Acco 230_Financial Statement Analysis_Ch 12 Information about past performance is helpful to assess the prior success of a business and

the effectiveness of management. Time series analysis (trend analysis) involves the comparison of information for a single company over time (two or more years). Component percentages are used to express each item on a particular financial statement as a percentage of a single base amount. The base amount on the income statement is net sales and the base amount on the BS is total assets. CLASS EXERCISE P12-1B. Horizontal and vertical analysis Net sales, net income, and total assets for Amanix Clothing Emporium for a four-year period below: (in thousands) Net sales Net income Ending Total Assets Requirements 1. Compute trend percentages for each item for 2011-2014. Use 2011 as the base year. ArmanixClothing Emporium Trend Percentages 2014 Net Sales Net Income Ending Total Assets 2013 2012 2011 2014 $386 31 196 2013 $357 26 177 2012 $324 12 170 2011 $337 22 152

2. Compute the rate of return on net sales for 2012-2014, rounding to three decimal places. In this industry, rates of 6% are average, rates above 8% are considered good, and rates above 10% are viewed as outstanding. Net income Net sales

The rate of return on net sale =

The rate of return on net sales shows the portion of each dollar of net sales that a firm is able to turn into income.

Acco 230_Financial Statement Analysis_Ch 12

(Dollar amounts in thousands) 2014 Rate of return on net sales = 2013 2012

3. How does Armanix Clothing Emporiums return on net sales compare with the industry?

Acco 230_Financial Statement Analysis_Ch 12

The component percentage is derived by dividing a statement item by the base amount from that statement. The amount is then multiplied by 100 to convert it to a percent. Component percentages appear on common-size statements. Common-size statements display important relationships and trends used in financial statement analysis. CLASS EXERCISE P12-2B. Common-size financial statements and profitability ratios Verifine Used Auto Sales asked for your help in comparing the companys profit performance and financial position with the average for the auto sales industry. The proprietor has given you the companys income statement and balance sheet as well as the average data for retailers of used autos. Verifine Used Auto Sales Income Statement Compared with Industry Average Year Ended December 31, 2014 VERIFINE $548,000 348,528 199,472 122,752 76,720 1,096 $75,624 INDUSTRY AVERAGE 100% 62.1% 37.9% 27.8% 10.1% 0.4% 9.7%

Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Income Other Expenses Net Income

Verifine Used Auto Sales Balance Sheet Compared with Industry Average December 31, 2014 VERIFINE $229,034 50,830 8,970 10,166 $299,000 $118,105 50,830 130,065 $299,000 INDUSTRY AVERAGE 70.9% 23.6% 0.8% 4.7% 100.0% 48.1% 16.6% 35.3% 100.0%

Current Assets Plant Assets, Net Intangible Assets, Net Other Assets Total Assets Current Liabilities Long-Term Liabilities Shareholders Equity Total Liabilities and Shareholders Equity Requirements

1. Prepare a two-column, common-size income tatement and a two-column, common-size balance sheet for Verifine Used Auto Sales. The first column of each statement should present Verifine Used Auto Sales common-size statement and the second column should show the industry averages.

Acco 230_Financial Statement Analysis_Ch 12 Verifine Used Auto Sales Common-Size Income Statement Compared to Industry Average Year Ended December 31, 2014 Industry Verifine Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Income Other Expenses Net Income Average

Acco 230_Financial Statement Analysis_Ch 12 Verifine Used Auto Sales Common-Size Balance Sheet Compared to Industry Average December 31, 2014 Industry Verifine Current Assets Plant Assets, Net Intangible Assets, Net Other Assets Total Assets Current Liabilities Long-Term Liabilities Shareholders Equity Total Liabilities and Shareholders Equity Average

2. For the profitability analysis, examine Verifine used Auto Sales (a) ratio of gross profit to net sales, (b) ratio of operating income to net sales, and (c) ratio of net income to net sales. Compare these figures with the industry averages. Is Verifine Used Auto Sales profit performance better or worse than the industry average?

3. For the analysis of financial position, examine Verifine Used Auto Sales (a) ratio of current assets to total assets and (b) ratio of shareholders equity to total assets. Compare these ratios with the industry averages. Is Verifine Used to Sales financial position better or worse than the industry average?

Acco 230_Financial Statement Analysis_Ch 12 CLASS EXERCISE P12-3B. Current ratio, debt ratio, EPS Current ratio The current ratio is the most widely used liquidity ratio. The current ratio is calculated by dividing current assets by current liabilities. A high current ratio indicates that the business has sufficient current assets to pay its current liabilities as they come due. Current ratio = Current assets Current liabilities

Debt ratio The debt ratio shows the relationship between total liabilities and total assets. In other words, it shows the proportion of assets financed with debt. Debt ratio = Total liabilities Total assets Earnings per Share (EPS) This ratio relates income to a number of shares rather than to a number of dollars. EPS is one of the most widely used ratios. Companies often release quarterly EPS information to the media. EPS must be computed for the IS. If a company has extraordinary items in deriving NI, EPS must also be computed for NI before extraordinary items. There may be many complexities when computing EPS.

