Chapter 15 Financial Statement Analysis Demonstration Problems © 2016 Pearson Education, Ltd. 15-1.
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FinancialStatementAnalysis
15
Revised by Judy Beebe, Western Oregon University
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Horizontal Analysis
The percentage analysis of
increases and decreases inrelated items in comparative
financial statements is called
horizontal analysis.
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Exhibit 1 Comparative Balance Sheets
Assets
Current assets $ 550,000 $ 533,000 $ 17,000 3.2%
Long-term investments 95,000 177,500 (82,500) (!.5%)
"ro#., #ant, an e&ui#. (net) ,500 70,000 (25,500) (5.%)
'ntangie assets 50,000 50,000
ota assets $1,139,500 $1,230,500 $ (91,000)(7.%)
Liaiities
Current iaiities $ 210,000 $ 23,000 $ (33,000) (13.!%)
Long-term iaiities 100,000 200,000 100,000) (50.0%)
ota iaiities $ 310,000 $ 3,000 $(133,000)(30.0%) *to+oers /&uit
"reerre !% sto+, $100 #ar $ 150,000 $ 150,000
Common sto+, $10 #ar 500,000 500,000
etaine earnings 179,500 137,500 $ 2,000 30.5%
ota sto+oers e&uit $ 829,500 $ 787,500 $ 2,000 5.3%
ota ia. 4 sto+oers e&. $1,139,500 $1,230,500 $ (91,000)(7.%)
2008 2007 Amount "er+ent'n+rease (e+rease)
Lin+on Com#an
Com#arative 6aan+e *eete+emer 31, 2008 an 2007
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Assets
Current assets $ 550,000 $ 533,000 $ 17,000 3.2%
Long-term investments 95,000 177,500 (82,500) (!.5%)
"ro#., #ant, an e&ui#. (net) ,500 70,000 (25,500) (5.%)
'ntangie assets 50,000 50,000
ota assets $1,139,500 $1,230,500 $ (91,000)(7.%)
Liaiities
Current iaiities $ 210,000 $ 23,000 $ (33,000) (13.!%)
Long-term iaiities 100,000 200,000 100,000) (50.0%)
ota iaiities $ 310,000 $ 3,000 $(133,000)(30.0%) *to+oers /&uit
"reerre !% sto+, $100 #ar $ 150,000 $ 150,000
Common sto+, $10 #ar 500,000 500,000
etaine earnings 179,500 137,500 $ 2,000 30.5%
ota sto+oers e&uit $ 829,500 $ 787,500 $ 2,000 5.3%
ota ia. 4 sto+oers e&. $1,139,500 $1,230,500 $ (91,000)(7.%)
2008 2007 Amount "er+ent
Lin+on Com#an
Com#arative 6aan+e *eete+emer 31, 2008 an 2007
'n+rease (e+rease)
orionta Anasis
ieren+e $17,000
6ase ear (2007) $533,000: 3.2%
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Assets
Current assets $ 550,000 $ 533,000 $ 17,000 3.2%
Long-term investments 95,000 177,500 (82,500) (!.5%)
"ro#., #ant, an e&ui#. (net) ,500 70,000 (25,500) (5.%)
'ntangie assets 50,000 50,000
ota assets $1,139,500 $1,230,500 $ (91,000)(7.%)
Liaiities
Current iaiities $ 210,000 $ 23,000 $ (33,000) (13.!%)
Long-term iaiities 100,000 200,000 100,000) (50.0%)
ota iaiities $ 310,000 $ 3,000 $(133,000)(30.0%) *to+oers /&uit
"reerre !% sto+, $100 #ar $ 150,000 $ 150,000
Common sto+, $10 #ar 500,000 500,000
etaine earnings 179,500 137,500 $ 2,000 30.5%
ota sto+oers e&uit $ 829,500 $ 787,500 $ 2,000 5.3%
ota ia. 4 sto+oers e&. $1,139,500 $1,230,500 $ (91,000)(7.%)
2008 2007 Amount "er+ent
Lin+on Com#an
Com#arative 6aan+e *eete+emer 31, 2008 an 2007
'n+rease (e+rease)
orionta Anasis
ieren+e $(82,500)
6ase ear (2007) $177,500
: (!.5%)
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Comparative Schedule of
Current Assets
Lin+on Com#anCom#arative *+eue o Current Assets
e+emer 31, 2008 an 2007
Increase !ecrease)
Cash " #$%5$$ " 64%&$$ " 25%'$$ 3#.#(
Marketa)le sec*rities &5%$$$ 6$%$$$ 15%$$$ 25.$(
+cco*nts receiva)le net, 115%$$$ 12$%$$$ 5%$$$, 4.2(,
