Chapter 3

Financial Statements and Ratio Analysis

• Generally accepted accounting principles (GAAP): are the practice and procedure
guidelines used to prepare and maintain financial records and reports; authorized by the
Financial Accounting Standards Board (FASB).
• Financial Accounting Standards Board (FASB): The accounting profession’s rule-
setting body, which authorizes generally accepted accounting principles (GAAP).

• Public Company Accounting Oversight Board (PCAOB): A not-for-profit

corporation established to protect the interests of investors and further the public interest
in the preparation of informative, fair, and independent audit reports.
__________________________________________________________________________
The Stockholders’ Report
 The stockholders’ report summarizes and documents the firm’s financial activities
during the past year. It begins with a letter to the stockholders from the firm’s president
and/or chairman of the board.

 The letter to stockholders is the primary communication from management. It

describes the events that are considered to have had the greatest effect on the firm during
the year. It also typically discusses management philosophy, corporate governance
issues, strategies, and actions, as well as plans for the coming year.

 The four key financial statements are: Income Statement, Cash Flow Statement,
Retained Earnings Statement and Balance Sheet

 Notes to the financial statements Explanatory notes keyed to relevant accounts in the
statements; they provide detailed information on the accounting policies, procedures,
calculations, and transactions underlying entries in the financial statements.

Why do companies analyze their financial statements?

• To look at how your company is doing compared to earlier periods of time, and
• How is the performance of your company, compared to other companies in the same
industry!
1. Cross-Sectional Analysis: Used to compare different firms at the same point in time.
2. Time-Series Analysis: Used to evaluate a firm’s performance over time.
3. Combined Analysis: Combined analysis simply uses a combination of both time
series analysis and cross-sectional analysis.

1
 Ratio How to calculate it… Purpose of use… Comment
1. Liquidity Ratios

Current Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 It measures how the The higher,
company can pay its the better.
bills when they come
Quick Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 due.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

2. Activity Ratios
Inventory 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 Measures how many The higher,
Turnover 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 times; inventories are the better
sold and replaced.
Average age 365 Measures how many
of inventory 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 days; inventories are
sold and replaced.
Average 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 Measures the number
Collection 𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 of days; to collect the The lower,
Period 365 receivables. the better.
Measures how many
Average 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 days, a company pays
Payment 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 its bills.
Period 365 Note: the annual
purchases can be
percentage of CGS.
How the company
Total Asset 𝑆𝑎𝑙𝑒𝑠 uses the assets to Higher,
Turnover 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 generate sales. better.

3. Debt Ratios
Measures the
Debt Ratio 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 proportion of total
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 assets that is financed
by the firm’s
creditors Higher,
Measures the firm’s better.
Time Interest 𝐸𝐵𝐼𝑇 ability to make
Earned Ratio 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 contractual interest
payments.

2
 4. Profitability Ratios
Measures the
Gross Profit 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 percentage of sales
Margin 𝑆𝑎𝑙𝑒𝑠 dollars remaining
after paying for
goods.
Measures the
Operating 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 percentage of sales
Profit Margin 𝑆𝑎𝑙𝑒𝑠 dollars remaining
after paying for
Operating Expenses. The higher,
Measures the the better.
Net Profit 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 percentage of sales
dollars remaining after
Margin 𝑆𝑎𝑙𝑒𝑠
paying for all Expenses
and preferred stock
dividends.
Earnings per 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 Shows the
Share (EPS) # 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 “available” earnings
for the common stock
Measures how the
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 company uses its
Assets 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 assets, to generate
(ROA) profits. AKA ROI
Measures how the
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 company generates
Equity 𝐶𝑜𝑚𝑜𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦 profits, from the
(ROE) money invested by
the shareholders.
5. Market Ratio
Measures how much
Price 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 the investors are
Earnings 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) willing to pay for The higher,
Ratio (P/E) each dollar earnings. the better
Market/ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 Shows how the
Book Ratio 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 investors view the
(M/B) firm’s performance.

Note: Common Stockholders’ equity = Total Stockholders’ equity – any preferred stock equity
𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝐸𝑞𝑢𝑖𝑡𝑦
Book Value =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝐶𝑆 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

Common Stock Equity = Common Stock + PIC + RE

3
P3 – 25 page 157

STERLING COMPANY
Income Statement
For the year ended December 31, 2012
Sales Revenue $10,000,000
Less: Cost of Goods Sold 7,500,000
Gross Profits $2,500,000
Less: Operating Expenses
Selling Expenses $300,000
General and admin. Expenses 650,000
Lease Expense 50,000
Depreciation Expense 200,000 $1,200,000
Operating Profits $1,300,000
Less: Interest Expense 200,000
Net Profit before taxes $1,100,000
Less: Taxes 440,000
Net Profit After Taxes $660,000
Less: Preferred Stock Dividends 50,000
Earnings Av. For CS $610,000

