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Chapter 15: Q1RQ (page 835)
Question: What are the three main ways to analyze financial statements?
Answer
1. Horizontal analysis, 2. Vertical analysis, 3. Ratio analysis
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Determining the effects of business transactions on selected ratios Financial statement data of Style Traveler Magazine include the following items:
Cash | \( 23,000 |
Accounts Receivable, Net | 81,000 |
Merchandise Inventory | 185,000 |
Total Assets | 635,000 |
Accounts Payable | 99,000 |
Accrued Liabilities | 37,000 |
Short-term Notes Payable | 51,000 |
Long-term Liabilities | 224,000 |
Net Income | 68,000 |
Common Shares Outstanding | 20,000 shares |
Requirements
Current Ratio Debt Ratio Earnings per Share |
2.Compute the three ratios after evaluating the effect of each transaction that follows. Consider each transaction separately
Using ratios to decide between two stock investments
Assume that you are purchasing an investment and have decided to invest in a company in the digital phone business. You have narrowed the choice to Digitalized Corp. and Every Zone, Inc. and have assembled the following data.
Selected income statement data for the current year:
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 |
Selected balance sheet and market price data at the end of the current year:
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 |
Selected balance sheet data at the beginning of the current year:
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 |
Your strategy is to invest in companies that have low price/earnings ratios but appear to be in good shape financially. Assume that you have analyzed all other factors and that your decision depends on the results of ratio analysis.
Requirements
a. Acid-test ratio
b. Inventory turnover
c. Days’ sales in receivables
d. Debt ratio
e. Earnings per share of common stock
f. Price/earnings ratio
g. Dividend payout
2. Decide which company’s stock better fits your investment strategy.
Using ratios to evaluate a stock investment
Comparative financial statement data of Sanfield, Inc. follow:
| SANFIELD, INC. Comparative Income Statement Years Ended December 31, 2018, and 2017 | ||
2018 | 2017 | |
Net Sales Revenue | \( 462,000 | \) 430,000 |
Cost of Goods Sold | 236,000 | 213,000 |
Gross Profit | 226,000 | 217,000 |
Operating Expense | 135,000 | 133,000 |
Income from Operations | 91,000 | 84,000 |
Interest Expense | 8,000 | 12,000 |
Income Before Income Tax | 83,000 | 72,000 |
Income Tax Expense | 18,000 | 22,000 |
Net Income | \( 65,000 | \) 50,000 |
| SANFIELD, INC. Comparative Balance Sheet December 31, 2018, and 2017 | |||
2018 | 2017 | 2016 | |
Asset | |||
Current Assets: | |||
Cash | \( 99,000 | \) 97,000 | |
Accounts Receivable, Net | 109,000 | 117,000 | \( 100,000 |
Merchandise Inventory | 142,000 | 164,000 | 207,000 |
Prepaid Expenses | 15,000 | 5,000 | |
Total Current Assets | 365,000 | 383,000 | |
Property, Plant, and Equipment, Net | 215,000 | 177,000 | |
Total Assets | \) 580,000 | \( 560,000 | \) 599,000 |
Liabilities | |||
Total Current Liabilities | \( 222,000 | \) 244,000 | |
Long-term Liabilities | 113,000 | 92,000 | |
Total Liabilities | 335,000 | 336,000 | |
Stockholders’ Equity | |||
Preferred Stock, 4% | 92,000 | 92,000 | |
Common Stockholders’ Equity, no par | 153,000 | 132,000 | 85,000 |
Total Liabilities and Stockholders’ Equity | \( 580,000 | \) 560,000 | |
1. Market price of Sanfield’s common stock: \(51.48 at December 31, 2018, and \)37.08 at December 31, 2017.
2. Common shares outstanding: 16,000 on December 31, 2018 and 15,000 on December 31, 2017 and 2016.
3. All sales are on credit.
Requirements
1. Compute the following ratios for 2018 and 2017:
2. Decide (a) whether Sanfield’s ability to pay debts and sell inventory improved or deteriorated during 2018 and (b) whether the investment attractiveness of its common stock appears to have increased or decreased.
Ross’s Lipstick Company’s long-term debt agreements make certain demands on the business. For example, Ross may not purchase treasury stock in excess of the balance of retained earnings. Also, long-term debt may not exceed stockholders’ equity, and the current ratio may not fall below 1.50. If Ross fails to meet any of these requirements, the company’s lenders have the authority to take over management of the company.Changes in consumer demand have made it hard for Ross to attract customers.
Current liabilities have mounted faster than current assets, causing the current ratio to fall to 1.47. Before releasing financial statements, Ross’s management is scrambling to improve the current ratio. The controller points out that an investment can be classified as either long-term or short-term, depending on management’s intention. By deciding to convert an investment to cash within one year, Ross can classify the investment as short-term—a current asset. On the controller’s recommendation, Ross’s board of directors votes to reclassify long-term investments as short-term.
Requirements
1. What effect will reclassifying the investments have on the current ratio? Is Ross’s true financial position stronger as a result of reclassifying the investments?
2. Shortly after the financial statements are released, sales improve; so, too, does the current ratio. As a result, Ross’s management decides not to sell the investments it had reclassified as short-term. Accordingly, the company reclassified the investments as long-term. Has management behaved unethically? Give the reasoning underlying of your answer.
Preparing common-size statements, analysis of profitability and financial position, comparison with the industry, and using ratios to evaluate a company
Consider the data for Randall Department Stores presented in Problem P15-31B.
Requirements
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