Inventories 264%$$$ 2'3%$$$ 1#%$$$, 6.&(,
-repaid epenses 5%5$$ 5%3$$ 2$$ 3.'(Total c*rrent assets "55$%$$$ "533%$$$ "1&%$$$ 3.2(
2$$' 2$$& +mo*nt -ercent
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Lin+on Com#anCom#arative *+eue o Current Assets
e+emer 31, 2008 an 2007
Increase !ecrease)
Cash " #$%5$$ " 64%&$$ " 25%'$$ 3#.#(
Marketa)le sec*rities &5%$$$ 6$%$$$ 15%$$$ 25.$(
+cco*nts receiva)le net, 115%$$$ 12$%$$$ 5%$$$, 4.2(,
Inventories 264%$$$ 2'3%$$$ 1#%$$$, 6.&(,
-repaid epenses 5%5$$ 5%3$$ 2$$ 3.'(Total c*rrent assets "55$%$$$ "533%$$$ "1&%$$$ 3.2(
2$$' 2$$& +mo*nt -ercent
orionta Anasis
ieren+e $25,8006ase ear (2007) $!,700
: 39.9%
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Lin+on Com#an
Com#arative 'n+ome *tatement;or te <ear /ne e+emer 31, 2008 an 2007
*aes $1,530,500 $1,23,000 $29!,500 2.0%
*aes returns an ao=an+es 32,500 3,000 (1,500) (.%)
>et saes $1,98,000 $1,200,000 $298,000 2.8%Cost o goos so 1,03,000 820,000 223,000 27.2%
?ross #roit $ 55,000 $ 380,000 $ 75,000 19.7%
*eing e@#enses $ 191,000 $ 17,000 $ ,000 29.9%
Aministrative e@#enses 10,000 97,00 !,!00 !.8%
ota o#erating e@#enses $ 295,000 $ 2,00 $ 50,!00 20.7%
'n+ome rom o#erations $ 1!0,000 $ 135,!00 $ 2,00 18.0%
ter in+ome 8,500 11,000 (2,500) (22.7%)
$ 1!8,500 $ 1!,!00 $ 21,900 1.9%
ter e@#ense (interest) !,000 12,000 (!,000) (50.0%)
'n+ome eore in+ome ta@ $ 1!2,500 $ 13,!00 $ 27,900 20.7%
'n+ome ta@ e@#ense 71,500 58,100 13,00 23.1%
>et in+ome $ 91,000 $ 7!,500 $ 1,500 19.0%
2008 2007 Amount "er+ent'n+rease (e+rease)
Comparative Income Statement 15-1
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Lin+on Com#an
Com#arative 'n+ome *tatement;or te <ear /ne e+emer 31, 2008 an 2007
Current assets $1,530,500 $1,23,000 $29!,500 2.0%
*aes returns an ao=an+es 32,500 3,000 (1,500) (.%)
>et saes $1,98,000 $1,200,000 $298,000 2.8%Cost o goos so 1,03,000 820,000 223,000 27.2%
?ross #roit $ 55,000 $ 380,000 $ 75,000 19.7%
*eing e@#enses $ 191,000 $ 17,000 $ ,000 29.9%
Aministrative e@#enses 10,000 97,00 !,!00 !,.8%
ota o#erating e@#enses $ 295,000 $ 2,00 $ 50,!00 20.7%
'n+ome rom o#erations $ 1!0,000 $ 135,!00 $ 2,00 18.0%
ter in+ome 8,500 11,000 (2,500) (22.7%)$ 1!8,500 $ 1!,!00 $ 21,900 1.9%
ter e@#ense (interest) !,000 12,000 (!,000) (50.0%)
'n+ome eore in+ome ta@ $ 1!2,500 $ 13,!00 $ 27,900 20.7%
'n+ome ta@ e@#ense 71,500 58,100 13,00 23.1%
>et in+ome $ 91,000 $ 7!,500 $ 1,500 19.0%
2008 2007 Amount "er+ent'n+rease (e+rease)
orionta Anasis
'n+rease amount $29!,5006ase ear (2007) $1,23,000
: 2.0%
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Comparative Retained
Earnins Statement
+ percentage analysis that
sho/s the relationship of eachcomponent to the total /ithin
a single statement is called
vertical analysis.
Lin+on Com#anCom#arative etaine /arnings *tatement
e+emer 31, 2008 an 2007
Increase !ecrease)
0etained earnings% an. 1 "13&%5$$ "1$$%$$$ "3&%5$$ 3&.5(
et income for year #1%$$$ &6%5$$ 14%5$$ 1#.$(
Total "22'%5$$ "1&6%5$$ "52%$$$ 2#.5(,
!ividends
n preferred stock " #%$$$ " #%$$$
n common stock 4$%$$$ 3$%$$$ 1$%$$$ 33.3(
Total " 4#%$$$ " 3#%$$$ "1$%$$$ 25.6(
Total c*rrent assets "1&#%5$$ "13&%5$$ "42%$$$ 3$.5(
2$$' 2$$& +mo*nt -ercent
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+ percentage analysis that
sho/s the relationship of each
component to the total /ithina single statement is called
vertical analysis.