STERLING COMPANY
Balance Sheet
December 31, 2012
Assets Liabilities and SHE
Cash $200,000 Accounts Payable $900,000
Marketable Securities 50,000 Notes Payable 200,000
Accounts Receivable 800,000 Accruals 100,000
Inventories 950,000 Total Current Liab. $1,200,000
Total Current Assets $2,000,000 Long-term debts 3,000,000
Preferred Stock1 $1000,000
Gross Fixed Assets $12,000,000 Common Stock2 600,000
Less: Accumulated Dep. 3,000,000 PIC – CS 5,200,000
Net Fixed Assets $9,000,000 Retained Earnings 1,000,000
Other Assets 1,000,000 Total SHE $7,800,000
Total Assets $12,000,000 Total Liab. & SHE $12,000,000
Additional Information:
 Preferred Stock (25,000 Shares, $2 dividends per share)1
 Common Stock ( 200,000 Shares, $3 par value)2 Market price was $39.5
 Annual Credit Purchases $6,200,000

4
 Ratio How to calculate it… Calculations
1. Liquidity Ratios
Current Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 2,000
= 1.67
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 1,200
Quick Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 2,000 − 950
= 0.88
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 1,200
2. Activity Ratios
Inventory 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 7,500
= 7.89
Turnover 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 950
Average age 365 365
= 46.26 𝐷𝑎𝑦𝑠
of inventory 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 7.89
Average 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 800
= 29.2 𝐷𝑎𝑦𝑠
Collection 𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 10,000
Period 365 365
Average 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 900
= 53 𝐷𝑎𝑦𝑠
Payment 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 6,200
Period 365 365
Total Asset 𝑆𝑎𝑙𝑒𝑠 10,000
= 0.833
Turnover 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 12,000
3. Debt Ratios
Debt Ratio 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 4,200
= 0.35
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 12,000
Time Interest 𝐸𝐵𝐼𝑇 1,300
= 6.5
Earned Ratio 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 200
4. Profitability Ratios
Gross Profit 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 2,500
= 0.25
Margin 𝑆𝑎𝑙𝑒𝑠 10,000
Operating 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 1,300
= 0.13
Profit Margin 𝑆𝑎𝑙𝑒𝑠 10,000
Net Profit 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 610
= 0.061
Margin 𝑆𝑎𝑙𝑒𝑠 10,000
Earnings per 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 610
= 3.05
Share (EPS) # 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 200
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 610
= 0.0508
Assets (ROA) 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 12,000
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 610
= 0.0897
Equity (ROE) 𝐶𝑜𝑚𝑜𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦 6,800
5. Market Ratio
Price Earnings 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 39.5
= 12.95
Ratio (P/E) 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) 3.05
Market/ Book 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 39.5
= 1.16
Ratio (M/B) 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 34

5
6
Financial Report:

Liquidity: Sterling Company’s overall liquidity as reflected by the current ratio and quick
ratio appears to be following different trends, but is below the industry average.

Activity: The activity of accounts receivable has improved, but inventory turnover has
deteriorated and is currently below the industry average. The firm’s average payment period
appears to have speeded up from 2010, although the firm is still paying more slowly than the
average company.

Debt: The firm’s debt ratios have increased from 2010 and are very close to the industry
averages, indicating currently acceptable values but an undesirable trend. The firm’s fixed
payment coverage has declined and is well below the industry average figure, indicating a
deterioration in servicing ability.

Profitability: The firm’s gross profit margin, while in line with the industry average, has
declined, probably due to higher cost of goods sold. The operating and net profit margins
have been stable and are also above industry averages. Both the ROA and the ROE appear
to have improved slightly and are better than the industry averages. EPS made a significant
increase in 2011 and 2012. The P/E ratio indicates an increasing degree of investor
confidence in the firm’s future earnings potential.

Market: The firm’s P/E ratio was good in 2010, fell significantly in 2011, but recovered in
2012. The ratio is now above the industry average. The market to book ratio initially showed
signs of improving in 2011 and 2012. The market’s interpretation of Sterling’s earning ability
indicates a lot of uncertainty. The fluctuation in the M/B ratio also shows signs of uncertainty.

In summary, the firm needs to attend to inventory and accounts payable and should not incur
added debts until its leverage and fixed-charge coverage ratios are improved. Other than
these indicators, the firm appears to be doing well, especially in generating return on sales.
The market seems to have some lack of confidence in the stability of Sterling’s future.