EPS

Income Average # C/S shares outstanding

The average # C/S shares outstanding is based on a weighted average. Income is only the amount that relates to common shareholders. If a company has preferred shareholders, adjustments may be needed to the numerator. Common stock equivalents (convertible P/S, etc.) are factored into the computation of the denominator.

Acco 230_Financial Statement Analysis_Ch 12 Financial statement data of ABC Fencing, Inc. included the following items: Cash Short-Term Investments Accounts receivable, Net Inventory Prepaid Expenses Total Assets Short-Term Notes Payable Accounts Payable Accrued Liabilities Long-Term Notes Payable Other Long-Term Liabilities Net Income Number of Common Shares Outstanding Requirements 1. Compute ABC Fencings current ratio, debt ratio, and earnings per share. Assume that the company had no preferred shares outstanding. Round all ratios to two decimal places. (Dollar Amounts and Shares Quantities in Thousands) Current Ratio Debt Ratio Earnings per Share $21,000 25,000 102,000 121,000 15,000 660,500 45,000 106,000 44,000 160,000 37,000 77,000 37,000

Acco 230_Financial Statement Analysis_Ch 12 2. Compute each of the same three ratios after evaluating the effect of each transaction that follows: a. Purchased merchandise of $40,000 on account, debiting inventory. (Dollar Amounts and Shares Quantities in Thousands) Current Ratio Debt Ratio Earnings per Share

b. Issued 2,000 common shares, receiving cash of $78,000.

c. Borrowed $78,000 on a long-term note payable.

d. Received cash on account, $18,000.

Acco 230_Financial Statement Analysis_Ch 12 CLASS EXERCISE P12-4B. Calculate various ratios for analysis Comparative financial statement data of Danfield Furniture Company below: Danfield Furniture Company Income Statement Years Ended December 31, 2014 and 2013 2014 Net Sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations Interest Expense Income Before Income Tax Income Tax Expense Net Income $483,000 244,000 239,000 145,000 94,000 14,000 80,000 28,000 $52,000 2013 $458,000 234,000 224,000 137,000 87,000 24,000 63,000 24,000 $39,000

Danfield Furniture Company Balance Sheet December 31, 2004 and 2013 (Selected 2012 amounts given for computation of ratios) 2014 Current Assets: Cash Accounts Receivable Net Inventory Prepaid Expenses Total Current Assets Property, Plant and Equipment, Net Total Assets Total Current Liabilities Long-Term Liabilities Total Liabilities Preferred Shareholders Equity 8% Common Shareholders Equity Total Liabilities and Shareholders Equity Other information follows: 1. Market price of common shares was $48.50 at December 31, 2014, and $31.75 at December 31, 2013. 2. Common shares outstanding were 17,000 during 2014 and 15,000 during 2013. 3. All sales were made on credit. 4. The full amount of preferred dividends was paid. 9 $95,000 104,000 161,000 38,000 398,000 196,000 $594,000 $212,000 129,000 341,000 99,000 154,000 $594,000 2013 $98,000 114,000 151,000 28,000 391,000 175,000 $566,000 $228,000 116,000 344,000 99,000 123,000 $566,000 2012

$107,000 193,000

97,000

Acco 230_Financial Statement Analysis_Ch 12 Requirements 1. Compute the following ratios for 2014 and 2013: a. Current ratio (Dollar Amounts and Shares Quantities in Thousands) 2014 Current ratio: 2013

b. Inventory turnover The inventory turnover measures the number of times a company sells its average level of inventory during a year. A high rate o turnover indicates ease in selling inventory; a lower rate indicates difficulty. Inventory turnover = Cost of goods sold Average inventory

Inventory turnover:

c. Accounts receivable turnover The accounts receivable turnover measures the ability to collect cash from credit customers. The higher the ratio, the faster the company collects cash. However, a receivable turnover ratio that is too high may indicate that credit is too tight. Account receivable turnover = Net credit sales Average net accounts receivable

Accounts Receivable turnover:

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Acco 230_Financial Statement Analysis_Ch 12 d. Times-interest-earned ratio The times-interest-earned ratio indicates a companys ability to continue to service its debe. It measures the number of times operating income can cover (pay) interest expense. A high ratio means that a company is able to meet its interest obligations because earnings are significantly greater than annual interest obligations. A low ratio indicates that a company may encounter difficulty meeting its obligations. Times-interest-earned ratio = Operating income Interest expense

