income statement, and we put numbers in it on the right: (given) \$10,000,000 Cost na EBIT (given) \$ 1,000,000 INT (given) 300,000 EBT \$ 700,000 Taxes (34%) 238,000 NI \$ 462,000 Now we can use some ratios to get some more data: Total assets turnover 2 S/T; T S/2 \$10,000,000/2 \$5,000,000. D/ 60%; so E/ 40%; and, therefore, Equity multiplier T/E 1/(E/) 1/ Now we can complete the Du Pont equation to determine ROE: ROE \$462,000/\$10,000,000 \$10,000,000/\$5,000, % Known data: T \$1,000,000 BEP 0.2 EBIT/Total assets, so EBIT 0.2(\$1,000,000) \$200,000. k d 8% T 40% D/ %, so Equity \$500,000. D/ 0% D/ 50% EBIT \$200,000 \$200,000 Interest 0 40,000* EBT \$200,000 \$160,000 Tax (40%) 80,000 64,000 NI \$120,000 \$ 96,000 NI ROE Equity \$120,000 \$1,000,000 \$96,000 12%; 19.2%. \$500,000 Difference in ROE 19.2% % 7.2%. *If D/ 50%, then half of assets are financed by debt, so Debt \$500,000. t an 8% interest rate, INT \$40, Statement a is correct. Refer to the solution setup for Problem 3-10 and Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-9

10 think about it this way: (1) dding assets will not affect common equity if the assets are financed with debt. (2) dding assets will cause expected EBIT to increase by the amount EBIT BEP(added assets). (3) Interest expense will increase by the amount k d (added assets). (4) Pre-tax income will rise by the amount (added assets)(bep - k d ). ssuming BEP > k d, if pre-tax income increases so will net income. (5) If expected net income increases but common equity is held constant, then the expected ROE will also increase. Note that if k d > BEP, then adding assets financed by debt would lower net income and thus the ROE. Therefore, Statement a is true--if assets financed by debt are added, and if the expected BEP on those assets exceeds the cost of debt, then the firm s ROE will increase. Statements b and c are false, because the BEP ratio uses EBIT, which is calculated before the effects of taxes or interest charges are felt, and d is false unless k d > BEP. Of course, Statement e is also false a. Currently, ROE is ROE 1 \$15,000/\$200, %. The current ratio will be set such that 2.5 C/CL. CL is \$50,000, and it will not change, so we can solve to find the new level of current assets: C 2.5(CL) 2.5(\$50,000) \$125,000. This is the level of current assets that will produce a current ratio of 2.5. t present, current assets amount to \$210,000, so they can be reduced by \$210,000 - \$125,000 \$85,000. If the \$85,000 generated is used to retire common equity, then the new common equity balance will be \$200,000 - \$85,000 \$115,000. ssuming that net income is unchanged, the new ROE will be ROE 2 \$15,000/\$115, %. Therefore, ROE will increase by 13.04% % 5.54%. b. 1. Doubling the dollar amounts would not affect the answer; it would still be 5.54%. 2. Common equity would increase by \$25,000 from the Part a scenario, which would mean a new ROE of \$15,000/\$140, %, which would mean a difference of 10.71% % 3.21%. 3. n inventory turnover of 2 would mean inventories of \$100,000, down \$50,000 from the current level. That would mean an ROE of \$15,000/\$150, %, so the change in ROE would be 10.00% - 7.5% 2.5%. 4. If the company had 10,000 shares outstanding, then its EPS would be \$15,000/10,000 \$1.50. The stock has a book value of \$200,000/10,000 \$20, so the shares retired would be \$85,000/\$20 4,250, leaving 10,000-4,250 5,750 shares. The new EPS would be \$15,000/5,750 \$2.6087, so the increase in EPS would be \$ \$1.50 \$1.1087, which is a 73.91% increase, the same as the increase in ROE. 5. If the stock was selling for twice book value, or 2 x \$20 \$40, then only half as many shares could be retired (\$85,000/\$40 2,125), so the remaining shares would be 10,000-2,125 7,875, and nswers and Solutions: 3-10 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

