Chapter 15: Q13RQ (page 835)

What are some common red flags in financial statement analysis?

Short Answer

Expert verified

Red Flags in Financial Analysis are as follows- Sales trending down from the past years, consistently higher liabilities than Assets, etc.

Step by step solution

Meaning of Red Flag

A red flag is an adviser's or entrepreneur's sign that points up a potential concern with an organization's financial report.

Identification of Red Flags

There is no appropriate way to detect red flags. The primary research a trader, analyst, or economist uses will influence how to identify problems with an investment opportunity. Examining financial documents, economic indicators, or historical data may be a component of this. Investors must conduct thorough research when deciding whether to invest in a firm.

Step 3:Some Easily Identifiable Red Flags

1. Increasing Debt Equity Ratio

2. Consistently Decreasing Revenues

3. Fluctuating Cash Flows

4. Unwanted changes in the price of shares on the market

5. A pending lawsuit against the company.

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	Digitalized	Every Zone
Net sales revenue (all on credit)	\(423,035	\)493,845
Cost of goods sold	210,000	260,000
Interest expenses	0	19,000
Net income	51,000	72,000

	Digitalized	Every Zone
Current assets:
Cash	\(24,000	\)17,000
Short-term investment	40,000	14,000
Accounts receivables, Net	40,000	48,000
Merchandise inventory	66,000	97,000
Prepaid expenses	23,000	12,000
Total current assets	\(193,000	\)188,000

Total assets	266,000	323,000
Total current liabilities	105,000	96,000
Total liabilities	105,000	128,000
Common stock
\(1 par (12,000 shares)	12,000
\)1 par (17,000 shares)		17,000
Total stockholders equity	161,000	195,000
Market price per share of common stock	76.50	114.48
Dividend paid per common stock	1.10	1.00

	Digitalized	Every Zone
Balance sheet:
Accounts Receivable, net	\(41,000	\)54,000
Merchandise Inventory	81,000	87,000
Total Assets	261,000	272,000
Common Stock:
\(1 par (12,000 shares)	12,000
\)1 par (17,000 shares)		17,000

	THE PADDLE COMPANY Comparative Financial Statements Years Ended December 31			RECREATIONAL LIFE VESTS Comparative Financial Statements Years Ended December 31
Income statement	2019	2018	2017	2019	2018	2017
Net sales revenue	\(430,489	\)425,410		\(410,570	\)383,870
Cost of goods sold	258,756	256,797		299,110	280,190
Gross profit	171,733	168,613		111,460	103,680
Operating expenses	153,880	151,922		78,290	70,830
Operating income	17,853	16,691		33,170	32,850
Interest expenses	865	788		2,780	2,980
Income before income tax	16,988	15,903		30,390	29,870
Income tax expenses	5,137	4,809		8,780	8,630
Net income	\(11,851	\)11,094		\(21,610	\)21,240
Balance sheet

Assets
Cash & Cash Equivalents	\(69,159	\)70,793		\(65,730	\)55,270
Accounts Receivable	44,798	44,452	\(44,104	39,810	38,650	\)36,460
Merchandise Inventory	79,919	66,341	76,363	68,500	65,230	59,930
Other Current Assets	15,494	16,264		24,450	37,630
Total Current Assets	209,370	197,850		198,490	196,780
Long-term Assets	89,834	90,776		116,760	116,270
Total Assets	\(299,204	\)288,626	\(276,482	\)315,250	$$313,050	\(310,640

Liabilities
Current Liabilities	\)69,554	\(60,232		\)90,810	\(90,010
Long-term Liabilities	31,682	29,936		96,310	105,890
Total Liabilities	101,236	90,168		187,120	195,900

Stockholders’ Equity
Common Stock	72,795	80,885		111,530	102,480
Retained Earnings	125,173	117,573		16,600	14,670
Total Stockholders’ Equity	197,968	198,458		128,130	117,150	103,840
Total Liabilities and Stockholder’s Equity	\)299,204	\(288,626		\)315,250	\(313,050

Other data
Market price per share	\)21.38	\(33.82		\)46.37	$51.64
Annual dividend per share	0.32	0.30		0.53	0.45
Weighted average number of shares outstanding	9,000	8,000		9,000	8,000

a. Current ratio	h. Profit margin ratio
b. Cash ratio	i. Asset turnover ratio
c. Inventory turnover	j. Rate of return on common stockholders’ equity
d. Accounts receivable turnover	k. Earnings per share
e. Gross profit percentage	l. Price/earnings ratio
f. Debt ratio	m. Dividend yield
g. Debt to equity ratio	n. Dividend payout

What are some common red flags in financial statement analysis?

Short Answer

Step by step solution

Meaning of Red Flag

Identification of Red Flags

Step 3:Some Easily Identifiable Red Flags

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Theta Designs INC
Vertical Analysis
For the year ended December 31, 2017, and 2018
Assets	2018 (\()	2017 (\))

Total current assets	25,000	73,440
Property, Plant and Equipment, Net	153,600	168,300
Other Assets	21,400	64,260
Total Assets	200,000	306,000

Liabilities
Total current liabilities	27,600	49,266
Long term debt	72,400	208,998
Total Liabilities	100,000	258,264

Stockholders’ Equity
Total stockholders’ Equity	100,000	47,736
Total liabilities and stockholders’ equity	200,000	306,000