Lin+on Com#anCom#arative etaine /arnings *tatement
e+emer 31, 2008 an 2007
Increase !ecrease)
0etained earnings% an. 1 "13&%5$$ "1$$%$$$ "3&%5$$ 3&.5( et income for year #1%$$$ &6%5$$ 14%5$$ 1#.$(
Total "22'%5$$ "1&6%5$$ "52%$$$ 2#.5(,
!ividends
n preferred stock " #%$$$ " #%$$$
n common stock 4$%$$$ 3$%$$$ 1$%$$$ 33.3(Total " 4#%$$$ " 3#%$$$ "1$%$$$ 25.6(
Total c*rrent assets "1&#%5$$ "13&%5$$ "42%$$$ 3$.5(
2$$' 2$$& +mo*nt -ercent
orionta Anasis
'n+rease amount $37,500
6ase ear (2007) $100,000: 37.5%
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Example Exercise 15-1
15-1
The comparative cash and acco*nts receiva)le for a
company are provided )elo/
2$$' 2$$&Cash "62%5$$ "5$%$$$
+cco*nts receiva)le net, &4%4$$ '$%$$$
ased on this information% /hat is the amo*nt and
percentage of increase or decrease that /o*ld )e sho/nin a )alance sheet /ith hori7ontal analysis8
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9or -ractice -: 15;1+% -: 15;1
Follow My Example 15-1
15-1
Cash "12%5$$ increase "62%5$$ <
"5$%$$$,% or 25(
+cco*nts
0eceiva)le "5%6$$ decrease "&4%4$$ < "'$%$$$,
or <&(
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!ertical Analysis
+ percentage analysis *sed to
sho/ the relationship of eachcomponent to the total /ithin a
single statement is called
vertical analysis.
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In a vertical analysis of the aan+e
seet% each asset item is stated as a
percent of the tota assets. :ach
lia)ility and stockholders= e>*ity item
is stated as a percent of the total
lia)ilities and stockholders= e>*ity.
!ertical Analysis of Balance Sheet 15-1
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Lin+on Com#anCom#arative 6aan+e *eet
;or te <ears /ne e+emer 31, 2008 an 2007
Assets
Current assets $ 550,000 8.3% $ 533,000 3.3%
Long-term investments 95,000 8.3 177,500 1.
"ro#ert, #ant, 4 e&ui#. (net) ,500 39.0 70,000 38.2'ntangie assets 50,000 . 50,000 .1
ota assets $1,139,500 100.0% $1,230,500 100.0%
Liaiities
Current iaiities $ 210,000 18.% $ 23,000 19.7%
Long-term iaiities 100,000 8.8 200,000 1!.3
ota iaiities $ 310,000 27.2% $ 3,000 3!.0%
*to+oers /&uit"reerre !% sto+, $100 #ar $ 150,000 13.2% $ 150,000 12.2%
2.2% Common sto+, $10 #ar 500,000 3.9 500,000 0.!
etaine earnings 179,500 15.7 137,500 11.2
ota sto+oers e&uit $ 829,500 72.8% $ 787,500 !.0%
ota ia. 4 *to+oers e&uit $1,139,500 100.0% $1,230,500 100.0%
Amount "er+ent Amount "er+ent
2008 2007
ota assets $1,139,500 100.0% $1,230,500100.0%
ota ia. 4 sto+oers e&uit $1,139,500 100.0% $1,230,500100.0%
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To demonstrate ho/ vertical
analysis percentages are
calc*lated for the )alance sheet%let=s see ho/ the 4'.3 percent
/as calc*lated for the 2$$'
c*rrent assets in the net slide.
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Lin+on Com#anCom#arative 6aan+e *eet
;or te <ears /ne e+emer 31, 2008 an 2007
Assets
Current assets $ 550,000 8.3% $ 533,000 3.3%
Long-term investments 95,000 8.3 177,500 1.
"ro#ert, #ant, 4 e&ui#. (net) ,500 39.0 70,000 38.2'ntangie assets 50,000 . 50,000 .1
ota assets $1,139,500 100.0% $1,230,500 100.0%
Liaiities
Current iaiities $ 210,000 18.% $ 23,000 19.7%
Long-term iaiities 100,000 8.8 200,000 1!.3
ota iaiities $ 310,000 27.2% $ 3,000 3!.0%
*to+oers /&uit"reerre !% sto+, $100 #ar $ 150,000 13.2% $ 150,000 1
2.2% Common sto+, $10 #ar 500,000 3.9 500,000 0.!
etaine earnings 179,500 15.7 137,500 11.2
ota sto+oers e&uit $ 829,500 72.8% $ 787,500 !.0%
ota ia. 4 *to+oers e&uit $1,139,500 100.0% $1,230,500 100.0%
Amount "er+ent Amount "er+ent
2008 2007
ota assets $1,139,500 100.0% $1,230,500100.0%
ota ia. 4 sto+oers e&uit $1,139,500 100.0% $1,230,500100.0%
Berti+a Anasis
Current assets $550,000
ota assets $1,139,500: 8.3%
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In a vertical analysis of the
in+ome statement% each item is
stated as a percent of net saes.+s an eample% let=s see ho/ the
percent of 12.'( /as calc*lated
for 2$$' selling epenses.