11 the new EPS would be \$15,000/7,875 \$1.9048, for an increase of \$ \$ \$ c. We could have started with lower inventory and higher accounts receivable, then had you calculate the DSO, then move to a lower DSO which would require a reduction in receivables, and then determine the effects on ROE and EPS under different conditions. Similarly, we could have focused on fixed assets and the F turnover ratio. In any of these cases, we could have had you use the funds generated to retire debt, which would have lowered interest charges and consequently increased net income and EPS. If we had to increase assets, then we would have had to finance this increase by adding either debt or equity, which would have lowered ROE and EPS, other things held constant. Finally, note that we could have asked some conceptual questions about the problem, either as a part of the problem or without any reference to the problem. For example, If funds are generated by reducing assets, and if those funds are used to retire common stock, will EPS and/or ROE be affected by whether or not the stock sells above, at, or below book value? 3-13 a. (Dollar amounts in thousands.) Firm Industry verage Current assets Current liabilities \$655,000 \$330, DSO ccounts receivable /360 \$336,000 \$4, days 35 days Inventory \$1,607,500 \$241, Fixed assets Total assets \$1,607, \$292,500 \$1,607, \$947,500 Net income \$27,300 \$1,607, % 1.2% Net income Total assets \$27,300 \$947, % 3.6% Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-11

12 Firm Industry verage Net income Common equity \$27,300 \$361, % 9.0% Total debt Total assets \$586,500 \$947, % 60.0% b. For the firm, \$947,500 ROE PM T.. turnover EM 1.7% %. \$361,000 For the industry, ROE 1.2% %. Note: To find the industry ratio of assets to common equity, recognize that 1 - (total debt/total assets) common equity/total assets. So, common equity/total assets 40%, and 1/ total assets/common equity. c. The firm s days sales outstanding is more than twice as long as the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company s profit margin is higher than the industry average, its other profitability ratios are low compared to the industry--net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry. d. If 2001 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2001 ratios will be misled, and a return to normal conditions in 2002 could hurt the firm s stock price Debt (0.50)(Total assets) (0.50)(\$300,000) \$150, ccounts payable Debt Long-term debt \$150,000 - \$60,000 \$90, Common stock Total liabilities and equity - Debt - Retained earnings \$300,000 - \$150,000 - \$97,500 \$52, (1.5)(Total assets) (1.5)(\$300,000) \$450, Inventory /5 \$450,000/5 \$90,000. nswers and Solutions: 3-12 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

13 6. ccounts receivable (/360)(DSO) (\$450,000/360)(36) \$45, Cash + ccounts receivable (0.80)(ccounts payable) Cash + \$45,000 (0.80)(\$90,000) Cash \$72,000 - \$45,000 \$27, Fixed assets Total assets - (Cash + ccts rec. + Inventories) \$300,000 - (\$27,000 + \$45,000 + \$90,000) \$138, Cost of goods sold ()(1-0.25) (\$450,000)(0.75) \$337, a. (Dollar amounts in millions.) Industry Firm verage Current ratio Current assets Current liabilities \$303 \$ Debt to total assets Debt Total assets \$135 \$450 30% 30% Times interest earned EBIT Interest \$49.5 \$ EBITD coverage \$61.5 \$ Inventory turnover Inventory \$795 \$ DSO ccounts receivable /360 \$66 \$795/ days 24 days F.. Turnover Net fixed assets \$795 \$ T.. Turnover Total assets \$795 \$ Profit margin Net income \$27 \$ % 3% Return on total assets Net income Total assets \$27 \$ % 9% Return on common equity RO EM 6% % 12.9% Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-13

14 lternatively, ROE Net income Equity \$27 8.6%. \$315 b. ROE Profit margin Total assets turnover Equity multiplier Net income Total assets Total assets Common equity \$27 \$795 \$ % %. \$795 \$450 \$315 Firm Industry Comment Profit margin 3.4% 3.0% Good Total assets turnover Poor Equity multiplier * Good D E * 1 - T T T 1 EM E 0.7 lternatively, EM ROE/RO 12.9%/9% c. nalysis of the Du Pont equation and the set of ratios shows that the turnover ratio of sales to assets is quite low. Either sales should be increased at the present level of assets, or the current level of assets should be decreased to be more in line with current sales. Thus, the problem appears to be in the balance sheet accounts. d. The comparison of inventory turnover ratios shows that other firms in the industry seem to be getting along with about half as much inventory per unit of sales as the firm. If the company s inventory could be reduced, this would generate funds that could be used to retire debt, thus reducing interest charges and improving profits, and strengthening the debt position. There might also be some excess investment in fixed assets, perhaps indicative of excess capacity, as shown by a slightly lower-than-average fixed assets turnover ratio. However, this is not nearly as clear-cut as the overinvestment in inventory. e. If the firm had a sharp seasonal sales pattern, or if it grew rapidly during the year, many ratios might be distorted. Ratios involving cash, receivables, inventories, and current liabilities, as well as those based on sales, profits, and common equity, could be biased. It is possible to correct for such problems by using average rather than end-of-period figures a. Here are the firm s base case ratios and other data as compared to the nswers and Solutions: 3-14 Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

