Appendix A Project: Financial Statement Analysis spring 2019 5% of course grade Background: This assignment uses a company case study for financial statement analysis. Students are required to solve financial ratios and analyze these ratios using a time series trend. The students must identify strengths and weakness of the company and make recommendations to the manager of the company. Instructions: Part A: Use 2017 and 2016 comparative income statements and balance sheets for XYZ Company provided in the following tab. Calculate the following ratios for 2017: working capital current ratio quick ratio days sales receivable inventory turnover debt to equity times-interest-earned return on assets (ROA) earnings per share (EPS) price to earnings (PE) Note: All work must be completed in EXCEL using formulas for grading. You must create a NEW EXCEL FILE indicating you are the file creatoer and then you can copy/paste the problem from tab 2. Do NOT work directly out of this file!! (Answers submitted in Word or without formulas in Excel will receive a zero.) All files must be original. DO NOT SHARE FILES OR USE A COMMON TEMPLATE FOR CALCULATIONS. The question only specifically asks for 2017 ratios. However, in order to do a thorough analysis in part b you may need to compute 2016 ratios as well for comparisons when applicable. (There are some ratios that you will not be able to compute from the prior year because of a lack of data.) Part B: Write a professional memo addressed to the company’s management to discuss your evaluation of solvency and performance based on calculations from part A. (No bullet lists and/or incomplete sentences.) The memo should explain the significance of the specific ratios and address strengths and weakness of the company. Memos should be typed in Word and uploaded to Blackboard through the Assignment menu. Grading: Calculations in Part A should be well-organized in Excel by the three classifications noted: Short-term solvency, Long-term solvency and Performance (Profitability). Memos should be a minimum of 500 words. See the FSA Memo Grading Rubric attached for specific grading requirements. Due Date: Projects will be due by the end of the day, Monday, 2/25/19 ACCT 2312 - Spring 2019 Financial Statement Analysis Project Instructions: Comparative income statements and balance sheets for XYZ Company follow for 2017 and 2016. XYZ Comparative Income Statements December 31, 2017 and 2016 Sales Cost of goods sold Gross profit Selling and administrative expenses Operating income Other expenses (revenues) Interest revenue Interest expense Total other expenses (revenues) Income before income taxes Income taxes Net Income $ $ $ $ $ $ $ $ $ $ $ 2017 6,394,000 3,812,500 2,581,500 1,788,000 793,500 (52,000) 43,500 (8,500) 802,000 361,000 441,000 $ $ $ $ $ $ $ $ $ $ $ 2016 6,126,000 3,702,500 2,423,500 1,788,000 635,500 (44,500) 43,500 (1,000) 636,500 361,000 275,500 XYZ Company Comparative Balance Sheets For Years Ended December 31, 2017 and 2016 2017 2016 Assets Cash Marketable securities Accoutns receivable Inventory Prepaid expenses Total current assets $ 176,000 $ 173,500 $ 488,500 $ 805,500 $ 67,500 $ 1,711,000 $ 184,500 $ 156,500 $ 528,000 $ 815,000 $ 63,000 $ 1,747,000 Investments and other assets Property, plant, and equipment, net Trademarks and other intangibles Total assets $ 392,500 $ 1,414,500 $ 136,500 $ 3,654,500 $ 307,000 $ 1,246,000 $ 145,500 $ 3,445,500 Liabilities and stockholders' equity Current maturities of long-term debt Accounts payable and accrued expenses Total current liabilities $ $ $ Notes payable Long-term debt Total liabilities $ 94,500 $ 333,000 $ 1,353,500 $ 92,500 $ 274,500 $ 1,351,000 Common stock, $10 par value Additional paid-in capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 67,500 $ 119,000 $ 2,114,500 $ 2,301,000 $ 3,654,500 $ 67,500 $ 118,000 $ 1,909,000 $ 2,094,500 $ 3,445,500 10,000 916,000 926,000 Additional Company Information Market value of common stock: $40 in 2017 and $30 in 2016 Credit terms: n/30 days 2016 Days Sales Receivable: 32 days 2016 Inventory Turnover: 5 times Industry Average for Inventory Turnover: 4.5 times Bank requires a Times-Interest Earned Ratio of 10 Industry Average for ROA: 12% $ $ $ 12,500 971,500 984,000 Financial Statements And Ratios Objectives 1. Financial statement analysis. 2. Summarize the uses and limitations of analytical measures. – Considerations with Use 3. Types of Analysis 4. Apply financial statement analysis to assess the solvency of a business. 5. Apply financial statement analysis to assess the profitability of a business. Financial Statement Analysis •Process of interpreting and evaluating financial statements by using data and disclosures. Considerations with Use •Ratios by themselves do not give you much information about the business •Useful to compare against own historical performance, against competitive data and/or against standards of lending agreements. •Apples to Apples Comparison Horizontal Analysis What is horizontal analysis? Horizontal Analysis It’s an analysis of the percentage increases and decreases of related items in comparative financial statements. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments Fixed assets (net) Intangible assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Preferred 6% stock, $100 par Common stock, $10 par Retained earnings Total stockholders’ equity Total liab. & SE 2006 $ 550,000 95,000 444,500 50,000 $1,139,500 Balance Sheet Increase (Decrease) 2005 Amount Percent $ 533,000 $ 17,000 3.2% 177,500 (82,500) (46.5%) 470,000 (25,500) (5.4%) 50,000 — $1,230,500 $ (91,000) (7.4%) $ 210,000 100,000 $ 310,000 $ 243,000 200,000 $ 443,000 $ (33,000) (100,000) $(133,000) (13.6%) (50.0%) (30.0%) $ 150,000 500,000 179,500 $ 829,500 $1,139,500 $ 150,000 500,000 137,500 $ 787,500 $1230,500 — — $42,000 $42,000 $(91,000) 30.5% 5.3% (7.4%) Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments Fixed assets (net) Intangible assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Preferred 6% stock, $100 par Common stock, $10 par Retained earnings Total stockholders’ equity Total liab. & SE Increase (Decrease) 2006 2005 Amount Percent $ 550,000 $ 533,000 $ 17,000 3.2% 95,000 177,500 (82,500) (46.5%) 444,500 Analysis: 470,000 (25,500) (5.4%) Horizontal 50,000 50,000 — $1,139,500 $1,230,500$17,000 $ (91,000) (7.4%) Difference = 3.2% Base year (2005) $533,000 $ 210,000 $ 243,000 $ (33,000) (13.6%) 100,000 $ 310,000 200,000 $ 443,000 (100,000) $(133,000) (50.0%) (30.0%) $ 150,000 500,000 179,500 $ 829,500 $1,139,500 $ 150,000 500,000 137,500 $ 787,500 $1230,500 — — $42,000 $42,000 $(91,000) 30.5% 5.3% (7.4%) Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments Fixed assets (net) Intangible assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Preferred stock, $100 par Common stock, $10 par Retained earnings Total stockholders’ equity Total liab. & SE 2006 $ 550,000 95,000 444,500 50,000 $1,139,500 Increase (Decrease) 2005 Amount Percent $ 533,000 $ 17,000 3.2% 177,500 (82,500) (46.5%) 470,000 (25,500) (5.4%) 50,000 — $1,230,500 $ (91,000) (7.4%) Horizontal Analysis: $ 210,000 $ 243,000 $ (33,000) (13.6%) Difference $(82,500) 100,000 200,000 (100,000) (50.0%) = (46.5%) $ 310,000 $ 443,000 $(133,000) (30.0%) Base year (2005) $177,500 $ 150,000 500,000 179,500 $ 829,500 $1,139,500 $ 150,000 500,000 137,500 $ 787,500 $1230,500 — — $42,000 $42,000 $(91,000) 30.5% 5.3% (7.4%) Lincoln Company Comparative Balance Sheet December 31,Okay, 2006 andgo 2005 to the next slideIncrease (Decrease) 2006the 2005 Amount Percent and calculate Assets Current assets $ 550,000 $ 533,000 $ 17,000 3.2% percentage change for fixed Long-term investments 95,000 177,500 (82,500) (46.5%) Fixed assets (net) assets. 444,500 470,000 (25,500) (5.4%) Intangible assets 50,000 50,000 — Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%) Liabilities Current liabilities $ 210,000 Analysis: $ 243,000 $ (33,000) (13.6%) Horizontal Long-term liabilities 100,000 200,000 (100,000) (50.0%) Total liabilities $Difference 310,000 $ 443,000 ? $(133,000) (30.0%) = ? Stockholders’ Equity Base year (2005) ? Preferred 6% stock, $100 par $ 150,000 $ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500 $42,000 30.5% Total stockholders’ equity $ 829,500 $ 787,500 $42,000 5.3% Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%) Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments Fixed assets (net) Intangible assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Preferred 6% stock, $100 par Common stock, $10 par Retained earnings Total stockholders’ equity Total liab. & SE 2006 $ 550,000 95,000 444,500 50,000 $1,139,500 Increase (Decrease) 2005 Amount Percent $ 533,000 $ 17,000 3.2% 177,500 (82,500) (46.5%) 470,000 (25,500) (5.4%) 50,000 — $1,230,500 $ (91,000) (7.4%) $ 210,000 100,000 $ 310,000 $ 243,000 200,000 $ 443,000 $ (33,000) (100,000) $(133,000) $ 150,000 500,000 179,500 $ 829,500 $1,139,500 $ 150,000 500,000 137,500 $ 787,500 $1230,500 — — $42,000 $42,000 $(91,000) (5.4%) (13.6%) (50.0%) (30.0%) 30.5% 5.3% (7.4%) Lincoln Company Comparative Income Statement December 31, 2006 and 2005 Sales Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other income Other expense Income before income tax Income tax Net income 2006 $1,530,500 32,500 $1,498,000 1,043,000 $ 455,000 $ 191,000 104,000 $ 295,000 $ 160,000 8,500 $ 168,500 6,000 $ 162,500 71,500 $ 91,000 Income Statement Increase (Decrease) 2005 Amount Percent $1,234,000 $296,500 24.0% 34,000 (1,500) (4.4%) $1,200,000 $298,000 24.8% 820,000 223,000 27.2% $ 380,000 $ 75,000 19.7% $ 147,000 $ 44,000 29.9% 97,400 6,600 6.8% $ 244,400 $ 50,600 20.7% $ 135,600 $ 24,400 18.0% 11,000 (2,500) (22.7%) $ 146,600 $ 21,900 14.9% 12,000 (6,000) (50.0%) $ 134,600 $ 27,900 20.7% 58,100 13,400 23.1% $ 76,500 $ 14,500 19.0% Lincoln Company Comparative Income Statement December 31, 2006 and 2005 Sales Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses operating expenses Operating income Other income Other expense Income before income tax Income tax Net income Increase (Decrease) 2006 2005 Amount Percent $1,530,500 $1,234,000 $296,500 24.0% 24.0% 32,500 34,000 (1,500) (4.4%) $1,498,000 $1,200,000 $298,000 24.8% 1,043,000 820,000 223,000 27.2% $ 455,000 $ 380,000 $ 75,000 19.7% Horizontal Analysis: $ 191,000 $ 147,000 $ 44,000 29.9% 104,000 97,400 6,600 6.8% Total Increase amount $296,500 $ 295,000 $ 244,400 $ 50,600 = 24.0%20.7% $ 160,000 $ 135,600 $ 24,400 18.0% Base year (2005) $1,234,000 8,500 11,000 (2,500) (22.7%) $ 168,500 $ 146,600 $ 21,900 14.9% 6,000 12,000 (6,000) (50.0%) $ 162,500 $ 134,600 $ 27,900 20.7% 71,500 58,100 13,400 23.1% $ 91,000 $ 76,500 $ 14,500 19.0% Lincoln Company Comparative