!ertical Analysis of Income Statement 15-1
2$2$
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*aes $1,530,500 102.2% $1,23,000 102.8%
*aes returns an ao=. 32,500 2.2 3,000 2.8
>et saes $1,98,000 100.0% $1,200,000 100.0%
Cost o goos so 1,03,000 !9.! 820,000 !8.3
?ross #roit $ 55,000 30.% $ 380,000 31.7%*eing e@#enses $ 191,000 12.8% $ 17,000 12.3%
Aministrative e@#enses 10,000 !.9 97,00 8.1
ota o#erating e@#enses $ 295,000 19.7% $ 2,00 20.%
'n+ome rom o#erations $ 1!0,000 10.7 $ 135,!00 11.3%
ter in+ome 8,500 0.! 11,000 0.9
$ 1!8,500 11.3% $ 1!,!00 12.2%
ter e@#ense (interest) !,000 0. 12,000 1.0'n+ome eore in+ome ta@ $ 1!2,500 10.9% $ 13,!00 11.2%
'n+ome ta@ e@#ense 71,500 .8 58,100 .8
>et in+ome $ 91,000 !.1% $ 7!,500 !.%
2008 2007
Amount "er+ent Amount "er+ent
Lin+on Com#anCom#arative 'n+ome *tatement
;or te <ears /ne e+emer 31, 2008 an 2007
15-1
Comparative Income Statement
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*aes $1,530,500 102.2% $1,23,000 102.8%
*aes returns an ao=. 32,500 2.2 3,000 2.8
>et saes $1,98,000 100.0% $1,200,000 100.0%
Cost o goos so 1,03,000 !9.! 820,000 !8.3
?ross #roit $ 55,000 30.% $ 380,000 31.7%*eing e@#enses $ 191,000 12.8% $ 17,000 12.3%
Aministrative e@#enses 10,000 !.9 97,00 8.1
ota o#erating e@#enses $ 295,000 19.7% $ 2,00 20.%
'n+ome rom o#erations $ 1!0,000 10.7 $ 135,!00 11.3%
ter in+ome 8,500 0.! 11,000 0.9
$ 1!8,500 11.3% $ 1!,!00 12.2%
ter e@#ense (interest) !,000 0. 12,000 1.0'n+ome eore in+ome ta@ $ 1!2,500 10.9% $ 13,!00 11.2%
'n+ome ta@ e@#ense 71,500 .8 58,100 .8
>et in+ome $ 91,000 !.1% $ 7!,500 !.%
2008 2007
Amount "er+ent Amount "er+ent
Lin+on Com#anCom#arative 'n+ome *tatement
;or te <ears /ne e+emer 31, 2008 an 2007
Berti+a Anasis
*eing e@#enses $191,000
>et saes $1,98,000: 12.8%
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Common"Size Statements
In a common-sized statements% all
items are epressed as a percentage.
Common;si7ed statements are*sef*l in comparing the c*rrent
period /ith prior periods% individ*al
)*sinesses% or one )*siness /ith
/ith ind*stry percentages.
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Common"Size Income
Statement
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Example Exercise 15-2
15-1
Income statement information for ?ee Corporation is
provided )elo/ ?ee Corporation
@ales
"1$$%$$$
Cost of goods sold
65%$$$
Aross profit
" 35%$$$
-repare a vertical analysis of the income statement for?ee Corporation.
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9or -ractice -: 15;2+% -: 15;2
Follow My Example 15-2
15-1
@ales "1$$%$$$ 1$$( "1$$%$$$B"1$$%$$$,
Cost of goods sold65%$$$ 65"65%$$$B"1$$%$$$,
Aross profit 35%$$$ 35( "35%$$$B"1$$%$$$,
Amount "er+entage
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Solvency Analysis
The a)ility of a )*siness to meet
its financial o)ligations de)ts,
is called solvency.
The a)ility of a )*siness to earn
income is called profitability.
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Current #osition Analysis
sing meas*res to assess a
)*siness=s a)ility to pay its
c*rrent lia)ilities is calledcurrent position analysis. @*ch
analysis is of special interest to
short;term creditors.
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$or%in Capital
The ecess of c*rrent assets of a
)*siness over its c*rrent lia)ilities
is called working capital . The/orking capital is often *sed in
eval*ating a company=s a)ility to
meet c*rrently mat*ring de)ts.
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oring +a#ita (a D ) $30,000
Current asset
Cas $ 90,500
Earetae se+urities 75,000A++ounts re+eivae (net) 115,000
'nventories 2!,000
"re#ai e@#enses 5,500
a. ota +urrent assets $550,000
. Current iaiities 210,000
Lin+on Com#an
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Current Ratio
The current ratio% sometimes
called the working capital
ratio or bankers’ ratio% iscomp*ted )y dividing the total
c*rrent assets )y the total
c*rrent lia)ilities.