Times-interestearned ratio:

e. Return on common shareholders equity. The rate of return on common shareholders equity shows the amount of net income returned as a percentage of common shareholders equity. Rate of return on common shareholders equity = Net income-preferred dividends Average common shareholders equity

Rate of return on common sharesholders' equity: f. Earnings per share of common shares Earnings per common share = Net income-preferred dividends Number of common shares outstanding

Earnings per share of common shares:

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Acco 230_Financial Statement Analysis_Ch 12 g. Price/earnings ratio The price/earnings ratio is the ratio of the market price of a common share to the companys earnings per share. This ratio shows how much investors are willing to pay per dollar of earnings. Price/earnings ratio = Market price per share Earnings per share

Price/earnings ratio: 2. Decide (a) whether Danfield Furniture Companys financial position improved or deteriorated during 2014 and (b) whether the investment attractiveness of its common shares appears to have increased or decreased.

3. How will what you learned in this problem help you evaluate an investment?

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Acco 230_Financial Statement Analysis_Ch 12 CLASS ECERCISE P12-5B. Calculate various ratios for analysis Assume you are purchasing an investment and decide to invest in a company in the home remodeling business. You narrow the choice to Bobs Home Repair, Inc. or Stellar Stability, Corp. You assemble the following selected data: Net Sales ( all on credit) Cost of Goods Sold Income from Operations Interest Expense Net Income Bobs Home Repair, Inc. $282,000 158,000 88,000 15,000 44,000 Stellar Stability, Corp. $226,000 129,000 48,000 24,00

Selected balance sheet and market price data at the end of the current year follow: Bobs Home Repair, Inc. Current Assets: Cash Short-Term Investments Accounts Receivable, Net Inventory Prepaid Expenses Total Current Assets Total Assets Total Current Liabilities Total Liabilities Preferred Shares, 5%, 180 shares Common Shares, 7,000 Shares 4,000 Shares Total Shareholders Equity Market price per common share Stellar Stability, Corp. $14,000 15,000 25,000 50,000 4,000 108,000 166,000 68,000 71,000 7,000 10,000 121,000 $43,12 95,000 $30.87

$13,000 12,000 30,000 69,000 5,000 129,000 201,000 54,000 80,000 18,000

Selected balance sheet data at the beginning of the current year follow: Accounts Receivable, Net Inventory Total Assets Preferred Shares, 5% (180 shares) Common Shares, 7,000 Shares 4,000 Shares Total Shareholders Equity Bobs Home Repair, Inc. $29,000 52,000 162,000 18,000 10,000 77,000 Stellar Stability, Corp $26,000 62,000 157,000 7,000 72,000

Your investment strategy is to purchase the shares of the company that has a low price/earnings ratio but appears to be in good shape financially. Assume that you analyzed all other factors and your decision depends on the results of the ratio analysis to be performed.

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Acco 230_Financial Statement Analysis_Ch 12 Requirement 1. Compute the following ratio for both companies for the current year and decide which companys shares better fit your investment strategy. (Dollar Amounts and Shares Quantities in Thousands) a. Quick ratio The quick ratio tells us whether the entity could pay all its current amiabilities if they came due immediately. Inventory and prepaid expenses are not included in the acid-test ratio because they are not available to pay current liabilities. Quick ratio = Cash + short-term investments + net current receivable Current liabilities

(Dollar Amounts and Shares Quantities in Thousands) Bobs Home Repair Quick ratio: Stellar Stability

b. Inventory turnover Cost of goods sold Average inventory

Inventory turnover =

Inventory turnover:

c. Days sales in receivables .The days sales in receivables also measures the ability to collect receivables. Days sales in receivables tell us how many days sales remain in Accounts Receivable.

Days sales in receivables=

365 Accounts receivable turnover

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Acco 230_Financial Statement Analysis_Ch 12 Days sales in receivables:

d. Debt ratio Debt ratio = Total liabilities Total assets

Debt ratio:

e. Earnings per share of common shares Earnings per common share = Net income-preferred dividends Number of common shares outstanding

Earnings per share of common shares:

f.

Price/earnings ratio Price/earnings ratio = Market price per share Earnings per share

Price/earnings ratio:

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Acco 230_Financial Statement Analysis_Ch 12 CLASS ECERCISE P12-6B. Financial statement ratio analysis You have been hired as an investment analyst at Harriet Winston Company. It is your job to recommend investments for your client. The only information you have are the following ratio values for two companies in the video game industry. Ratio Days to collect receivables Inventory turnover Gross profit percentage Net income as a percentage of sales Time-interest-earned ratio Return on equity Return on assets Requirement 1. Write a memo to your client recommending the company you believe to be a more attractive investment. Explain the reasons for your recommendation. Mario and Luco, Co. 60 10 69% 17% 14 37% 15% Witches and Warlocks, Inc. 54 8 75% 11% 18 45% 13%

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