Income Statement December 31, 2006 and 2005 Sales Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses operating expenses Operating income Other income Other expense Income before income tax Income tax Net income Increase (Decrease) 2006 2005 Amount Percent $1,530,500 $1,234,000 $296,500 24.0% 32,500 34,000 (1,500) (4.4%) $1,498,000 $1,200,000 $298,000 24.8% 24.8% 1,043,000 820,000 223,000 27.2% $ 455,000 $ 380,000 $ 75,000 19.7% $ 191,000 $ 147,000 $ 44,000 29.9% 104,000 97,400 6,600 6.8% Total $ 295,000 $ 244,400 $ 50,600 20.7% Horizontal Analysis: $ 160,000 $ 135,600 $ 24,400 18.0% 8,500 Increase amount 11,000 $298,000 (2,500) (22.7%) $ 168,500 $ 146,600 $ 21,900 = 24.8%14.9% Base year (2005) 12,000 $1,200,000 (6,000) (50.0%) 6,000 $ 162,500 $ 134,600 $ 27,900 20.7% 71,500 58,100 13,400 23.1% $ 91,000 $ 76,500 $ 14,500 19.0% Vertical Analysis A percentage analysis can be used to show the relationship of each component to a total within a single statement. Vertical Analysis The total, or 100% item, on the balance sheet is “total assets.” Lincoln Company Comparative Balance Sheet December 31, 2006 Amount Percent Assets Current assets $ 550,000 Long-term investments 95,000 Property, plant, & equip. (net) 444,500 Intangible assets 50,000 Total assets $1,139,500 Liabilities Current liabilities $ 210,000 Long-term liabilities 100,000 Vertical Analysis: Total liabilities $ 310,000 Stockholders’ Equity Current assets $550,000 Preferred stock, 6%, $100 par $ 150,000 = Totalstock, assets Common $10 par $1,139,500 500,000 Retained earnings 179,500 Total stockholders’ equity $ 829,500 Total liab. & SE $1,139,500 Balance Sheet December 31, 2005 Amount Percent 48.3% 48.3% 8.3 39.0 4.4 100.0% $ 533,000 177,500 470,000 50,000 $1,230,500 43.3% 14.4 38.2 4.1 100.0% 18.4% 8.8 27.2% $ 243,000 200,000 $ 443,000 19.7% 16.3 36.0% 13.2% 48.3% $ 150,000 500,000 137,500 $ 787,500 $1,230,500 12.2% 40.6 11.2 64.0% 100.0% 43.9 15.7 72.8% 100.0% Lincoln Company Comparative Balance Sheet December 31, 2006 Amount Percent December 31, 2005 Amount Percent Assets Current assets $ 550,000 48.3% $ 533,000 43.3% 43.3% Long-term investments 95,000 8.3 177,500 14.4 Property, plant, & equip. (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 Total assets $1,139,500 100.0% $1,230,500 100.0% Liabilities Current liabilities $ 210,000 18.4% $ 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 Vertical Analysis:27.2% Total liabilities $ 310,000 $ 443,000 36.0% Stockholders’ Equity Current assets $533,000 Preferred 6% stock, $100 par $ 150,000 13.2% $ 150,000 12.2% = 43.3% $1,230,500500,000 Common stock, $10 par Total assets 500,000 43.9 40.6 Retained earnings 179,500 15.7 137,500 11.2 Total stockholders’ equity $ 829,500 72.8% $ 787,500 64.0% Total liab. & SE $1,139,500 100.0% $1,230,500 100.0% Lincoln Company Comparative Balance Sheet Assets Current assets Long-term investments Property, plant, & equip. (net) Intangible assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Preferred 6% stock, $100 par Common stock, $10 par Retained earnings Total stockholders’ equity Total liab. & SE December 31, 2006 Amount Percent December 31, 2005 Amount Percent $ 550,000 95,000 444,500 50,000 $1,139,500 48.3% 8.3 39.0 4.4 100.0% $ 533,000 177,500 470,000 50,000 $1,230,500 43.3% 14.4 38.2 4.1 100.0% $ 210,000 100,000 $ 310,000 18.4% 8.8 27.2% $ 243,000 200,000 $ 443,000 19.7% 16.3 36.0% $ 150,000 500,000 179,500 $ 829,500 $1,139,500 13.2% 43.9 15.7 72.8% 100.0% $ 150,000 500,000 137,500 $ 787,500 $1,230,500 12.2% 40.6 11.2 64.0% 100.0% Lincoln Company Income Comparative