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31
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Current ratio (aF) 2.! 2.2
a. Current assets $550,000 $533,000
. Current iaiities 210,000 23,000
oring +a#ita (a D ) $30,000 $290,000
2008 2007
Lin+on Com#an
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&uic% Ratio
+ ratio that meas*res the
Dinstant= de)t;paying a)ilityof a company is called the
quick ratio or acid-test ratio.
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2008 2007
Gui+ ratio (aF) 1.3 1.0
Gui+ assets
Cas $ 90,500 $ !,700
Earetae se+urities 75,000 !0,000
A++ounts re+eivae (net) 115,000 120,000
a. ota &ui+ assets $280,500 $2,700
. Current iaiities $210,000 $23,000
Lin+on Com#an
Quick assets are cash
and other c*rrent assets
that can )e >*icklyconverted to cash.
Quick assets are cash
and other c*rrent assets
that can )e >*icklyconverted to cash.
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34
Example Exercise 15-3
15-
The follo/ing items are reported on a company=s
)alance sheet
Cash
"3$$%$$$
Marketa)le sec*rities
1$$%$$$
+cco*nts receiva)le net,
2$$%$$$
Inventory
!etermine a, the c*rrent ratio and ), the >*ick ratio.
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359or -ractice -: 15;3+% -: 15;3
Follow My Example 15-3a. C*rrent 0atio E C*rrent +ssetsBC*rrent ?ia)ilities
C*rrent 0atio E "3$$%$$$ F "1$$%$$$ F "2$$%$$$ F
"2$$%$$$,B"4$$%$$$
C*rrent 0atio E2.0
). G*ick 0atio E G*ick +ssets cash% marketa)le sec*rities%
and acco*nts receiva)le,BC*rrent ?ia)ilities
acco*nts paya)le,
G*ick 0atio E "3$$%$$$ F "1$$%$$$ F "2$$%$$$,B"4$$%$$$
G*ick 0atio E 1.5
15-
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Accounts Receivable 'urnover
The relationship )et/een sales and
acco*nts receiva)le may )e stated as
the accounts receivable turnover .The ratio is to assess the efficiency of
the firm in collecting receiva)les and
in the managing of credit.
15-
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A++ounts re+eivae turnover
(aF) 12.7 9.2
a. >et saes $1,98,000 $1,200,000
A++ounts re+eivae (net)
6eginning o ear $ 120,000 $ 10,000/n o ear 115,500 120,000
ota $ 235,000 $ 2!0,000
. Average (otaF2) $ 117,500
$ 130,000
2008 2007Lin+on Com#an
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3'
(umber of )ays* Sales in
Receivables
The number of days’ sales in
receivables is an estimate of the length
of time in days, the acco*ntsreceiva)le have )een o*tstanding.
Comparing this meas*re /ith the credit
terms provides information on theefficiency in collecting receiva)les.
15-
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3#
>umer o as saes in
re+eivaes (aF) 28.! 39.5
a. Average (otaF2) $ 117,500$ 130,000
>et saes $1,98,000 $1,200,000
. Average ai saes on
a++ount (*aesF3!5) $ ,10 $ 3,288
2008 2007
Lin+on Com#an
15-
4$4$
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4$
Example Exercise 15-4
15-
+ company reports the follo/ing
et sales
"#6$%$$$
+verage acco*nts receiva)le net,
4'%$$$
!etermine a, the acco*nts receiva)le t*rnover and ),
the n*m)er of days= sales in receiva)les. 0o*nd to one
decimal place.
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41
9or -ractice -: 15;4+% -: 15;4
Follow My Example 15-4
15-
a. +cco*nts 0eceiva)le T*rnover E @alesB+verage acco*nts
receiva)le
+cco*nts 0eceiva)le T*rnover E "#6$%$$$B"4'%$$$
+cco*nts 0eceiva)le T*rnover E 20.0
). *m)er of !ays= @ales in 0eceiva)les E +verage acco*nts
receiva)leB+verage daily sales
*m)er of !ays= @ales in 0eceiva)les E "4'%$$$B
"#6$%$$$B 365,
*m)er of !ays= @ales in 0eceiva)les E "4'%$$$B"2%63$
*m)er of !ays= @ales in 0eceiva)les E 18.3 as
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42
Inventory 'urnover
The relationship )et/een the
vol*me of goods merchandise,
sold and inventory may )e statedas the inventory turnover . The
p*rpose of this ratio is to assess
the efficiency of the firm in
managing its inventory.
15-
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2008 2007
'nventor turnover (aF) 3.8 2.8
a. Cost o goos so $1,03,000 $ 820,000
'nventories
6eginning o ear $ 283,000 $ 311,000
/n o ear 2!,000 283,000
ota $ 57,000 $ 59,000
. Average (otaF2) $ 273,500
$ 297,000
Lin+on Com#an
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>umer o as saes in inventor (aF) 95.7 132.2
a. Average (otaF2) $ 273,500 $ 297,000
Cost o goos so $1,03,000 $ 820,000
. Average ai +ost o goos
so (C?*F3!5 as) $2,858 $2,27
2008 2007
(umber of )ays* Sales in Inventory
Lin+on Com#an
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45
Example Exercise 15-5
15-
+ company reports the follo/ing
Cost of goods sold
"56$%$$$
+verage inventory
112%$$$
!etermine a, the inventory t*rnover and
), the n*m)er of days= sales in inventory.