7
Dupont: ROA = Net Profit Margin × Total Asset Turnover
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆 𝑆𝑎𝑙𝑒𝑠 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆
= × =
𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Modified Dupont: ROE = ROA × FML

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆
= × =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑜𝑚𝑚𝑜𝑛𝑠 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑜𝑚𝑚𝑜𝑛𝑠 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦

Solving Problem 3 – 24 with Dupont

ROA = Net Profit Margin × Total Asset Turnover
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆 𝑆𝑎𝑙𝑒𝑠 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆
= × =
𝑆𝑎𝑙𝑒𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

610 10,000
=( = 0.061) × ( = 0.833) = 0.0508
10,000 12,000

ROE = ROA × FML

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆
= × =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑜𝑚𝑚𝑜𝑛𝑠 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑜𝑚𝑚𝑜𝑛𝑠 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦
610 12,000
=( = 0.0508) ×( = 1.764) = 0.0897
12,000 6,800

8
P3 – 23 page 154

FOX MANUFACTURING CO.

Income Statement
For the year ended December 31, 2012

Sales Revenue $600,000

Less: Cost of Goods Sold 460,000
Gross Profits $140,000
Less: Operating Expenses
General and admin. Expenses $30,000
Depreciation Expense 30,000 60,000
Operating Profits $80,000
Less: Interest Expense 10,000
Net Profit before taxes $70,000
Less: Taxes 27,100
Net Profit After Taxes $42,900

FOX MANUFACTURING CO.

Balance Sheet
December 31, 2012

Assets Liabilities and SHE

Cash $15,000 Accounts Payable $57,000
Marketable Securities 7,200 Notes Payable 13,000
Accounts Receivable 34,100 Accruals 5,000
Inventories 82,000 Total Current Liab. $75,000
Total Current Assets $138,300 Long-term debts 150,000
Common Stock* 110,200
Retained Earnings 73,100
Net Fixed Assets $270,000 Total SHE $183,300
Total Assets $408,300 Total Liab. & SHE $408,300
*20,000 shares outstanding

9
 Ratio How to calculate it… Calculations
1. Liquidity Ratios
Current Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 138,300
= 1.84
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 75,000
Quick Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 138,300 − 82,000
= 0.75
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 75,000
2. Activity Ratios
Inventory 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 460,000
= 5.61 𝑡𝑖𝑚𝑒𝑠
Turnover 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 82,000
Average age 365 365
= 65 𝑑𝑎𝑦𝑠
of inventory 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 5.61
Average 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 34,100
= 20.5 𝑑𝑎𝑦𝑠
Collection 𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 600,000
Period 365 365
Total Asset 𝑆𝑎𝑙𝑒𝑠 600,000
= 1.47
Turnover 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 408,300
3. Debt Ratios
Debt Ratio 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 225,000
= 0.55
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 408,300
Time Interest 𝐸𝐵𝐼𝑇 80,000
=8
Earned Ratio 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 10,000
4. Profitability Ratios
Gross Profit 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 140,000
= 0.23
Margin 𝑆𝑎𝑙𝑒𝑠 600,000
Operating 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 80,000
= 0.13
Profit Margin 𝑆𝑎𝑙𝑒𝑠 600,000
Net Profit 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 42,900
= 0.0715
Margin 𝑆𝑎𝑙𝑒𝑠 600,000
Earnings per 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 42,900
= $2.15
Share (EPS) # 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 20,000
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 42,900
= 0.105
Assets (ROA) 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 408,300
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 42,900
= 0.23
Equity (ROE) 𝐶𝑜𝑚𝑜𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦 183,300

10
Financial Report:

Liquidity: The current and quick ratios show a weaker position relative to the
industry average.

Activity: All activity ratios indicate a faster turnover of assets compared to the
industry. Further analysis is necessary to determine whether the firm is in a weaker
or stronger position than the industry. A higher inventory turnover ratio may indicate
low inventory, resulting in stockouts and lost sales. A shorter average collection
period may indicate extremely efficient receivables management, an overly zealous
credit department, or credit terms that prohibit growth in sales.

Debt: The firm uses more debt than the average firm, resulting in higher interest
obligations that could reduce its ability to meet other financial obligations.

Profitability: The firm has a higher gross profit margin than the industry, indicating
either a higher sales price or a lower cost of goods sold. The operating profit margin
is in line with the industry, but the net profit margin is lower than industry, an
indication that expenses other than cost of goods sold are higher than the industry.
Most likely, the damaging factor is high interest expenses due to a greater than
average amount of debt. The increased leverage, however, magnifies the return the
owners receive, as evidenced by the superior ROE.

11
P3 – 24 page 155

ZACH INDUSTRIES
Income Statement
For the year ended December 31, 2012

Sales Revenue $160,000

Less: Cost of Goods Sold 106,000
Gross Profits $54,000
Less: Operating Expenses
Selling Expenses $16,000
General and admin. Expenses 10,000
Lease Expense 1,000
Depreciation Expense 10,000 37,000
Operating Profits $17,000
Less: Interest Expense 6,100
Net Profit before taxes $10,900
Less: Taxes 4,360
Net Profit After Taxes $6,540