Income Statement Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Amount Percent Sales $1,530,500 102.2% $1,234,000 102.8% Sales returns 32,500 2.2 34,000 2.8 Net sales $1,498,000 100.0% $1,200,000 100.0% Cost of goods sold 1,043,000 69.6 820,000 68.3 Gross profit $ 455,000 30.4% $ 380,000 31.7% Selling expenses $ 191,000Net 12.8% sales $ 147,000 12.3% Administrative expenses 104,000 6.9 97,400 8.1 Total operating expenses $ 295,000is 100.0% 19.7% $ 244,400 20.4% Income from operations $ 160,000 10.7 $ 135,600 11.3% Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2% Other expense 6,000 0.4 12,000 1.0 Income before income tax $ 162,500 10.9% $ 134,600 11.2% Income tax expense 71,500 4.8 58,100 4.8 Net income $ 91,000 6.1% $ 76,500 6.4% Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Amount Percent Sales $1,530,500 102.2% $1,234,000 102.8% Sales returns 32,500 2.2 34,000 2.8 Net sales $1,498,000 100.0% $1,200,000 100.0% Cost of goods sold 1,043,000 69.6 820,000 68.3 Gross profit $ 455,000 30.4% $ 380,000 31.7% Selling expenses $ 191,000 12.8% 12.8% $ 147,000 12.3% Administrative expenses 104,000 6.9 97,400 8.1 Total operating expenses $ 295,000 19.7% $ 244,400 20.4% Income from operations $ 160,000 10.7 $ 135,600 11.3% Other income 8,500 0.6 11,000 0.9 Vertical Analysis: $ 168,500 11.3% $ 146,600 12.2% Other expense 0.4 12,000 1.0 Selling expenses $191,0006,000 Income before income tax $ 162,500= 12.8% 10.9% $ 134,600 11.2% Nettax sales $1,498,000 Income expense 71,500 4.8 58,100 4.8 Net income $ 91,000 6.1% $ 76,500 6.4% Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Amount Percent Sales $1,530,500 102.2% $1,234,000 102.8% Sales returns 32,500 2.2 34,000 2.8 Net sales $1,498,000 100.0% $1,200,000 100.0% Cost of goods sold 1,043,000 69.6 820,000 68.3 Gross profit $ 455,000 30.4% $ 380,000 31.7% Selling expenses $ 191,000 12.8% $ 147,000 12.3% Administrative expenses 104,000 6.9 97,400 8.1 Total operating expenses $ 295,000 19.7% $ 244,400 20.4% Income from operations $ 160,000 10.7 $ 135,600 11.3% Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2% Other expense 6,000 0.4 12,000 1.0 Income before income tax $ 162,500 10.9% $ 134,600 11.2% Income tax expense 71,500 4.8 58,100 4.8 Net income $ 91,000 6.1% $ 76,500 6.4% Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Amount Percent Sales $1,530,500 102.2% $1,234,000 102.8% Sales returns 32,500 2.2 34,000 2.8 Net sales $1,498,000 100.0% $1,200,000 100.0% Cost of goods sold 1,043,000 69.6 820,000 68.3 Gross profit $ 455,000 30.4% $ 380,000 31.7% Selling expenses $ 191,000 12.8% $ 147,000 12.3% Administrative expenses 104,000 6.9 97,400 8.1 Total operating expenses $ 295,000 19.7% $ 244,400 20.4% Income from operations $ 160,000 10.7 $ 135,600 11.3% Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2% Other expense 6,000 0.4 12,000 1.0 Income before income tax $ 162,500 10.9% $ 134,600 11.2% Income tax expense 71,500 4.8 58,100 4.8 Net income $ 91,000 6.1% $ 76,500 6.4% Common Size Statements Vertical analysis with both dollar and percentage amounts is also useful in comparing one company with another or with industry averages. Such comparisons are easier to make with the use of common-size statements in which all items are expressed in percentages. Common-Size Income Statement Competitor Analysis Benchmarking • Comparison with industry averages • Use: – – – – EDGAR - Securities and Exchange Commission Hoovers Dun and Bradstreet Standard and Poor’s Industry Survey Solvency Analysis ▪ Solvency is the ability of a business to meet its financial obligations (debts) as they are due. ▪ Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities. ▪ This ability is normally assessed by examining balance sheet relationships. ▪ Liquidity ratios and debt coverage ratios Current Position Analysis Working Capital and Current Ratio Current assets Current liabilities Working capital Current ratio 2006 $550,000 210,000 $340,000 2.6 2005 $533,000 243,000 $290,000 2.2 Use: To indicate the ability to meet Divide currently maturing obligations. current assets by current liabilities Current Position Analysis Quick Ratio Quick assets: Cash Marketable securities Accounts receivable (net) Total Current liabilities Quick ratio 2006 2005 $ 90,500 75,000 115,000 $280,500 $210,000 1.3 $ 64,700 60,000 120,000 $244,700 $243,000 1.0 Use: To indicate instant debt-paying ability. Accounts Receivable Analysis Accounts Receivable Turnover Net sales on account Accounts receivable (net): Beginning of year End of year Total Average (Total ÷ 2) 2006 $1,498,000 2005 $1,200,000 $ 120,000 115,500 $ 235,000 $ 117,500 $ 140,000 120,000 $ 260,000 $ 130,000 Net sales on account Average accounts receivable Accounts Receivable Analysis Accounts Receivable Turnover Net sales on account Accounts receivable (net): Beginning of year End of year Total Average Accounts receivable turnover 2006 $1,498,000 2005 $1,200,000 $ 120,000 115,500 $ 235,000 $ 117,500 12.7 $ 140,000 120,000 $ 260,000 $ 130,000 9.2 Use: To assess the efficiency in collecting receivables and in the management of credit. Accounts Receivable Analysis Number of Days’ Sales in Receivables 2006 Accounts receivable (net), end of year Net sales on account Average daily sales on account (sales ÷ 365) 2005 $ 115,000 $1,498,000 $ 120,000 $1,200,000 $ $ 4,104 365 Accounts Receivable Turnover Ratios 3,288 Accounts Receivable Analysis Number of Days’ Sales in Receivables 2006 2005 Accounts receivable turnover 12.7 9.2 28.74 36.67 Divide by 365 Number of days’ sales in receivables Use: To assess the efficiency in collecting receivables and in the management of credit. Inventory Analysis Inventory Turnover Cost of goods sold Inventories: Beginning of year End of year Total Average (Total ÷ 2) 2006 $1,043,000 2005 $ 820,000 $ 283,000 264,000 $ 547,000 $ 273,500 $ 311,000 283,000 $ 594,000 $ 297,000 Cost of goods sold Inventory turnover = Average inventory Inventory Analysis Inventory Turnover Cost of goods sold Inventories: Beginning of year End of year Total Average (Total ÷ 2) Inventory turnover 2006 $1,043,000 2005 $ 820,000 $ 283,000 264,000 $ 547,000 $ 273,500 3.8 $ 311,000 283,000 $ 594,000 $ 297,000 2.8 Use: To assess the efficiency in the management of inventory. Long-Term Solvency Ratios Debt Ratio Total assets Total liabilities Debt Ratio 2006 $444,500 $100,000 .22 2005 $470,000 $200,000 .42 Use: Show the proportion of assets financed with debt Long-Term Creditors Ratio of Liabilities to Stockholders’ Equity Total liabilities Total stockholders’ equity Ratio of liabilities to stockholders’ equity 2006 $310,000 $829,500 2005 $443,000 $787,500 0.37 0.56 Use: To indicate the margin of safety to creditors. Long-Term Creditors Number of Times Interest Charges Earned Income before income tax Add interest expense Amount available for interest 2006 2005 $ 900,000 $ 800,000 300,000 250,000 $1,200,000 $1,050,000 Income before Number of Times Interest = income tax + interest expense Charges Earned Interest expense Long-Term Creditors Number of Times Interest Charges Earned Income before income tax Add interest expense Amount available for interest Number of times earned 2006 2005 $ 900,000 $ 800,000 300,000 250,000 $1,200,000 $1,050,000 4.0 Use: To assess the risk to debt holders in terms of number of times interest charges were earned. 