0o*nd to one decimal place.
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9or -ractice -: 15;5+% -: 15;5
Follow My Example 15-5
15-
a. Inventory T*rnover E Cost of Aoods @oldB+verageInventory
Inventory T*rnover E "56$%$$$B"112%$$$
Inventory T*rnover E 5.0
). *m)er of !ays= @ales in Inventory E +verage InventoryB+verage !aily Cost of Aoods @old
*m)er of !ays= @ales in Inventory E "112%$$$B
"56$%$$$B365,
*m)er of !ays= @ales in Inventory E "112%$$$B"1%534 *m)er of !ays= @ales in Inventory E 73.0 as
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4&
Ratio of +ixed Assets to ,on"'erm
,iabilities
The ratio of fixed assets to long-
term liabilities is a solvency meas*re
that indicates the margin of safety ofthe noteholders or )ondholders. It
also indicates the a)ility of the
)*siness to )orro/ additional f*nds
on a long;term )asis.
15-
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2008 2007
atio o i@e assets to
ong-term iaiities (aF) . 2.
a. ;i@e assets (net) $,500 $70,000
. Long-term iaiities $100,000 $200,000
Lin+on Com#an
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Ratio of ,iabilities to Stoc%holders*
E-uity
The relationship )et/een the
total claims of the creditors and
o/nersthe ratio of liabilities to
stockholders’ equity is a
solvency meas*re that indicates
the margin of safety for creditors.
15-
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5$
atio o iaiities to
sto+oers e&uit (aF) 0. 0.!
a. ota iaiities $310,000 $3,000
. ota sto+oers e&uit $829,500 $787,500
2008 2007
Lin+on Com#an
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Example Exercise 15-6
15-
The follo/ing information /as taken from +cme
Company=s )alance sheet
9ied assets net,
"1%4$$%$$$
?ong;term lia)ilities
4$$%$$$Total lia)ilities
56$%$$$
Total stockholders= e>*ity
!etermine the company=s a, ratio of fied assets to
long;term lia)ilities and ), ratio of lia)ilities tostockholders= e>*ity.
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9or -ractice -: 15;6+% -: 15;6
Follow My Example 15-6
15-
a. 0atio of 9ied +ssets to ?ong;Term ?ia)ilities E 9ied +ssetsB?ong;
Term ?ia)ilities
0atio of 9ied +ssets to ?ong;Term ?ia)ilities E "1%4$$%$$$B
"4$$%$$$
0atio of 9ied +ssets to ?ong;Term ?ia)ilities E 3.5
). 0atio of ?ia)ilities to Total @tockholders= :>*ity E Total
?ia)ilitiesBTotal @tockholders= :>*ity
0atio of ?ia)ilities to Total @tockholders= :>*ity E "56$%$$$B
"1%4$$%$$$
0atio of ?ia)ilities to Total @tockholders= :>*ity E 0.
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(umber of 'imes Interest Chares
Earned
Corporations in some ind*stries
normally have high ratios of de)t to
stockholders= e>*ity. 9or s*ch
corporations% the relative risk of the
de)tholders is normally meas*red as the
number of times interest charges are
earned d*ring the year,% sometimescalled the fixed charge coverage ratio.
15-
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2008 2007
'n+ome eore in+ome ta@ $1!2,500 $13,!00
a. A interest e@#ense !,000 12,000. Amount avaiae to meet
interest +arges $1!8,500 $1!,!00
Lin+on Com#an
>umer o times interest
+arges earne (Fa) 28.1 12.2
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Example Exercise 15-7
15-
+ company reports the follo/ing
Income )efore income ta
"25$%$$$
Interest epense
1$$%$$$
!etermine the n*m)er of times interest charges
are earned.
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9or -ractice -: 15;&+% -: 15;&
Follow My Example 15-7
15-
*m)er of Times Interest Charges are :arned E
Income efore Income Ta F Interest :pense,B
Interest :pense *m)er of Times Interest Charges are :arned E
"25$%$$$ F "1$$%$$$,B"1$$%$$$
*m)er of Times Interest Charges are :arned E 3.5
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5&
#rofitability Analysis
Profitability is the a)ility of an entity to earn profits.
This a)ility to earn profits depends on the
effectiveness and efficiency of operations as
/ell as reso*rces availa)le as reported in the
)alance sheet.
Profitability analysis foc*ses primarily on
the relationship )et/een operating res*ltsreported in the income statement and
reso*rces reported in the )alance sheet.
15-!
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5'
Ratio of (et Sales to Assets
The ratio of net sales to assets
is a profita)ility meas*re thatsho/s ho/ effectively a firm
*tili7es its assets.