15 industry: Firm Industry Comment Quick Weak Current Weak Inventory turnover Poor Days sales outstanding 37 days 32 days Poor Fixed assets turnover Poor Total assets turnover Poor Return on assets 5.9% 9.1% Bad Return on equity Bad Debt ratio High Profit margin on sales Bad EPS \$4.71 n.a. -- Stock Price \$23.57 n.a. -- P/E ratio Poor P/CF ratio Poor M/B ratio 0.65 n.a. -- The firm appears to be badly managed--all of its ratios are worse than the industry averages, and the result is low earnings, a low P/E, P/CF ratio, a low stock price, and a low M/B ratio. The company needs to do something to improve. b. decrease in the inventory level would improve the inventory turnover, total assets turnover, and RO, all of which are too low. It would have some impact on the current ratio, but it is difficult to say precisely how that ratio would be affected. If the lower inventory level allowed the company to reduce its current liabilities, then the current ratio would improve. The lower cost of goods sold would improve all of the profitability ratios and, if dividends were not increased, would lower the debt ratio through increased retained earnings. ll of this should lead to a higher market/book ratio and a higher stock price. Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc. nswers and Solutions: 3-15

### Chapter 4 Analysis of Financial Statements ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 4 nalysis of Financial Statements NSWERS TO SELECTED END-OF-CHPTER QUESTIONS 4-1 a. liquidity ratio is a ratio that shows the relationship of a firm s cash and other current assets to its current

### Chapter 8 Analysis of Financial Statements ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 8 nalysis of Financial Statements NSWRS TO ND-OF-CHPTR QUSTIONS 8-3 Given that sales have not changed, a decrease in the total assets turnover means that the company s assets have increased. lso,

### Chapter 3 Analysis of Financial Statements

Chapter 3 nalysis of Financial Statements NSWRS TO ND-OF-CHPTR QUSTIONS 3-3 Given that sales have not changed, a decrease in the total assets turnover means that the company s assets have increased. lso,

### Integrated Case. 4-25 D Leon Inc., Part II Financial Statement Analysis

Integrated Case 4-25 D Leon Inc., Part II Financial Statement Analysis Part I of this case, presented in Chapter 3, discussed the situation of D Leon Inc., a regional snack foods producer, after an expansion

### Chapter 3 Analyzing Financial Statement

Chapter 3 Analyzing Financial Statement Five major areas to analyze. (1) Liquidity Position (2) Management of Assets (3) Management of Debt (4) Company's Profitability (5) Market's View of Company (1)

### Chapter 17: Financial Statement Analysis

FIN 301 Class Notes Chapter 17: Financial Statement Analysis INTRODUCTION Financial ratio: is a relationship between different accounting items that tells something about the firm s activities. Purpose

### FNCE 3010 (Durham). HW2 (Financial ratios)

FNCE 3010 (Durham). HW2 (Financial ratios) 1. What effect would the following actions have on a firms net working capital and current ratio (assume NWC is positive and current ratio is initially greater

### Chapters 3-4 Financial Statements, Cash Flow, and Analysis of Financial Statements. Balance Sheet. Total Liabilities and Shareholder s Equity

Chapters 3-4 Financial Statements, Cash Flow, and Analysis of Financial Statements Balance Sheet Assets Cash Inventory Accounts Receivable Property Plant Equipment Liabilities and Shareholder s Equity

### Total shares at the end of ten years is 100*(1+5%) 10 =162.9.

FCS5510 Sample Homework Problems Unit04 CHAPTER 8 STOCK PROBLEMS 1. An investor buys 100 shares if a \$40 stock that pays a annual cash dividend of \$2 a share (a 5% dividend yield) and signs up for the

### 1) In words, an equity multiplier of 2 means that for every \$1:

Questions in [New Questions] 1) In words, an equity multiplier of 2 means that for every \$1: [A] of debt, a firm has \$2 in equity. [B] in equity, a firm has \$2 in debt. [C] in assets, a firm has \$2 in

### What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated?

What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? HOCK international - 2004 1 HOCK international - 2004 2 How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? HOCK

