Chapter 6

Chapter # 6
Analysis of Financial Statement
Sameer Hussain
www.a4accounting.weebly.com
Analysis of Financial Statements
Chapter # 6
SYLLABUS ACCORDING TO UNIVERSITY OF KARACHI:

 Financial Statement analysis.
 Tools of analysis.
 Dollar/Rupees and percentage change.
 Trend percentage.
 Component percentage.
 Common size Financial Statements and ratios.
 Interpretation.
WHAT THE EXAMINER USUALLY ASK?

 Computation of ratios and percentages.
 Trend percentages.
 Comments on ratios and percentages.
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Sameer Hussain www.a4accounting.weebly.com
Chapter # 6
FINANCIAL STATEMENT ANALYSIS

An analysis of the financial statements of a business to assess its performance and position.
Ratios are normally calculated from the financial statements to assess the profitability, solvency,
working capital management, liquidity, and capital structure of an organization.
RATIO ANALYSIS
The use of accounting ratios is to evaluate a company’s operating performance and financial
stability. Such ratios as return on capital employed and gross profit percentage can be used to
assess profitability. The liquidity ratios can be used to examine solvency and gearing ratios to
examine the financial structure of the company. The analysis of ratios can indicate how well a
company is run, the risks of financial insolvency, and the financial returns provided.
 Liquidity Ratio.
 Leverage Ratio.
 Activity Ratio.
 Investors/Shareholders Ratio.
 Profitability Ratio.
LIQUIDITY RATIO
Liquidity means the ability of the firm to pay its way. Liquidity ratios are the ratios that measure
a company’s liquid position.
LEVERAGE RATIO
Any ratio used to calculate the financial leverage of a company to get an idea of the company's
methods of financing or to measure its ability to meet financial obligations. There are several
different ratios, but the main factors looked at include debt, equity, assets and interest expenses.
ACTIVITY RATIO
Activity ratios are the rate at which the company sells its stock and the efficiency with which it
uses its assets.
INVESTORS RATIO
Information to enable decisions to be made on the extent of the risk and the earning potential of
a business investment is investors’ ratio.
PROFITABILITY RATIO
Profitability ratio is a class of financial metrics that are used to assess a business's ability to
generate earnings as compared to its expenses and other relevant costs incurred during a
specific period of time. For most of these ratios, having a higher value relative to a competitor's
ratio or the same ratio from a previous period is indicative that the company is doing well.
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Chapter # 6
LIQUIDITY LEVERAGE ACTIVITY INVESTORS PROFITABILITY

RATIO RATIO RATIO RATIO RATIO
Working Debt ratio Receivable Earnings per Net profit percentage
capital turnover share
Current ratio Equity ratio Inventory Price earnings Gross profit
turnover ratio percentage
Quick ratio Debt to equity Payable Earning rate Cost of goods sold
ratio turnover percentage
Total operating Dividend per Operating expense
days share percentage
Dividend yield Rate of return on
assets
Assets turnover
Rate of return on
shareholders’ equity
Book value per share
WORKING CAPITAL
Working capital is the capital that is used to finance the day-to-day operations of a company.
Working capital is calculated as the difference between current assets and current liabilities.
Working capital = Current assets – Current liabilities
CURRENT RATIO
Current ratio is the ratio of the current assets of a business to the current liabilities; it is used as
a test of liquidity.
Current assets
Current ratio =
Current liabilities
QUICK RATIO (ACID TEST RATIO)

Quick ratio is a ratio used for assessing the liquidity of a company; it is the ratio of the liquid
assets (i.e. current assets less the inventory) to the current liabilities.
Quick assets
Quick ratio =
Current liabilities
QUICK ASSETS
Quick assets are the assets held in cash or in something that can be readily turned into cash with
minimal capital loss (e.g. deposits in a bank current account, accounts receivable, marketable
investments).
Quick assets = Current assets – Inventory – Prepaid expenses
EQUITY RATIO
Total shareholders’ equity x 100
Equity ratio =
Total assets
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Chapter # 6
DEBT RATIO
A ratio used to examine the financial structure or gearing (leverage) of a business. The long-
term debt, normally including preference shares, of a business is expressed as a percentage of
its equity. A highly geared company is one in which the debt is higher than the equity, compared
to the other companies in a similar industry.
Total liabilities
Debt ratio =
Total assets
DEBT TO EQUITY RATIO