15-!
5#5#
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2008 2007
a. >et saes $1,98,000 $1,200,000
ota assets
6eginning o ear $1,053,000 $1,010,000/n o ear 1,0,500 1,053,000
ota $2,097,500 $2,0!3,000
. Average (otaF2) $1,08,750 $1,031,500
Lin+on Com#an
:cl*des long;term investments:cl*des long;term investments
15-!
6$6$
6$
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6$
2008 2007
a. >et saes $1,98,000 $1,200,000
ota assets
6eginning o ear $1,053,000 $1,010,000/n o ear 1,0,500 1,053,000
ota $2,097,500 $2,0!3,000
. Average (otaF2) $1,08,750 $1,031,500
Lin+on Com#an
atio o net saes to assets (aF) 1. 1.2
15-!
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Example Exercise 15-8
15-!
+ company reports the follo/ing et sales
"2%25$%$$$
+verage total sales
1%5$$%$$$
!etermine the ratio of net sales to assets.
Follow My Example 15-8
0atio of et @ales to Total +ssets E et @alesB+verage Total
+ssets
0atio of et @ales to Total +ssets E "2%25$%$$$B"1%5$$%$$$
0atio of et @ales to Total +ssets E 1.5
9or -ractice -: 15;'+% -: 15;'
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Rate Earned on 'otal Assets
The rate earned on total
assets meas*res the profita)ility of total assets%
/itho*t considering ho/ the
assets are financed.
15-!
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2008 2007
ate earne on tota
assets (aF) 8.2% 7.3%
>et in+ome $ 91,000 $ 7!,500
"us interest e@#ense !,000 12,000
a. ota $ 97,000 $ 88,500ota assets
6eginning o ear $1,230,500 $1,187,500
/n o ear 1,139,500 1,230,500
ota $2,370,000 $2,18,000
. Average (otaF2) $1,185,000 $1,209,000
Lin+on Com#an
15-!
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Example Exercise 15-9
15-!
+ company reports the follo/ing income statement and
)alance sheet information for the c*rrent year
et income
" 125%$$$
Interest epense
25%$$$+verage total assets
2%$$$%$$$
!etermine the rate earned on total assets.
6565
65
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9or -ractice -: 15;#+% -: 15;#
Follow My Example 15-9
15-!
0ate :arned on Total +ssets E et Income F Interest
:pense,B+verage Total +ssets
0ate :arned on Total +ssets E "125%$$$ F "25%$$$,B"2%$$$%$$$
0ate :arned on Total +ssets E 7.5%
6666
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Rate Earned on Stoc%holders* E-uity
The rate earned on
stockholders’ equity meas*reemphasi7es the rate of income
earned on the amo*nt invested
)y the stockholders.
15-!
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6&
ate earne on sto+oerse&uit (aF) 11.3% 10.0%
a. >et in+ome $ 91,000 $ 7!,500
*to+oers e&uit
6eginning o ear $ 787,500 $ 750,000/n o ear 829,500 787,500
ota $1,!17,000 $1,537,500
. Average (otaF2) $ 808,500 $ 7!8,750
2008 2007Lin+on Com#an
15-!
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6'
The difference in the rate
earned on stockholders= e>*ityand the rate earned on total
assets is called leverage.
,everae 15-!
6#6#
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6#
1$(
5(
$(
0ate earned on
total assets
0ate earned on
stockholders= e>*ity
8.2%
11.3%Leverage
3.1%
2008
7.3%
10.0%
Leverage
2.7%
2007
,everae 15-!
&$&$
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&$
The rate earned on common
stockholders’ equity foc*sesonly on the rate of profits
earned on the amo*nt invested
)y the common stockholders.
Rate Earned on Common
Stoc%holders* E-uity
15-!
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&1
2008 2007
>et in+ome $ 91,000 $ 7!,500
Less #reerre iviens 9,000 9,000
a. emainer+ommon sto+ $ 82,000 $ !7,500
Common sto+oers e&uit6eginning o ear $ !37,500 $ !00,000
/n o ear !79,500 !37,500
ota $1,317,000 $1,237,500
. Average (otaF2) $ !58,500 $ !18,750 ate earne on +ommon
sto+oers e&uit (aF) 12.5% 10.9%
Lin+on Com#an15-!
&2&2
&2
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&2
Example Exercise 15-10
15-!
+ company reports the follo/ing
et income
" 125%$$$-referred dividends
5%$$$
+verage stockholders= e>*ity
1%$$$%$$$
+verage common stockholders=
e>*ity
!etermine a, the rate earned on stockholders= e>*ity
and ), the rate earned on common stockholders=e>*ity.