### FUNDAMENTALS OF HEALTHCARE FINANCE. Online Appendix B Financial Analysis Ratios

3/27/09 FUNDAMENTALS OF HEALTHCARE FINANCE Online Appendix B Financial Analysis Ratios Introduction In Chapter 13 of Fundamentals of Healthcare Finance, we indicated that financial ratio analysis is a

### Key Concepts and Skills. Standardized Financial. Chapter Outline. Ratio Analysis. Categories of Financial Ratios 1-1. Chapter 3

Key Concepts and Skills Chapter 3 Working With Financial Statements Know how to standardize financial statements for comparison purposes Know how to compute and interpret important financial ratios Know

### CHAPTER 13. Financial Analysis: The Big Picture

CHAPTER 13 Financial Analysis: The Big Picture Discuss the Need for comparative analysis and identify the tools of financial statement analysis Throughout the book we will rely on three types of comparisons

### Chapters 3 and 13 Financial Statement and Cash Flow Analysis

Chapters 3 and 13 Financial Statement and Cash Flow Analysis Balance Sheet Assets Cash Inventory Accounts Receivable Property Plant Equipment Total Assets Liabilities and Shareholder s Equity Accounts

### Computing Liquidity Ratios Current Ratio = CA / CL 708 / 540 = 1.31 times Quick Ratio = (CA Inventory) / CL (708 422) / 540 =.53 times Cash Ratio =

1 Computing Liquidity Ratios Current Ratio = CA / CL 708 / 540 = 1.31 times Quick Ratio = (CA Inventory) / CL (708 422) / 540 =.53 times Cash Ratio = Cash / CL 98 / 540 =.18 times 2 Computing Leverage

### Financial Statement and Cash Flow Analysis

Chapter 2 Financial Statement and Cash Flow Analysis Answers to Concept Review Questions 1. What role do the FASB and SEC play with regard to GAAP? The FASB is a nongovernmental, professional standards

### TYPES OF FINANCIAL RATIOS

TYPES OF FINANCIAL RATIOS In the previous articles we discussed how to invest in the stock market and unit trusts. When investing in the stock market an investor should have a clear understanding about

### Chapter 4 Sample Problems

Chapter 4 Sample Problems 1. TCBW last year had an average collection period (days sales outstanding) of 35 days based on accounts receivable of \$460,000. All of the firm's sales are made on credit. The

### HEALTHCARE FINANCE An Introduction to Accounting and Financial Management. Online Appendix A Financial Analysis Ratios

11/16/11 HEALTHCARE FINANCE An Introduction to Accounting and Financial Management Online Appendix A Financial Analysis Ratios INTRODUCTION In Chapter 17, we indicated that financial ratio analysis is

### Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 3 Interpreting Financial Ratios Concept Check 3.1 1. What are the different motivations that

### Financial ratios can be classified according to the information they provide. The following types of ratios frequently are used:

Financial Ratios Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios

### CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH

CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH Answers to Concepts Review and Critical Thinking Questions 1. Time trend analysis gives a picture of changes in the company s financial situation over

### Chapter 4. Financial Analysis: Sizing up Firm Performance. Chapter Contents. Learning Objectives

Chapter 4 Financial Analysis: Sizing up Firm Performance Learning Objectives Chapter Contents Principles Used in this Chapter 1.Why Financial Statements are Analyzed 2.Common Size Statements Standardizing

Ratio Analysis CBDC, NB February, 2008 Presented by ACSBE Financial Analysis What is Financial Analysis? What Can Financial Ratios Tell? 7 Categories of Financial Ratios Significance of Using Ratios Industry

### Chapter 2 Financial Statements and Analysis

Chapter 2 Financial Statements and Analysis Solutions to Problems P2-1. LG 1: Reviewing Financial Statements Income statement: In this one-year summary of the firm s operations, Technica, Inc. showed a

### HEALTHCARE FINANCE: AN INTRODUCTION TO ACCOUNTING AND FINANCIAL MANAGEMENT. Online Appendix A Financial Ratios

HEALTHCARE FINANCE: AN INTRODUCTION TO ACCOUNTING AND FINANCIAL MANAGEMENT Online Appendix A Financial Ratios INTRODUCTION In Chapter 17, we indicated that ratio analysis is a technique commonly used to

### Income Measurement and Profitability Analysis

PROFITABILITY ANALYSIS The following financial statements for Spencer Company will be used to demonstrate the calculation of the various ratios in profitability analysis. Spencer Company Comparative Balance

### Return on Equity has three ratio components. The three ratios that make up Return on Equity are:

Evaluating Financial Performance Chapter 1 Return on Equity Why Use Ratios? It has been said that you must measure what you expect to manage and accomplish. Without measurement, you have no reference to

### Accounting - Analysis and Uses of Financial Statements - Final Exam 105 Questions 1. are least interested in financial statement analysis.