Total liabilities x 100
Debt to equity ratio =
Total shareholders’ equity
ACCOUNTS RECEIVABLE TURNOVER

A ratio for analyzing the level of accounts receivable in relation to the amount of credit sales.
The formula is net credit sales divided by average accounts receivable. A high turnover indicates
faster collection.
Net credit sales

Accounts receivable turnover in times =
Average accounts receivable
365
Accounts receivable turnover in days =
Receivable turnover in times
Accounts receivable (beg) + Accounts receivable (end)

Average receivable =
2
INVENTORY TURNOVER
A ratio for financial analysis that communicates the efficiency of inventory management. The
formula is inventory turnover = cost of goods sold/average inventory held. It is important to
match up the time period covered by the cost of goods sold and the time period of the average
inventory. If the ratio is high, it means inventory items are not in the warehouse long before
sale. If the ratio is low, it means the company has a lot of inventory on hand in relation to the
amount it sells. While a high ratio may indicate efficiency, a high ratio may also involve a risk of
running out of products and losing sales. A low ratio could mean that the company has obsolete
inventory that will never be sold, or that the company has built up inventory in anticipation of
higher prices or shortages. Interpretations of the inventory-turnover ratio require comparisons
with industry averages. However, some publishers of comparative data use sales in the
numerator of the ratio, so the reader has to investigate for comparability.
Cost of goods sold

Inventory turnover in times =
Average inventory
365
Inventory turnover in days =
Inventory turnover in times
Inventory (beg) + Inventory (end)

Average inventory =
2
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Chapter # 6
ACCOUNTS PAYABLE TURNOVER

A ratio for analyzing the level of accounts payable in relation to the amount of inventory
purchases. The formula is inventory purchases divided by average accounts payable. The higher
the turnover, the faster the company is paying for inventory purchases.
Net credit purchases

Accounts payable turnover in times =
Average accounts payable
365
Accounts payable turnover in days =
Payable turnover in times
Accounts payable (beg) + Accounts payable (end)

Average payable =
2
OPERATING CYCLE
Operating cycle is the average time between acquiring inventory and receiving cash from its
sale.
Operating cycle = Inventory turnover in days + Receivable turnover in days
Inventory turnover in days + Accounts receivable turnover

Average operating cycle = in days
2
NET PROFIT PERCENTAGE

Net profit margin is a ratio of financial performance calculated by expressing the net profit as
percentage of sales revenue.
Profit before Interest and Tax X 100

Net profit percentage =
Net sales
GROSS PROFIT PERCENTAGE

Gross profit percentage is a ratio of financial performance calculated by expressing the gross
profit as percentage of sales revenue. With retailing companies in particular, it is regarded as a
prime measure of their trading success.
Gross profit X 100

Gross profit percentage =
Net sales
COST OF GOODS SOLD PERCENTAGE

Cost of goods sold X 100
Cost of goods sold percentage =
Net sales
OPERATING EXPENSES PERCENTAGE

Operating expenses X 100
Operating expenses percentage =
Net sales
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Chapter # 6
RATE OF RETURN ON ASSETS

Rate of return on assets is an accounting ratio expressing the amount of profit for an accounting
period as a percentage of the assets of a company.
Net profit X 100

Rate of return on assets =
Total assets
ASSETS TURNOVER
A ratio used in financial statement analysis to investigate how efficiently assets are used to
generate earnings. The numerator is usually sales for the period and the denominator is the
average value of the specific assets held during the period covered by the sales. A higher ratio is
better, but the exact number depends on the industry & should be compared to industry norms.
Net sales X 100

Assets turnover =
Average assets
Total assets (beg) + Total assets (end)

Average assets =
2
RATE OF RETURN ON SHAREHOLDERS’ EQUITY
A financial analysis tool that measures how well a company generates earnings compared to the
amount of capital shareholders have invested in the firm. The formula is net income divided by
average common shareholders’ equity. If the company has preferred stock, the preferred stock
dividends are subtracted from net income before dividing by equity.
Net income X 100

Rate of return on shareholders’ equity =
Shareholders’ equity
EARNINGS PER SHARE (EPS)