4.2 Profitability Analysis ▪ Profitability is the ability of an entity to earn profits. ▪ This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available. ▪ Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet. The Common Stockholder Rate Earned on Total Assets Net income Plus interest expense Total Total assets: Beginning of year End of year Total Average (Total ÷ 2) Rate earned on total assets 2006 $ 91,000 6,000 $ 97,000 2005 $ 76,500 12,000 $ 88,500 $1,230,500 1,139,500 $2,370,000 $1,185,000 8.2% $1,187,500 1,230,500 $2,418,000 $1,209,000 7.3% Use: To assess the profitability of the assets. It measures the net income produced by total assets The Common Stockholder Rate Earned on Common Stockholders’ Equity Net income Less preferred dividends Remainder—common stock Common stockholders’ equity: Beginning of year End of year Total Average (Total ÷ 2) $ $ 2006 91,000 9,000 82,000 $ 637,500 679,500 $1,317,000 $ 658,500 $ $ 2005 76,500 9,000 67,500 $ 600,000 637,500 $1,237,500 $ 618,750 The Common Stockholder Rate Earned on Common Stockholders’ Equity Net income Less preferred dividends Remainder—common stock Common stockholders’ equity: Beginning of year End of year Total Average (Total ÷ 2) Rate earned on common stockholders’ equity $ $ 2006 91,000 9,000 82,000 $ $ 2005 76,500 9,000 67,500 $ 637,500 679,500 $1,317,000 $ 658,500 $ 600,000 637,500 $1,237,500 $ 618,750 12.5% 10.9% Use: To assess the profitability of the investment by common stockholders. The Common Stockholder Earnings Per Share on Common Stock Net income Less preferred dividends Remainder—common stock Shares of common stock Earnings per share on common stock 2006 $ 91,000 9,000 $ 82,000 50,000 $1.64 2005 $ 76,500 9,000 $ 67,500 50,000 $1.35 Use: To assess the profitability of the investment by common stockholders. The Common Stockholder Price-Earnings Ratio 2006 Market price per share of common $41.00 Earnings per share on common ÷ 1.64 Price-earnings ratio on common stock 25 2005 $27.00 ÷ 1.35 20 Use: To indicate future earnings prospects, based on the relationship between market value of common stock and earnings. Red Flags • • • • • • Movement of Sales, Inventory and Receivables Earnings Problems Decreased Cash Flow Too Much Debt Inability to Collect Receivables Buildup of Inventories Other Ratios Users of Ratios • Creditors – liquidity ratios and debt coverage ratios • Owners – Profitability and turnover ratios • Investors – Profitability, Payout and Market Share The End Rainbow Paint Co Comparitive Income Statement For the Years Ended December, 2019 and 2018 2009 Sales $ 5,125,000 $ Sales returns and allowances $ 125,000 $ Net Sales $ 5,000,000 $ Cost of goods sold $ 3,400,000 $ Gross profit $ 1,600,000 $ Selling expenses $ 650,000 $ Administrative expenses $ 325,000 $ Total operating expenses $ 975,000 $ Income from Operations $ 625,000 $ Interest Income $ 25,000 $ Interest Expenses $ 105,000 $ Income before income tax $ 545,000 $ Income tax expense $ 300,000 $ Net Income $ 245,000 $ Rainbow Paint Co Comparative Retained Earnings Statement For the Years Ended December, 2019 and 2018 2009 Retained earnings, January 1 $ 683,000 $ Add net income for year $ 245,000 $ Total $ 928,000 $ Deduct dividends: On common stock Total Retained earnings, December 31 $ $ $ 45,000 $ 45,000 $ 883,000 $ 2008 3,257,600 57,600 3,200,000 2,080,000 1,120,000 464,000 224,000 688,000 432,000 19,200 