ZACH INDUSTRIES
Balance Sheet
December 31, 2012

Assets Liabilities and SHE

Cash $500 Accounts Payable $22,000
Marketable Securities 1,000 Notes Payable 47,000
Accounts Receivable 25,000 Total Current Liab. $69,000
Inventories 45,500 Long-term debts 22,950
Total Current Assets $72,000
Land $26,000
Buildings and Equipment net 52,000 Common Stock* 31,500
Net Fixed Assets $78,000 Retained Earnings 26,550
Total Assets $150,000 Total Liab. & SHE $150,000
*3,000 shares outstanding at a market price of $25

12
 Ratio How to calculate it… Calculations
1. Liquidity Ratios
Current Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 72,000
= 1.04
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 69,000
Quick Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 72,000 − 45,500
= 0.38
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 69,000
2. Activity Ratios
Inventory 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 106,000
= 2.33
Turnover 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 45,500
Average age 365 365
= 157 𝑑𝑎𝑦𝑠
of inventory 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 2.33
Average 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 25,000
= 57 𝑑𝑎𝑦𝑠
Collection 𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 160,000
Period 365 365
Total Asset 𝑆𝑎𝑙𝑒𝑠 160,000
= 1.067
Turnover 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 150,000
3. Debt Ratios
Debt Ratio 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 91,950
= 0.613
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 150,000
Time Interest 𝐸𝐵𝐼𝑇 17,000
= 2.78
Earned Ratio 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 6,100
4. Profitability Ratios
Gross Profit 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 54,000
= 0.3375
Margin 𝑆𝑎𝑙𝑒𝑠 160,000
Operating 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 17,000
= 0.106
Profit Margin 𝑆𝑎𝑙𝑒𝑠 160,000
Net Profit 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 6,540
= 0.040
Margin 𝑆𝑎𝑙𝑒𝑠 160,000
Earnings per 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 6,540
= $2.18
Share (EPS) # 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 3000
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 6,540
= 0.040
Assets (ROA) 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 160,000
Return on 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆 6,540
= 0.11
Equity (ROE) 𝐶𝑜𝑚𝑜𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐸𝑞𝑢𝑖𝑡𝑦 58,050
5. Market Ratio
Price Earnings 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 25
= 11.46
Ratio (P/E) 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) 2.18
Market/ Book 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 25
= 1.29
Ratio (M/B) 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝐶𝑆 (31,500 + 26,550)
3000 𝑠ℎ𝑎𝑟𝑒𝑠

13
Financial Report:

Liquidity: Zach Industries’ liquidity position has deteriorated from 2011 to 2012 and is inferior
to the industry average. The firm may not be able to satisfy short-term obligations as they come
due.

Activity: Zach Industries’ ability to convert assets into cash has deteriorated from 2011 to 2012.
Examination into the cause of the 20.5-day increase in the average collection period is warranted.
Inventory turnover has also decreased for the period under review and is fair compared to
industry. The firm may be holding slightly excessive inventory.

Debt: Zach Industries’ debt position has improved since 2011 and is below average. Zach
Industries’ ability to service interest payments has deteriorated and is below the industry average.

Profitability: Although Zach Industries’ gross profit margin is below its industry average,
indicating high cost of goods sold, the firm has a superior net profit margin in comparison to
average. The firm has lower than average operating expenses. The firm has a superior return on
investment and return on equity in comparison to the industry and shows an upward trend.

Market: Zach Industries’ increase in their market price relative to their book value per share
indicates that the firm’s performance has been interpreted as more positive in 2012 than in 2011
and it is a little higher than the industry. Overall, the firm maintains superior profitability at the
risk of illiquidity. Investigation into the management of accounts receivable and inventory is
warranted.

14
Re-Constructing Balance Sheet

O’KEEF INDUSTRIES
Balance Sheet
December 31, 2012

Assets Liabilities and SHE

Cash $32,720 Accounts Payable $120,000
Marketable Securities 25,000 Notes Payable
Accounts Receivable Accruals 20,000
Inventories Total Current Liab.
Total Current Assets Long-term debts

Stockholders’ Equity 600,000

Net Fixed Assets
Total Assets $ Total Liab. & SHE $

The following financial data for 2012

1. Sales totaled $1,800,000
2. The gross profit margin was 25%
3. Inventory Turnover was 6
4. There are 365 days in the year
5. The average collection period was 40 days.
6. The current ratio was 1.6
7. The total assets turnover was 1.2
8. The debt ratio was 60%

Solution:

1. To get the inventories,

𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
 Gross Profit Margin
𝑆𝑎𝑙𝑒𝑠
𝑥
 25% =
1,800,000
 Gross Profit = 450,000
 ∴ 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 = 1,350,000

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑

 Inventory Turnover =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
1,350,000
 6=
𝑥
 ∴ Inventories = $225,000

15
2. To get the Accounts Receivable
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
 Average Collection Period =
𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠
365
𝒙
 40 days = 𝟏,𝟖𝟎𝟎,𝟎𝟎𝟎
𝟑𝟔𝟓
 ∴ Accounts Receivable = $197,280 (the number is approximated)