The profit attributable to each ordinary share in a company based on consolidated profit for the
period, after deducting minority interest and preference shares dividends. This profit figure is
divided by the weighted average number of shares in issue during the period.
Net profit
Earnings per share =
Average no. of shares
PRICE EARNINGS RATIO

Price earnings ratio is a comparison of the current market price of a company share to the
earning per share of the company. The price earnings ratio is one of the main indicators used by
the fundamental analysts to decide whether the shares in a company are expensive or cheap,
relative to the market.
Market price per share

Price earnings ratio =
Earnings per share
EARNINGS RATIO
Earnings per share X 100
Earnings ratio =
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Chapter # 6
BOOK VALUE PER SHARE

A financial ratio that is calculated as common stockholders’ equity divided by the number of
outstanding shares. Common stockholders’ equity is the total stockholders’ equity less the par
value of any preferred stock. This ratio is refined further if preferred stock is redeemable, has
dividends in arrears, or has a participating feature. In those cases, part of retained earnings is
deducted so that the equity really represents that which is available to common shareholders.
Book value per share =
Number of shares
NUMBER OF SHARES
Share capital
Number of shares =
Par value of share
DIVIDEND PER SHARE

The total dividend declared by a company in a year divided by the total number of ordinary
shares on which the divided is paid.
Cash dividend declared

Dividend per share =
Number of ordinary shares
DIVIDEND YIELD
A ratio computed by dividing the annual dividends paid per share of ordinary share by the
market price per share at a specific date; indicates the rate of return to shareholders in terms of
cash dividend distributions.
Dividend per share X 100

Dividend yield =
SHARE CAPITAL
Share capital = Shareholders’ equity – Retained earnings
SHAREHOLDERS’ EQUITY
Shareholders’ equity = Total assets – Total liabilities
RETURN ON CAPITAL EMPLOYED (ROCE)

Profit before interest and tax X 100
Return on capital employed =
Capital employed
Capital employed = Total assets – Total current liabilities
ILLUSTRATION # 1:
The following balances have been taken from the books of Furqan Co. Ltd. on 31 Dec. 2007:
Fixed assets Rs. 200,000 Long term liabilities Rs. 100,000
Current assets Rs. 700,000 Current liabilities Rs. 400,000
Share capital (Rs.10) Rs. 300,000 Retained earnings Rs. 100,000
Sales (all on credit) Rs. 600,000 Cost of goods sold Rs. 350,000
Average inventory Rs. 20,000 Average receivable Rs. 40,000
Operating expenses Rs. 150,000 Market price per share Rs. 25
Quick assets Rs. 450,000
REQUIRED
1. Working capital 2. Debt ratio
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Chapter # 6
3. Equity ratio 4. Current ratio
5. Inventory turnover 6. Receivable turnover
7. Rate of net income on sales 8. Earnings per share
9. Price earnings ratio 10. Total days of operating cycle
11. Quick ratio 12. Operating expenses rate
13. Rate of gross profit on sales 14. Cost of goods sold rate
15. Rate of return on assets 16. Assets turnover
17. Rate of return on shareholders’ equity 18. Book value per share
SOLUTION # 1:
1. Computation of Working Capital:
Current assets Rs. 700,000
Less: Current liabilities Rs. (400,000)
Working capital Rs. 300,000
2. Computation of Debt Ratio:

Debt ratio = Total liabilities
Total assets
Debt ratio = 500,000
900,000
Debt ratio = 0.56 : 1
3. Computation of Equity Ratio:

Equity ratio = Total shareholders’ equity
Total assets
Equity ratio = 400,000
900,000
Equity ratio = 0.44 : 1
4. Computation of Current Ratio:

Current ratio = Total current assets
Total current liabilities
Current ratio = 700,000
400,000
Current ratio = 1.75 : 1
5. Computation of Inventory Turnover:

Inventory turnover in times = Cost of goods sold
Average inventory
Inventory turnover in times = 350,000
20,000
Inventory turnover in times = 17.5 times
Inventory turnover in days = 365
Inventory turnover in times
Inventory turnover in days = 365
17.5
Inventory turnover in days = 21 days
6. Computation of Receivable Turnover:

Receivable turnover in times = Net credit sales
Average receivable
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Chapter # 6
Receivable turnover in times = 600,000
40,000
Receivable turnover in times = 15 times
Receivable turnover in days = 365
Receivable turnover in times
Receivable turnover in days = 365
15
Receivable turnover in days = 24 days
Computation of Net Income:

Net sales Rs. 600,000
Less: Cost of goods sold Rs. (350,000)
Gross profit Rs. 250,000
Less: Operating expenses Rs. (150,000)
Net income Rs. 100,000
7. Computation of Rate of Net Income:

Rate of net income on sales = Net income X 100
Net sales
Rate of net income on sales = 100,000 X 100
600,000
Rate of net income on sales = 16.67%
8. Computation of Earnings Per Share:

Earnings per share = Operating income
Number of shares
Earnings per share = 100,000
30,000
Earnings per share = Rs.3.33
Computation of Number of Shares:

Number of shares = Share capital
Par value of each share
Number of shares = 300,000
10
Number of shares = 30,000
9. Computation of Price Earnings Ratio:

Price earnings ratio = Market price per share
Earnings per share
Price earnings ratio = 25
3.33
Price earnings ratio = 7.51
10. Computation of Total Days of Operating Cycle:

Total days of operating cycle = Inventory turnover in days + Receivable turnover in days
Total days of operating cycle = 21 + 24
Total days of operating cycle = 45 days
11. Computation of Quick Ratio:

Quick ratio = Total quick assets
Total current liabilities
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Quick ratio = 450,000
400,000
Quick ratio = 1.125 : 1
12. Computation of Operating Expense Rate:

Operating expenses rate = Operating expenses X 100
Net sales
Operating expenses rate = 150,000 X 100
600,000
Operating expenses rate = 25%
13. Computation of Gross Profit Rate:

Gross profit rate = Gross profit X 100
Net sales
Gross profit rate = 250,000 X 100
600,000
Gross profit rate = 41.67%
14. Computation of Cost of Goods Sold Rate:

Cost of goods sold rate = Cost of goods sold X 100
Net sales
Cost of goods sold rate = 350,000 X 100
600,000
Cost of goods sold rate = 58.33%
15. Computation of Rate of Return on Assets:

Rate of return on assets = Net profit X 100
Total assets
Rate of return on assets = 100,000 X 100
900,000
Rate of return on assets = 11.11%
16. Computation of Assets Turnover:

Assets turnover = Net sales X 100
Average assets
Assets turnover = 600,000 X 100
900,000
Assets turnover = 66.67%
17. Computation of Rate of Return on Shareholders’ Equity:

Rate of return on shareholders’ equity = Net income X 100
Rate of return on shareholders’ equity = 100,000 X 100
400,000
Rate of return on shareholders’ equity = 25%
18. Computation of Book Value Per Share:

Book value per share = Total shareholders’ equity
Number of shares
Book value per share = 400,000
30,000
Book value per share = 13.33
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Chapter # 6
PRACTICE QUESTIONS
Question # 1: 2003 – Regular & Private (Advanced Accounting) – UOK
Compute trend percentages for the following items taken from financial statements of Modern
Fixtures over a five year period. Treat 1998 as the base year. State whether the trends are
favourable or unfavourable.
2002 2001 2000 1999 1998
Sales 85,000 74,000 61,500 59,000 50,000
Cost of goods sold 58,500 46,600 40,500 36,000 30,000

The following data are taken from the Fast Company:
Year 2002 2001 2000 1999
Sales Rs.450,000 360,000 330,000 321,000
Net income 22,950 14,550 21,450 19,200
REQUIRED
Compute trend percentages for sales and net income.
Question # 3: 1999 – Regular & Private (Advanced & Cost Accounting) – UOK
The following item from the income statement of Makli Limited for the year ended December
31, 1998 have been expressed as a percentage of net sales:
Net sales (Rs. One million) Rs.1,000,000
Beginning inventory 100,000
Net purchases 680,000
Ending inventory 80,000
Selling expenses 130,000
Administrative expenses 90,000
REQUIRED
Calculate beginning inventory rate, net purchases rate and ending inventory rate, selling
expenses rate and administrative expenses rate and cost of goods sold rate (all as percentage of
net sales).
Question # 4: 2010 – Regular (Advanced & Cost Accounting) – UOK