Accounting - Analysis and Uses of Financial Statements - Final Exam 105 Questions 1. are least interested in financial statement analysis. A. Auditors Tax lawyers Investors Creditors 2. According SFAC

### Financial Ratio Cheatsheet MyAccountingCourse.com PDF

Financial Ratio Cheatsheet MyAccountingCourse.com PDF Table of contents Liquidity Ratios Solvency Ratios Efficiency Ratios Profitability Ratios Market Prospect Ratios Coverage Ratios CPA Exam Ratios to

### Financial Ratios and Quality Indicators

Financial Ratios and Quality Indicators From U.S. Small Business Administration Online Women's Business Center If you monitor the ratios on a regular basis you'll gain insight into how effectively you

### Interpretation of Financial Statements

Interpretation of Financial Statements Author Noel O Brien, Formation 2 Accounting Framework Examiner. An important component of most introductory financial accounting programmes is the analysis and interpretation

### FSA Note: Summary of Financial Ratio Calculations

FSA Note: Summary of Financial Ratio Calculations This note contains a summary of the more common financial statement ratios. A few points should be noted: Calculations vary in practice; consistency and

### Financial ratio analysis

Financial ratio analysis A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Liquidity ratios 3. Profitability ratios and activity ratios 4. Financial leverage ratios 5. Shareholder

### Chapter 3 Financial Statements Analysis and Long-Term Planning

University of Science and Technology Beijing Dongling School of Economics and management Chapter 3 Financial Statements Analysis and Long-Term Planning Sep. 2012 Dr. Xiao Ming USTB 1 Key Concepts and Skills

### Using Financial Ratios: Interested Parties

Using Financial Ratios: Interested Parties Ratio analysis involves methods of calculating and interpreting financial ratios to assess a firm s financial condition and performance. It is of interest to

### CHAPTER 2 FINANCIAL STATEMENTS AND CASH FLOW

CHAPTER 2 FINANCIAL STATEMENTS AND CASH FLOW Solutions to Questions and Problems NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and

### Solutions to Chapter 4. Measuring Corporate Performance

Solutions to Chapter 4 Measuring Corporate Performance 1. a. 7,018 Long-term debt ratio 0. 42 7,018 9,724 b. 4,794 7,018 6,178 Total debt ratio 0. 65 27,714 c. 2,566 Times interest earned 3. 75 685 d.

### Financial Statements and Ratios: Notes

Financial Statements and Ratios: Notes 1. Uses of the income statement for evaluation Investors use the income statement to help judge their return on investment and creditors (lenders) use it to help

### Sample Exam Questions and Answers

1 Sample Exam Questions and Answers 1. Which of the following statements is most correct? a. Proprietorship is generally not easily and inexpensively formed. b. Partnership has limited liability and limited

### Brief Exercise 14-2 (20 minutes)

Brief Exercise 14-2 (20 minutes) 1. This Year Last Year Sales... 100.0% 100.0% Cost of goods sold... 62.3 58.6 Gross margin... 37.7 41.4 Operating expenses: Selling expenses... 18.5 18.2 Administrative

### 140 SU 3: Profitability Analysis and Analytical Issues

140 SU 3: Profitability Analysis and Analytical Issues QUESTIONS 3.1 Profitability Ratios Questions 1 and 2 are based on the following information. The financial statements for Dividendosaurus, Inc., for

### Essential Learning for CTP Candidates TEXPO Conference 2016 Session #03

TEXPO Conference 2016: Essential Learning for CTP Candidates Session #3 (Mon.1:45 3:00 pm) Overview of Basic CTP Math from ETM4 Chap 07: Earnings Credits Chap 09: Working Capital Chap 18: Fin. Statements

### Fundamental analysis

Fundamental analysis 2 June 2016 CERN Finance Club c.laner@cern.ch Introduction Let s cover the two main types of investment analysis used in traditional investing Today: Fundamental analysis Next time:

### Ratios from the Statement of Financial Position

For The Year Ended 31 March 2007 Ratios from the Statement of Financial Position Profitability Ratios Return on Sales Ratio (%) This is the difference between what a business takes in and what it spends