64,000 387,200 176,000 211,200 2008 541,800 211,200 753,000 30,000 30,000 723,000 Rainbow Paint Co Comparative Balance Sheet December 31, 2019, 2018 and 217 2019 Assets Current assets: Cash Marketable securities Accounts receivable (net) Inventories Prepaid expenses Total current assets Long-term investments Property, Plant and Equipment (net) Total assets Liabilities Current liabilities Long-term liabilities: Mortgage not payable, 10%, due 2012 Bonds payable, 8%, due 2015 Total long-term liabilities Total liabilities 2018 $ 175,000 $ 125,000 $ 150,000 $ 50,000 $ 425,000 $ 325,000 $ 720,000 $ 480,000 $ 30,000 $ 20,000 $ 1,500,000 $ 1,000,000 $ 250,000 $ 225,000 $ 2,093,000 $ 1,948,000 $ 3,843,000 $ 3,173,000 $ 750,000 $ 650,000 $ 410,000 $ $ 800,000 $ 800,000 $ 1,210,000 $ 800,000 $ 1,960,000 $ 1,450,000 Sotckholders' Equity Common Stock, $10 par Retained earnings Total Stockholders' Equity Total liabilities and stockholders' equity # of shares CS outstanding market value per share (given) $ 1,000,000 $ 1,000,000 $ 883,000 $ 723,000 $ 1,883,000 $ 1,723,000 $ 3,843,000 $ 3,173,000 100,000 $25 Credt Terms: n/30 days Bank requires a times interest earned ratio of 10. Working Capital Current Ratio Quick Ratio Days sales in receivable inventory turnover debt to equity times-interest earned ROA EPS P/E ratio current assets - current liabilities current assets/current liabilites (cash + marketable securities + receivables)/current liabilities Average AR/average daily sales average daily sales = net sales/365 COGS/average inventory total liabilities/total stockhoders' equity EBIT/Interest Expense (net income + interest expense)/average total assets net income /# of shares common stock outstanding market value per share/ EPS $ $ 2019 750,000 2.00 1.00 27.38 days 5.67 times 1.04 6.19 times 10% 2.45 10.20 2017 $ 125,000 $ 50,000 $ 320,000 $ 500,000 $ 20,000 $ 1,015,000 $ 225,000 $ 1,948,000 $ 3,188,000 $ 650,000 $ $ 800,000 $ 800,000 $ 1,450,000 $ 1,000,000 $ 738,000 $ 1,738,000 $ 3,188,000 $ $ 2018 350,000 1.54 0.77 36.79 4.24 0.84 7.05 8.65% 2.11 11.84 Ratio Working Capital Current Ratio Quick Ratio Days sales in receivable inventory turnover debt to equity times-interest earned ROA EPS P/E ratio $ 2019 2018 750,000 $ 350,000 2 1.538461538 1 0.769230769 27.375 36.78515625 5.666666667 4.244897959 1.040892193 0.841555427 6.19047619 7.05 0.09977195 0.086527276 2.45 2.112 10.20408163 11.83712121 Industry Competitor Standard Standard 740000 755000 2 1.6 1.1 0.81 30 5.4 6 4.23 0.4 0.56 7.5 8 0.14 0.14 4.5 4 6 6.85 Ratio Horizontal Analysis Comments FSA Memo for Principles II Not acceptable -Misses one or more ratios -Made 3 or more calculation errors --Did not use the ratios to make a decision or -Did not suggest a decision or -Suggested a decision that’s not supported by the ratios Acceptable -Calculated all necessary ratios -Made 1 or 2 minor calculation errors -Suggested a decision and supported it by referring only in a general way to the ratios or -Makes little or no comparison to the ratios of previous years or of industry competitors Length of discussion10% -Makes a one-sentence recommendation with no discussion -Word count 500 -Thoroughly discusses the company’s short-term and longterm ability to pay bills (liquidity) -Thoroughly discusses the company’s profitability and -Thoroughly discusses management of the company and --Thoroughly discusses market perceptions of the company -Typed -Well edited (no major errors in spelling, punctuation or grammar) -Ratios are labelled by type
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