(a) Selected data taken from the balance sheet of Imam Co. at the end of fiscal year on
December 31, 2010.
Cash 100,000
Marketable securities 50,000
Accounts receivable 150,000
Inventories 250,000
Prepaid expense 200,000
Current liabilities 250,000
REQUIRED
Compute:
1. Working capital 2. The current ratio 3. Acid test ratio
Note: Write relevant formula in the computations.
(b) Zulfiqar Company’s ordinary shares capital account for 2010 and 2009 showed:
Ordinary share Rs.10 par value Rs.45,000.
The following data are provided relative to 2010 & 2009:
2010 2009
Dividends Rs.2,250 Rs.3,600
Market price per share Rs.20 Rs.22
Earnings per share Rs.2.13 Rs.2.67
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Chapter # 6
REQUIRED
Compute for year 2010 and 2009:
(i) Dividend per share and (ii) Dividend yield
Note: Write relevant formula in the computations. Compare answer for the year 2010 with the
year 2009 and give comments.
The following balances have been taken from the books of Islamabad Co. Ltd. on Dec. 31, 1998:
Cash 60,000 Accounts payable 125,000
Marketable securities 40,000 Accrued expenses 25,000
Accounts receivable 80,000 Sales (on account) 600,000
Inventories 120,000 Cost of goods sold 360,000
REQUIRED
(a) Working capital (b) Current ratio
(c) Quick ratio (d) Accounts receivable turnover
(e) Inventory turnover
The following information has been taken from the record of Ashraf Company Ltd. at the end of
the current year:-
Total assets Rs.450,000
Quick assets 80,000
Total liabilities 202,500
Current liabilities 100,000
Fixed assets 250,000
Retained earnings 47,500
Sales (including cash sales of Rs.100,000) 1,000,000
Gross profit on sales 30%
Average inventory 70,000
Average receivable 90,000
Operating expenses 180,000
Market price of Rs.20 share is Rs.25.
REQUIRED
1. Working capital 2. Debt ratio
3. Equity ratio 4. Current ratio
7. Rate of net income on sales 8. Earnings per share
9. Earnings ratio 10. Total days of operating cycle
11. Quick ratio 12. Operating expenses rate
Question # 7: 2013 – Private (Advanced & Cost Accounting) – UOK

Following information have been taken from the financial records of a limited company:
Inventory – beginning Rs.3,000
Purchases 9,000
Inventory – ending 2,000
Accounts receivable – beginning 3,500
Accounts receivable – ending 2,500
Sales (credit) 15,000
Net profit 2,000
Total liquid assets 8,100
Total current assets 18,000
Total current liabilities 9,000
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Chapter # 6
REQUIRED
Compute the following:
(1) Working capital (2) Acid test ratio
(3) Current ratio (4) Inventory turnover (times and days)
(5) Receivable turnover (times and days) (6) Days of operating cycle

A condensed balance sheet for Amjad Ltd. prepared at the year ended December 31, 2010
appears as follows:
Assets Equities
Cash Rs.95,000 Notes payable (Due in 6 months) Rs.40,000
Accounts receivable 155,000 Accounts payable 110,000
Inventory 270,000 Long term liabilities 360,000
Prepaid expenses 60,000 Capital stock, Rs.50/- par 300,000
Plant & equipment – Net 570,000 Retained earnings 430,000
Other fixed assets 90,000
Total assets 1,240,000 Total equities 1,240,000
During the year the company earned a gross profit of Rs.1,116,000 on credit sales of
Rs.2,950,000. Accounts receivable, inventory and plant assets remained almost constant in
amount throughout the year.
REQUIRED
(a) Current ratio (b) Quick ratio
(c) Working capital (d) Debt ratio
(e) Accounts receivable turnover (f) Inventory turnover
(g) Book value per share

At the end of year the following information was obtained from the accounting records of Adnan
Ltd.
Sales (all on account) 400,000
Cost of goods sold 240,000
Average inventory 60,000
Average accounts receivable 40,000
Interest expense 3,000
Income taxes 4,000
Net income for the year 18,000
average investment in assets 250,000
Average stockholder’s equity 200,000
REQUIRED
On the basis of above information compute the following for the year:
(1) Inventory turnover (2) Accounts receivable turnover
(3) Total operating expenses (4) Gross profit percentage
(5) Return on average stockholders’ equity (6) Return on average assets