### 2. More important - provide a profile of firm s economic characteristics and competitive strategies.

RATIO ANALYSIS-OVERVIEW Ratios: 1. Provide a method of standardization 2. More important - provide a profile of firm s economic characteristics and competitive strategies. Although extremely valuable as

### Chapter-3 C FINANCIAL RATIO ANALYSIS. BSNL, India For Internal Circulation Only 1

Chapter-3 C FINANCIAL RATIO ANALYSIS BSNL, India For Internal Circulation Only 1 RATIO ANALYSIS FINANCIAL ANALYSIS is the process of identifying the financial strengths and weakness of the firm by properly

### The following information is available on Toy Inc. There are 100 shares outstanding, each selling for \$25

The following information is available on Toy Inc. There are 100 shares outstanding, each selling for \$25 Corporate tax 34.00% Interest rate 4.25% Retention ratio 65.00% Case A. Toy Inc. Zero growth in

### Brief History of Square Pharmaceuticals & Liquidity Ratios

Brief History of Square Pharmaceuticals & Liquidity Ratios BRIEF HISTORY Square Pharmaceuticals Ltd. is a renowned company in Bangladesh. It is a flagship company in the pharmaceutical industry which has

### FIN 3000. Chapter 4. Financial Analysis. Liuren Wu

FIN 3000 Chapter 4 Financial Analysis Liuren Wu Overview 1. Why Do We Analyze Financial Statements 2. Common Size Statements Standardizing Financial Information 3. Using Financial Ratios 4. Selecting a

### ESSENTIAL CONCEPTS IN MANAGERIAL FINANCE

ESSENTIAL CONCEPTS IN MANAGERIAL FINANCE Analysis of Financial Statements (Chapter 2) Financial Statements and Reports financial reporting is used to disclose information about the firm to investors, creditors,

### Solutions to Problems

Solutions to Problems P2-1. P2-2. LG 1: Reviewing basic financial statements Income statement: In this one-year summary of the firm s operations, Technica, Inc. showed a net profit for 2009 and the ability

### 2. More important - provide a profile of firm s economic characteristics and competitive strategies.

RATIO ANALYSIS-OVERVIEW Ratios: 1. Provide a method of standardization 2. More important - provide a profile of firm s economic characteristics and competitive strategies. C Company Sales \$ 100,000 \$ 125,000

### CHAPTER 2 INTRODUCTION TO CORPORATE FINANCE

CHAPTER 2 INTRODUCTION TO CORPORATE FINANCE Solutions to Questions and Problems NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and

### FI3300 Corporation Finance

Learning Objectives FI3300 Corporation Finance Spring Semester 2010 Dr. Isabel Tkatch Assistant Professor of Finance Explain the objectives of financial statement analysis and its benefits for creditors,

### Investment Analysis (FIN 383) Fall Homework 9

Investment Analysis (FIN 383) Fall 2009 Homework 9 Instructions: please read carefully You should show your work how to get the answer for each calculation question to get full credit The due date is Tue

### FINANCIAL ANALYSIS GUIDE

MAN 4720 POLICY ANALYSIS AND FORMULATION FINANCIAL ANALYSIS GUIDE Revised -August 22, 2010 FINANCIAL ANALYSIS USING STRATEGIC PROFIT MODEL RATIOS Introduction Your policy course integrates information

### Course 1: Evaluating Financial Performance

Excellence in Financial Management Course 1: Evaluating Financial Performance Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides a basic understanding of how to use ratio analysis for evaluating

### Ratio Analysis. A) Liquidity Ratio : - 1) Current ratio = Current asset Current Liability

A) Liquidity Ratio : - Ratio Analysis 1) Current ratio = Current asset Current Liability 2) Quick ratio or Acid Test ratio = Quick Asset Quick liability Quick Asset = Current Asset Stock Quick Liability

### Often stock is split to lower the price per share so it is more accessible to investors. The stock split is not taxable.