3. To get the Notes Payable

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
 Current Ratio =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
480,000
 1.6 =
𝑥
 Current Liabilities = $300,000
 ∴ Notes Payable = 160,000
4. To get the total Assets and Total Liab & SHE
𝑆𝑎𝑙𝑒𝑠
 Assets Turnover =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
1,800,000
 1.2 =
𝑥
 ∴ Total Assets = Total Liab & SHE = 1,500,000
∴ Net Fixed Assets
• Total Assets – Current Assets
• 1,500,000 – 480,000 = 1,020,000
∴ Long-term Liabilities
• Total Liabilities and Stockholders’ Equity = Stockholders’ Equity – Long-
term debts – Current Liabilities
• 1,500,000 = 600,000 + x + 300,000
• Long-term debts = $600,000
O’KEEF INDUSTRIES
Balance Sheet
December 31, 2012
Assets Liabilities and SHE
Cash $32,720 Accounts Payable $120,000
Marketable Securities 25,000 Notes Payable 160,000
Accounts Receivable 197,280 Accruals 20,000
Inventories 225,000 Total Current Liab. 300,000
Total Current Assets $480,000 Long-term debts 600,000

Stockholders’ Equity 600,000

Net Fixed Assets 1,020,000
Total Assets $1,500,000 Total Liab. & SHE $1,500,000

16
Final Exam 2010
GENERAL AVIATION INC.
Balance Sheet
December 31, 2005
Assets Liabilities and SHE
Cash $8,005 Accounts Payable $28,000
Marketable Securities Notes Payable
Accounts Receivable Accruals 18,800
Inventories Total Current Liab.
Total Current Assets Long-term debts
Total Liabilities
Preferred Stock 2,451
Gross Fixed Assets Common Stock 30,000
Less: Accumulated Dep. 50,000 Paid-in-capital 6,400
Net Fixed Assets Retained Earnings 90,800
Total SHE
Total Assets Total Liab. & SHE
Additional Information:
1. Sales totaled $720,000 6. The current ratio was 2.35
2. Gross Profit Margin: 38.7% 7. Total Assets turnover: 2.81
3. Inventory turnover: 6 8. The Debt Ratio was 49.4%
4. Fiscal year is 360 days 9. Total Current Assets was $159,565
5. Average Collection period was 31 days
1. To get the Accounts Receivables:
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
a. Average Collection Period = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑛𝑒𝑢𝑒
360
𝑥
b. 31 = 720,000
360
c. Accounts Receivables = $62,000
2. To get Inventories
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡𝑠
a. Gross Profit Margin =
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥
b. 38.7 % =
720,000
c. Gross Profit = $278,640
d. ∴ 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 = $441,360
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
Inventory Turnover =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
441,360
e. 6 =
𝑥
f. Inventories = $73,560

17
3. To get Marketable Securities
a. Since total current Assets = $159,565
b. Therefore, marketable securities = $16,000

4. To get Notes Payable

𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
a. Current Ratio =
𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
159,565
b. 2.35 =
𝑥
c. Total Current Liabilities = $67,900
d. ∴ 𝑁𝑜𝑡𝑒𝑠 𝑃𝑎𝑦𝑏𝑎𝑙𝑒 = $21,100

5. To get the Net Fixed Assets

𝑆𝑎𝑙𝑒𝑠
a. Total Assets Turnover =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
720,000
b. 2.81 =
𝑥
c. Total Assets = Total Liab & SHE = $ 256,227.75 ~ $256,228
d. Net fixed Assets = 256,228 – 159,565 = $96,663
e. Gross Fixed Assets = 96,663 + 50,000 = $146,663

6. To get the Long-term Liabilities

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
a. Debt Ratio =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑥
b. 49.4% =
256,230
c. Total Liabilities = $126,577.62 ~ 126,577
d. Long-term liabilities = 126577 – 67900 = $58,677
GENERAL AVIATION INC.
Balance Sheet
December 31, 2005
Assets Liabilities and SHE
Cash $8,005 Accounts Payable $28,000
Marketable Securities 16,000 Notes Payable 21,100
Accounts Receivable 62,000 Accruals 18,800
Inventories 73,560 Total Current Liab. 67,900
Total Current Assets $159,565 Long-term debts 58,677
Total Liabilities 126,577
Preferred Stock 2,451
Gross Fixed Assets 146,663 Common Stock 30,000
Less: Accumulated Dep. (50,000) Paid-in-capital 6,400
Net Fixed Assets 96,663 Retained Earnings 90,800
Total SHE $129,651
Total Assets $256,228 Total Liab. & SHE $256,228
18
Final Exam 2013
COLE EAGEAN ENTRPRIESES.
Balance Sheet
December 31, 2005
Assets Liabilities and SHE
Cash $4,500 Accounts Payable $10,000
Accounts Receivable Notes Payable
Inventories Accruals 1,000
Total Current Assets Total Current Liab.
Long-term debts
Total Liabilities
Net Fixed Assets Total SHE
Total Assets Total Liab. & SHE