Following are the selected data taken from books of Rafiq Co. Ltd. at the end of year 2010:
Accounts payable 200,000
Merchandise inventory (opening) 120,000
Bills payable 50,000
Accounts receivable (Opening) 380,000
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Chapter # 6
Cash 108,000
Accounts receivable (Ending) 350,000
Merchandise inventory (Ending) 150,000
Credit sales (Net) 1,825,000
Total operating expenses 600,000
REQUIRED
On the basis of above information, find out:
(1) Working capital (2) Inventory turnover
(3) Current ratio (4) Accounts receivable turnover
(5) Acid test ratio (6) Gross profit percentage
(7) Net profit percentage (8) Operating expenses rate
Question # 11: 2004 – Private (Advanced Accounting) – UOK

Following are the selected balances taken from the books of Annie Ltd. at the end of 2004.
Merchandise inventory (1.1.04) 60,000
Accounts receivable (1.1.04) 190,000
Notes payable 15,000
Cash 54,000
Accounts receivable (31.12.04) 175,000
Credit sales (Net) 912,500
Merchandise inventory (31.12.04) 75,000
REQUIRED
On the basis of above information, compute:
(1) Current ratio (2) Acid test ratio
(3) Inventory turnover (4) Accounts receivable turnover
(5) Net profit percentage (6) Gross profit percentage
(7) Average days to accounts receivable & inventory turnover
Question # 12: 2004 – Regular (Advanced Accounting) – UOK

Following are the selected data taken from books of Nisa Ltd. at the end of year 2003:
Cost of goods sold Rs. 540,000
Merchandise inventory (opening) 120,000
Accounts receivable (opening) 380,000
Cash 108,000
Accounts receivable (ending) 350,000
Merchandise inventory (ending) 150,000
Credit sales (net) 1,825,000
Total operating expenses 600,000
REQUIRED
On the basis of above information, find out:
1. Working capital 2. Inventory turnover
3. Current ratio 4. Accounts receivable turnover
5. Acid test ratio 6. Gross profit percentage
7. Net profit percentage 8. Operating expense rate
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Chapter # 6
Following are the selected data taken from the books of Masooma & Co. at the end of year 2004.
Cash 22,400
Inventory at start 29,600
Inventory at end 25,800
Prepaid expenses 19,200
Accounts receivable beginning 59,700
Accounts receivable ending 49,400
Purchases 246,200
Sales 384,000
Sales discount 14,000
Non-operating expenses 4,000
Total assets 250,000
Total liabilities 100,000
REQUIRED
(a) Equity ratio (b) Current ratio
(c) Rate of gross profit on sales (d) Quick ratio
(e) Rate of net income on sales (f) Return on assets
(g) Return on equity (h) Total days of operating cycle.
Question # 14: 2005 – Regular (Advanced Accounting) – UOK

(a) The following information has been taken from the balance sheet of Kashmir Carpets at
the end of June 2004.
Accounts payable Rs.100,000
Accounts receivable 80,000
Accrued liabilities 5,000
Cash 50,000
Income tax payable 7,000
Inventory 130,000
Prepaid expenses 14,000
REQUIRED
1. Working capital 2. Current ratio 3. Acid test ratio
(b) The following data has been extracted from the financial statements of Green Grocers:
2004 2003
Net sales (70% credit sales) 2,048,000 2,335,000
Cost of goods sold 1,048,000 1,397,000
Average monthly inventory 203,000 190,000
Inventory end of the year 243,000 205,000
Accounts receivable 150% of average inventory. --- 50,000
REQUIRED
Determine for each year:
3. No. of days sales in inventory 4. Days of operating cycle
(c) Comment on favourable and unfavourable trend revealed by the data.
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Chapter # 6
The selected data given below are taken from the records of the Hasan Co. Ltd. at the end of the
year 2007:
Cash 30,000 Accounts receivable (beg) 4,150
Prepaid insurance 12,500 Accounts receivable (end) 43,500
Inventory (beginning) 18,150 Sales 255,000
Inventory (ending) 32,500 Operating expenses 52,300
Purchases 120,000 Accounts payable 22,500
Share capital (par value Rs.10) 250,000 Accrued expenses 32,500
Retained earnings 30,000 Total assets 650,000
REQUIRED
Determine the following ratios on the basis of the above information:
1. Working capital 2. Acid test ratio
3. Current ratio 4. Operating expense ratio
5. Rate of gross profit on sales 6. Equity ratio
7. Accounts receivable turnover rate 8. Inventory turnover rate