Reading: Chapter 8 Chapter 8. Stock: Introduction 1. Rights of stockholders 2. Cash dividends 3. Stock dividends 4. The stock split 5. Stock repurchases and liquidations 6. Preferred stock 7. Analysis

### Chapter. How Well Am I Doing? Financial Statement Analysis

Chapter 17 How Well Am I Doing? Financial Statement Analysis 17-2 LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Explain the need for and limitations of financial statement

### ICAP GROUP S.A. FINANCIAL RATIOS EXPLANATION

ICAP GROUP S.A. FINANCIAL RATIOS EXPLANATION OCTOBER 2006 Table of Contents 1. INTRODUCTION... 3 2. FINANCIAL RATIOS FOR COMPANIES (INDUSTRY - COMMERCE - SERVICES) 4 2.1 Profitability Ratios...4 2.2 Viability

### 3 Financial Analysis and Planning

3 Financial Analysis and Planning BASIC CONCEPTS AND FORMULAE 1. Financial Analysis and Planning Financial Analysis and Planning is carried out for the purpose of obtaining material and relevant information

### Principles of Managerial Finance Solution Lawrence J. Gitman CHAPTER 2. Financial Statements And Analysis

Principles of Managerial Finance Solution Lawrence J. Gitman CHAPTER 2 Financial Statements And Analysis INSTRUCTOR S RESOURCES Overview This chapter examines the key components to the stockholders' report:

### 2-8. Identify whether each of the following items increases or decreases cash flow:

Problems 2-8. Identify whether each of the following items increases or decreases cash flow: Increase in accounts receivable Increase in notes payable Depreciation expense Increase in investments Decrease

### FINANCIAL ACCOUNTING TOPIC: FINANCIAL ANALYSIS

SYLLABUS Compulsory part Basic ratio analysis 1. State the general functions of accounting ratios. 2. Calculate and interpret the following ratios: a. working capital/current ratio, quick/liquid/acid test

### Chapter 12 Financial Planning and Forecasting Financial Statements ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 12 Financial Planning and Forecasting Financial Statements ANSWERS TO END-OF-CHAPTER QUESTIONS 12-1 a. The operating plan provides detailed implementation guidance designed to accomplish corporate

### CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH

CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH Answers to Concepts Review and Critical Thinking Questions 5. The sustainable growth rate is greater than 20 percent, because at a 20 percent growth rate

### E2-2: Identifying Financing, Investing and Operating Transactions?

E2-2: Identifying Financing, Investing and Operating Transactions? Listed below are eight transactions. In each case, identify whether the transaction is an example of financing, investing or operating

### CHAPTER 2 FINANCIAL STATEMENTS, TAXES AND CASH FLOW

CHAPTER 2 FINANCIAL STATEMENTS, TAXES AND CASH FLOW Answers to Concepts Review and Critical Thinking Questions 1. Liquidity measures how quickly and easily an asset can be converted to cash without significant

### Liquidity analysis: Length of cash cycle

2. Liquidity analysis: Length of cash cycle Operating cycle of a merchandising firm: number of days it takes to sell inventory + number of days until the resulting receivables are converted to cash Acquisition

### IFRS Financial Ratios.

100 IFRS Financial Ratios Author s preface Dear readers, in order to make solid investments, investors compare companies within their peer group. For this purpose, key ratios such as EBIT, working capital

### Financial Analysis. Financial Analysis

Financial Analysis Eliciting information from the financial statements of a firm. Type of information sought depends on the person or firm involved. Who is interested? - Management for planning and evaluating.

### FINANCIAL RATIO ANALYSIS: PUTTING THE NUMBERS TO WORK

FINANCIAL RATIO ANALYSIS: PUTTING THE NUMBERS TO WORK By John Bajkowski Financial ratio analysis uses historical financial statements to quantify data that will help give investors a feel for a firm s

### CHAPTER 5. RATIO ANALYSIS, FINANCIAL PLANNING AND FINANCIAL ANALYSIS

CHAPTER 5. RATIO ANALYSIS, FINANCIAL PLANNING AND FINANCIAL ANALYSIS The financial statements discussed in Chapter 4 provide valuable information about a firm s financial and business health. Ratio analysis

### Uses and Limitations of Ratio Analysis

Uses and Limitations of Ratio Analysis Balkrishna Parab ACS, AICWA balkrishnaparab@jbims.edu F inancial statement analysis involves comparing the firm s performance with that of other firms in the same

### Ratios Formula Purpose/Use

Ratio Review: Formulas, Purpose & Use Word of Caution: Please remember that the significance of any particular ratio in the ratio analysis set is highly dependent upon the industry. For example, Gross

### MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the

MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the following 33 questions designed to test your knowledge of the

### Ratio Analysis: Liquidity, Activity & Coverage

Ratio Analysis: Liquidity, Activity & Coverage Quality of Earnings Fraudulent actions Above-average financial risk One-time transactions Borrow from the future/reach into the past Ride the depreciation

### a. A U.S. Treasury bill is an example of a money market transaction. b. Long-term corporate bonds are examples of capital market transactions.