Additional Information:
a. Sales totaled $110,000 e. The current ratio was 2.4
b. Gross Profit Margin: 25% f. Total Assets turnover: 1.13
c. Inventory turnover: 3 g. The Debt Ratio was 53.8%
d. Fiscal year is 360 days h. Average Collection period was 65 days

1. To get the Accounts Receivables:

𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
a. Average Collection Period = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑛𝑒𝑢𝑒
360
𝑥
b. 65 = 110,000
360
c. Accounts Receivables = $19,860

2. To get Inventories
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡𝑠
a. Gross Profit Margin =
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥
b. 25 % =
110,000
c. Gross Profit = $27,500
d. ∴ 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 = $82,500

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑

e. Inventory Turnover =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
82,500
f. 3 =
𝑥
g. Inventories = $27,500

19
3. To get Notes Payable
𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
a. Current Ratio =
𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
51,860
b. 2.4 =
𝑥
c. Total Current Liabilities = $21,610
d. ∴ 𝑁𝑜𝑡𝑒𝑠 𝑃𝑎𝑦𝑏𝑎𝑙𝑒 = $21,100

4. To get the Net Fixed Assets

𝑆𝑎𝑙𝑒𝑠
a. Total Assets Turnover =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
110,000
b. 1.13 =
𝑥
c. Total Assets = Total Liab & SHE = $97,345.13 ~ $97,350
d. Net fixed Assets = 97,350 – 51,860 = $45,490

5. To get the Long-term Liabilities

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
a. Debt Ratio =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑥
b. 53.8% =
97,350
c. Total Liabilities = $52,374.2 ~ 52,370
d. Long-term liabilities = 52,370 – 21,610 = $30,760
COLE EAGEAN ENTRPRIESES.
Balance Sheet
December 31, 2005
Assets Liabilities and SHE
Cash $4,500 Accounts Payable $10,000
Accounts Receivable 19,860 Notes Payable 10,610
Inventories 27,500 Accruals 1,000
Total Current Assets 51,860 Total Current Liab. 21,610
Long-term debts 30,760
Total Liabilities 52,370
Net Fixed Assets 45,490 Total SHE 44,980
Total Assets $97,350 Total Liab. & SHE $97,350

20
Final Exam 2014

1. Return on Assets = 2%

2. Total Assets Turnover = 0.5

3. Cost of goods Sold = $105,000

4. Gross Profit Margin = 30% =

Required: Calculate the Net Profit

Solution
𝑆𝑎𝑙𝑒𝑠 −𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
1. Gross Profit Margin =
𝑆𝑎𝑙𝑒𝑠
𝑥−105,000
30% =
𝑥
Sales = $150,000

𝑆𝑎𝑙𝑒𝑠
2. Total Assets Turnover =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
150,000
50% =
𝑥
Total Assets = $300,000

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘

3. Return on Assets =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑥
2% =
300,000
Earnings Available for common stock = $6000

21
 Key Financial Statements
Income Statement

Income Statement: Provides a financial summary of the firm’s operating results during a
specified period.

AUDIO SUPPLY COMPANY

Income Statement
For the Year Ended December 31, 2015
Sales Revenue $463,200
Less: Cost of Goods Sold (316,000)
Gross Profit 147,200
Operating Expenses
Salaries Expenses $64,000
Utilities Expenses 17,000
Advertising Expenses 16,000
Depreciation Expense 8,000
Insurance Expense 9,000 (114,000)
Operating Profits (EBIT) 33,200
Less: Interest Expense (1,600)
Net Income Before Taxes 31,600
Less: Taxes (20%) (6,320)
Net Income After Taxes 25,280
Less: Preferred Stock dividends (5,280)
Earnings Available for Common Stock $20,000

Notes about the Income Statement

1. Name of Company is ALL CAPS
2. Statement name & period is (Capitalize Each Word)
3. Dollar Sign at the beginning of each column
4. Since there is CGS, therefore the company sells goods
5. Sub column for similar items (E.g. Operating Expenses)
6. Interest Expense is Excluded from Operating Expenses since it is Financial Expenses
7. Preferred Stock Dividends is non-taxable
8. Interest Expense is Taxable (Financial Expense)
9. The two lines under the EA4CS
10. Currency sign as well

NOTE: Depreciation is a non-cash expense

22
Mid-term 2009, 2011 & 2012

LONG LIFE LIGHT BULB

Income Statement
For the Year Ended December 31, 2009
Gross Profit $1,000,000
Less: Operating Expenses (345,000)
Operating Profits (EBIT) 655,000
Less: Interest Expenses (125,000)
Net Profit before Taxes 530,000
Less: Taxes (30%) (159,000)
Net Profit After Taxes 371,000
Less: Preferred Dividends (57,000)
Earnings Available for Common Stock $314,000

a. Earnings Available for common Stock: $314,000

b. Earnings Available for common Stock 314,000

Less: Common Stock Dividends ($4.25 × 15,000 = 63,750)
Increase in Retained Earnings $250,250