&3&3
&3
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&3
9or -ractice -: 15;1$+% -: 15;1$
Follow My Example 15-10
15-!
a. 0ate :arned on @tockholders= :>*ity E et IncomeB+verage
@tockholders= :>*ity
0ate :arned on @tockholders= :>*ity E "125%$$$B"1%$$$%$$$
0ate :arned on @tockholders= :>*ity E 12.5%
). 0ate :arned on Common @tockholders= :>*ity E et
Income < -referred !ividends,B+verage Common
@tockholders= :>*ity
0ate :arned on Common @tockholders= :>*ity E
"125%$$$ < "5%$$$,B"'$$%$$$0ate :arned on Common @tockholders= :>*ity E 15%
&4&4
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Earnins per Share on Common Stoc%
ne of the profita)ility
meas*res often >*oted )y the
financial press is earning per
share !P"# on common stock .
It is also normally reported in
the income statement in
corporate ann*al reports.
15-!
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2008 2007
/arnings #er sare on +ommon
sto+ (aF) $1.! $1.35
>et in+ome $ 91,000 $ 7!,500
"reerre iviens 9,000 9,000
a. emainerientiie =it +ommon sto+ $ 82,000 $ !7,500
. *ares o +ommon sto+50,000 50,000
Lin+on Com#an
15-!
&6&6
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#rice"Earnins Ratio
+nother profita)ility meas*re
>*oted )y the financial press
is the price-earnings P$!#
ratio on common stock. The
price;earnings ratio is an
indicator of a firm=s f*t*re
earnings prospects.
15-!
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&&
2008 2007
"ri+e-earnings ratio on
+ommon sto+ 25 20
Earet #ri+e #er sare o
+ommon sto+ $1.00 $27.00
/arnings #er sare on +ommon
sto+ F 1.! F 1.35
Lin+on Com#an
15-!
&'&'
&'
15-
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&'
Example Exercise 15-11
15-!
+ company reports the follo/ing
et income
"25$%$$$
-referred dividends
"15%$$$
@hares of common stock
o*tstanding
2$%$$$Market price per share of
common stock
"35
a. !etermine the company=s earnings per share on
common stock. ). !etermine the company=s price;earnings ratio.
0o*nd to one decimal place.
&#&#
&#
15-
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&#
Follow My Example 15-11
15!
a, :arnings -er @hare of Common @tock E et
Income < -referred !ividends,B@hares of
Common @tock *tstanding:arnings per @hare of Common @tock E
"25$%$$$ < "15%$$$,B2$%$$$
:arnings per @hare of Common @tock E
$11.75
%ontinued#
'$'$
'$
15-
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'$
15!
), -rice;:arnings 0atio E Market -rice per @hare of
Common @tockB:arnings per @hare on Common
@tock -rice;:arnings 0atio E "35.$$B"11.&5
-rice;:arnings 0atio E 3.0
Follow My Example 15-11
9or -ractice -: 15;11+% -: 15;11
%oncluded#
'1'1
'1
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'1
)ividends per Share
&ividends per share can )e reported
/ith earnings per share to indicate the
relationship )et/een dividends and
earnings. Comparing these t/o pershare amo*nts indicates the etent to
/hich the corporation is retaining its
earnings for *se in operations.
15-!
'2'2
'2
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'2!ividends :arnings
$0.80
$1.!
2008
$0.!0
$1.35
2007
"er
sare
$2.00
$1.50
$1.00
$0.50
$0.00
Lin+on Com#an
)ividends and Earnin per
Share of Common Stoc%
15-!
'3'3
'3
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'3
The dividend yield on common
stock is a profita)ility meas*re
that sho/s the rate of ret*rn tocommon stockholders in terms
of cash dividends.
)ividend .ield 15-!
'4'4
'4
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'4
2008 2007
ivien ie on
+ommon sto+ 2.0% 2.2%
iviens #er sare o
+ommon sto+ $ 0.80$ 0.!0
Earet #ri+e #er sare o
+ommon sto+ F1.00
F27.00
Lin+on Com#an
15-!
'5'5
'5
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'5
Corporate Annual Reports
In addition to the financial statements and
the accompanying notes% corporate ann*al
reports *s*ally incl*de the follo/ing
sections Management !isc*ssion and +nalysis
0eport on ade>*acy of internal control
0eport on fairness of financial statements
15-"
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'6
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'6
The 'anagement &iscussion and (nalysis
'&)(# incl*des an analysis of the res*lts
of operations and disc*sses management=sopinion a)o*t f*t*re performance. It
compares the prior year=s income statement
/ith the c*rrent year=s. It also contains an
analysis of the firm=s financial condition.
/anaement )iscussion and
Analysis
15-"
'&'&
'&
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'&
Management is re>*ired )y the @ar)anes;
ley +ct of 2$$2 to provide a report stating
their responsi)ility for esta)lishing andmaintaining internal control. In addition% the
report m*st state management=s concl*sion
concerning the effectiveness of internal
controls over financial reporting.
Report on Ade-uacy of
Internal Control
15-"
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''
+ll p*)licly held corporations are
re>*ired to have an independent a*dit
eamination, of their financialstatements. The C-+s /ho cond*ct the
a*dit render an opinion on the fairness
of the statements.
Report on +airness of +inancial
Statements
15-"