1-1 A firm s intrinsic value is an estimate of a stock s true value based on accurate risk and return data. It can be estimated but not measured precisely. A stock s current price is its market price the

### Chapter 1 Financial Statement and Cash Flow Analysis

Chapter 1 Financial Statement and Cash Flow Analysis MULTIPLE CHOICE 1. Which of the following items can be found on an income statement? a. Accounts receivable b. Long-term debt c. Sales d. Inventory

### Chapter 4 Financial Planning and Forecasting Financial Statements ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 4 Financial Planning and Forecasting Financial Statements ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 4-1 a. The operating plan provides detailed implementation guidance designed to accomplish

### Finance and Accounting For Non-Financial Managers

Finance and Accounting For Non-Financial Managers Accounting/Finance Recording, classifying, and summarizing financial transactions in terms of dollars and their interpretation 1 Key Accounting Terms Accounting

### Understanding balance sheets & profit & loss statements

Insightss Insights 29 January 2016 Understanding balance sheets & profit & loss statements We explain how balance sheets and profit and loss statements work, as well as some financial ratios that can help

### RATIO ANALYSIS FORMULAS + THEORIES

A) Cash Position Ratio : - 1) Absolute Cash Ratio = Cash Reservoir Current Liabilities 2) Cash Position to Total asset Ratio = Cash Reservoir * 100 (Measure liquid layer of assets) Total Assets 3) Interval

### Learning Objective: Compare the financial implications of the different forms of business organizations. Learning Objective: Compare the

1. award: MC Qu. 6 Todd and Cathy created a firm that is... Todd and Cathy created a firm that is a separate legal entity and will share ownership of that firm on a 50 50 basis. Which type of entity did

### performance of a company?

How to deal with questions on assessing the performance of a company? (Relevant to ATE Paper 7 Advanced Accounting) Dr. M H Ho This article provides guidance for candidates in dealing with examination

### Ratio Analysis 0.75. Fixed Assets Fixed Assets + Net Working Capital =0.75 Fixed Assets

Ratio Analysis CA Past Years Exam Answer Answer to Q.1: (Nov, 009) Fixed assets ` 18,00,000 Proprietor s funds ` 4,00,000 Note: 1 Ratio of fixed assets to proprietor s funds 0.75 Properietors Fund 0.75

### Chapter 2 Financial Statement and Cash Flow Analysis

Chapter 2 Financial Statement and Cash Flow Analysis MULTIPLE CHOICE 1. Which of the following items can be found on an income statement? a. Accounts receivable b. Long-term debt c. Sales d. Inventory

### Chapter-3 Solutions to Problems

Chapter-3 Solutions to Problems P3-1. P3-2. Reviewing basic financial statements LG 1; Basic Income statement: In this one-year summary of the firm s operations, Technica, Inc. showed a net profit for

### Financial Accounting. Financial Statement Analysis

Financial Accounting Financial Statement Analysis Dr. Charles W. Mulford Scheller College of Business Georgia Institute of Technology Atlanta, GA 30332-0520 (404) 894-4395 cwmulford@gmail.com Financial

Business 2019 Finance I Lakehead University Midterm Exam Philippe Grégoire Fall 2002 Time allowed: 2 hours. Instructions: Calculators are permitted. One 8.5 11 inches crib sheet is allowed. Verify that

### Finance Master. Winter 2015/16. Jprof. Narly Dwarkasing University of Bonn, IFS

Finance Master Winter 2015/16 Jprof. Narly Dwarkasing University of Bonn, IFS Chapter 2 Outline 2.1 Firms Disclosure of Financial Information 2.2 The Balance Sheet 2.3 The Income Statement 2.4 The Statement

### 1.1 Role and Responsibilities of Financial Managers

1 Financial Analysis 1.1 Role and Responsibilities of Financial Managers (1) Planning and Forecasting set up financial plans for their organisations in order to shape the company s future position (2)

### SOLUTIONS. Learning Goal 30

S1 Learning Goal 30 Multiple Choice 1. d 2. d 3. b 4. a Earnings per share is also used directly for comparing profitability on a per-share basis. 5. d 6. c An airline would have a much greater investment

### Discussion Board Articles Ratio Analysis

Excellence in Financial Management Discussion Board Articles Ratio Analysis Written by: Matt H. Evans, CPA, CMA, CFM All articles can be viewed on the internet at www.exinfm.com/board Ratio Analysis Cash