23
Mid-term 2012

RELIABLE AUTO PARTS COMPANY

Income Statement
For the Year Ended December 31, 2012
Sales Revenue $85,000
Less: Cost of Goods Sold (50,000)
Gross Profits 35,000
Less: Operating Expenses
Selling Expenses $4,000
General and admin. Expenses 7,500
Depreciation Expense 5,000 (16,500)
Operating Profits (EBIT) 18,500
Less: Interest Expense (3,500)
Net Profit before taxes 15,000
Less: Taxes (40%) (6,000)
Net Profit After Taxes 9,000
Less: Preferred Stock Dividends (500)
Earnings Av. For CS $8,500

8,500
EPS = = $1.7
5,000

24
Problem P3-3, Page 96

Answer:

25
Mid-term 2009 (True or False)

Answer: False, Net Profit before Taxes

Mid-term 2011

Answer:

26
 Cash Flow Statement
Statement of Cash Flows Provides a summary of the firm’s operating, investment, and financing cash flows
and reconciles them with changes in its cash and marketable securities during the period.

This statement not only provides insight into a company’s investment, financing and operating activities, but
also ties together the income statement and previous and current balance sheets.

ROLMAN CORPORATION
Cash Flow Statement
For the year ended December 31st, 2014
In 000s
Cash Flow from Operating Activities
Net profits after taxes $231
Depreciation 239
Increase in accounts receivable (138)
Decrease in inventories 11
Increase in accounts payable 112
Increase in accruals 45
Cash provided by operating activities $500

Cash Flow from Investment Activities

Increase in gross fixed assets (347)
Change in equity investments in other firms 0
Cash provided by investment activities ($347)

Cash Flow from Financing Activities

Decrease in notes payable (20)
Increase in long-term debts 56
Changes in stockholders’ equity 11
Dividends paid (108)
Cash provided by financing activities ($61)
Net increase in cash and marketable securities $92

Inflows Outflows
Decrease in any asset Increase in any asset
Increase in any liability Decrease in any liability
Net profits after taxes Net loss
Depreciation and other noncash charges Dividends paid
Sale of stock Repurchase or retirement of stock

27
 Retained Earnings Statement

Retained earnings: The cumulative total of all earnings, net of dividends that have been retained and
reinvested in the firm since its inception.

Statement of retained earnings: Reconciles the net income earned during a given year, and any cash
dividends paid, with the change in retained earnings between the start and the end of that year. An abbreviated
form of the statement of stockholders’ equity.

Dividends: A corporate distribution of cash or stock to its stockholders on a proportional basis.

Cash Dividends: Distribution of cash to stockholders

Example: Presented below a partial balance sheet for Rolman Corporation

ROLMAN CORPORATION
Balance Sheet (Partial)
September 1st, 2015
Stockholders’ Equity
Paid-in Capital
Capital Stock
Common Stock, $5 par value, 1,000,000 shares
authorized, 500,000 issued, 494,000 outstanding. $2,500,000
Additional paid-in capital in excess of par value 1,529,000 $4,029,000
Retained Earnings 200,000
Total Paid-in capital and Retained Earnings 4,229,000
Less: Treasury Stock (6,000 shares) (54,000)
Total Stockholders’ Equity $4,175,000

If the company declared $0.2 for each share on September 15th; compute the cash dividends! And prepare
Statement of retained earnings on September 30th, assuming profits were $25,000!

The company has 494,000 shares outstanding, and declared $0.2 for each share
𝐶𝑎𝑠ℎ 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 = 494,000 𝑠ℎ𝑎𝑟𝑒𝑠 × $0.2 = $98,800
ROLMAN CORPORATION
Retained Earnings Statement
For the month ended September 30, 2015
Retained Earnings beginning: September 1st $200,000
Add: Net Income 25,000
225,000
Less: Cash Dividends (98,800)
Retained Earnings ending: September 30th $126,200

28
E3–3 Cooper Industries, Inc., began 2012 with retained earnings of $25.32 million. During the year it paid
four quarterly dividends of $0.35 per share to 2.75 million common stockholders. Preferred stockholders,
holding 500,000 shares, were paid two semiannual dividends of $0.75 per share. The firm had a net profit
after taxes of $5.15 million. Prepare the statement of retained earnings for the year ended December 31, 2012.

COOPER INDUSTRIES
Retained Earnings Statement
For the year ended December 31, 2012
Retained Earnings beginning: January 1st $25,320,000
Add: Net Income 5,150,000
30,470,000

Less: Cash Dividends

Preferred Stock (($0.75 × 500,000) × 2 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠) $750,000
Common Stock (($0.35 × 2,750,000) × 4 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠) 3,850,000 (4,600,000)
Retained Earnings ending: December 31st $25,870,000

P3–10 Statement of retained earnings Hayes Enterprises began 2012 with a retained earnings balance of
$928,000. During 2012, the firm earned $377,000 after taxes. From this amount, preferred stockholders were
paid $47,000 in dividends. At year-end 2012, the firm’s retained earnings totaled $1,048,000. The firm had
140,000 shares of common stock outstanding during 2012.

a. Prepare a statement of retained earnings for the year ended December 31, 2012, for Hayes
Enterprises. (Note: Be sure to calculate and include the amount of cash dividends paid in 2012.)
b. Calculate the firm’s 2012 earnings per share (EPS).
c. How large a per-share cash dividend did the firm pay on common stock during 2012?

Answer:

a. Cash dividends paid on common stock = Net profits after taxes – preferred dividends – change in retained earnings
= $377,000 – $47,000 – (1,048,000 – $928,000) = $210,000

HAYES ENTERPRISE
Retained Earnings Statement
For the year ended December 31, 2012
Retained Earnings beginning: January 1st $928,000
Add: Net Income 377,000
1,305,000

Less: Cash Dividends

Preferred Stock $47,000
Common Stock 210,000 (257,000)
Retained Earnings ending: December 31st $1,048,000

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐶𝑆 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥−𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑠𝑡𝑜𝑐𝑘 𝑑𝑖𝑣𝑖𝑑𝑒𝑑𝑠 377,000−47,000
b. 𝐸𝑃𝑆 = = = = $2.36
# 𝑜𝑓 𝐶𝑆 𝑆ℎ𝑎𝑟𝑒𝑠 # 𝑜𝑓 𝐶𝑆 𝑆ℎ𝑎𝑟𝑒𝑠 140,000

𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑠ℎ 𝑑𝑖𝑑𝑖𝑣𝑑𝑒𝑛𝑑𝑠 𝑓𝑜𝑟 𝐶𝑆 210,000

c. 𝐷𝑃𝑆 = = = $1.5 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
# 𝑜𝑓 𝐶𝑆 𝑆ℎ𝑎𝑟𝑒𝑠 140,000
29
P3–9 Initial sale price of common stock Beck Corporation has one issue of preferred stock and one issue of
common stock outstanding. Given Beck’s stockholders’ equity account that follows, determine the original
price per share at which the firm sold its single issue of common stock.

Answer:
𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒+𝑃𝑎𝑖𝑑 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 225+ 2,625
Price = = = $9.5 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 300

Balance Sheet
Balance Sheet: Summary statement of the firm’s financial position at a given point in time.

Current Assets: Assets that a company expects to convert to cash or use up within
one year.

Fixed Assets: Assets with relatively long useful lives and currently being used in
operations.

Current Liabilities: Obligations that a company expects to pay from existing current
assets within the coming year.

Long-term Liabilities: Obligations that the company expects to pay after 1 year.

Stockholders’ Equity: Includes Preferred stock, Common Stock, Retained Earnings

less Treasury stock.

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘

𝑬𝑷𝑺 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐶𝑆 𝑆ℎ𝑎𝑟𝑒𝑠

𝐶𝑎𝑠ℎ 𝑑𝑖𝑣𝑖𝑑𝑒𝑑𝑛𝑠 𝑝𝑎𝑖𝑑 𝑡𝑜 𝐶𝑆

𝑫𝑷𝑺 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐶𝑆 𝑆ℎ𝑎𝑟𝑒𝑠

Price of Stock = total par value + total paid in capital

30
 FRANKLIN COMPANY
Balance Sheet
December 31, 2014
(In 000)
Assets
Current Assets
Cash $6,600
Short-term Investment 2,000
Accounts Receivable 7,000
Notes Receivable 1,000
Inventories 3,000
Supplies 2,100
Prepaid Insurance 400 $22,100

Property, Plant & Equipment

Furniture $4,000
Less: Accumulates Depreciation: Furniture (900) 3,100
Equipment 24,000
Less: Accumulates Depreciation: Equipment (5,000) 19,000
Building 9,000
Less: Accumulates Depreciation: Building (1,800) 7,200
Land 10,000 39,300
Total Assets $61,400

Liabilities & Stockholders’ Equity

Current Liabilities
Accounts Payable $11,000
Notes Payable 2,100
Accruals 2,950 $16,050

Long Term Liabilities

Notes Payable 11,300

Total Liabilities 27,350

Stockholders’ Equity
Common Stock, $1 par value, 15,000,000
Authorized. 1,000,000 shares outstanding. 1,000
Paid-in-capital in excess of par value 17,000
Retained Earnings 16,050 34,050
Total Liabilities & Stockholders’ Equity $61,400

31
P3–6 Balance sheet preparation Use the appropriate items from the following list to
prepare in good form Owen Davis Company’s balance sheet at December 31, 2012.

Answer:

32