The data shown below were taken from the financial records of Shahid Ltd. at the end of 1996:-
Accounts payable 50,000 Accrued liabilities 33,000
Cash 32,000 Inventories – Jan. 1, 1996 42,000
Inventories – Dec. 31, 1996 38,000 Marketable securities 10,000
Operating expenses 120,000 Prepaid expenses 25,000
Purchases (net) 360,000 Accounts receivable – Jan. 1, 1996 61,000
Accounts receivable – Jan. 31, 1996 61,000 Long term loan 150,000
Plant assets 400,000 Sales (all on credit) 604,000
Sales return and allowances 20,000 Retained earnings 133,000
Share capital (Rs.10 par) ? Market price per share Rs.18
REQUIRED
On the basis of above information compute the following:
1. Current ratio 2. Quick ratio
3. Equity ratio 4. Debt ratio
7. Rate of net income on sales 8. Book value per share
9. Earnings per share 10. Price earnings ratio
Parkland Ltd. balance sheet dated December 31, 1990 is given below:
Assets Equities
Cash 20,000 Bank overdraft 10,000
Marketable securities 20,000 Notes payable 50,000
Inventories 200,000 Long term loan 120,000
Prepaid expenses 10,000 Share capital (Rs.10 par) 200,000
Building 300,000 Retained earnings 220,000
Other plant assets 120,000 Reserves 50,000
Total assets 750,000 Total equities 750,000
Total sales during the year amounted to Rs.1,200,000.
Gross profit for the year was Rs.440,000.
Inventory and accounts receivable remained almost constant throughout the year.
REQUIRED
1. Working capital 2. Current ratio
3. Acid test ratio 4. Equity ratio
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5. Debt ratio 6. Receivable turnover
7. Inventory turnover 8. Book value per share

The following terms are taken from financial statement of Aman Company. All sales are made on
account:
Sales (on account) 1,800,000
Plant and equipment 2,400,000
Average shareholders’ equity 3,800,000
Long term liabilities 900,000
Average accounts receivable 375,000
Average merchandise inventory 255,000
Gross profit 525,000
REQUIRED
1. Accounts receivable turnover.
2. Merchandise inventory turnover.
3. Ratio of plant and equipment to long term liabilities.
4. Rate of return on shareholders’ equity.
5. Gross profit percentage.

The following items have been taken from the financial record of Fazal & Company:
Cash Rs.50,000; Accounts receivable on January 1, 2010 Rs.90,000; Office supplies Rs.9,000;
Inventory on December 31, 2010 Rs.60,000; 5-year bonds payable Rs.140,000; operating
expenses Rs.32,000; Bank overdraft Rs.135,000; Accounts receivable on December 31, 2010
Rs.120,000; Ordinary shares capital Rs.400,000 (par value Rs.10 each share); Cost of sales
Rs.225,000 which is 75% of sales; Retained earnings Rs.57,000 (exclusive of current year
income); Accrued expenses Rs.90,000; Prepaid expenses Rs.171,000; Inventory on January 1,
2010 was Rs.90,000; Plant and machinery Rs.195,000.
REQUIRED
(a) Current ratio (b) Inventory turnover days
(c) Receivable turnover days (d) Equity ratio
(e) Earnings per share (f) Book value per share
Presented below are data relating to financial statements of Al-Farid Limited at the end of first
year of its operation:
Balance Sheet
As on December 31, 1988
Assets Equities
Cash 6,000 Allowance for bad debts 3,000
Marketable securities 20,000 Allowance for depreciation 50,000
Merchandise inventory 86,000 Outstanding expenses 15,000
Plant assets 350,000 Long term bonds payable 70,000
Share capital (Par Rs.10) 200,000
Total assets 540,000 Total equities 540,000
Sales revenue 1,200,000
Page 96
Chapter # 6
Note:
a) Dividend paid during the year at 25% of paid-up capital.
b) Market price per share is Rs.18.
c) Credit sales for the year were Rs.1,125,000.
REQUIRED
Calculate the following:
1. Quick ratio 2. Current ratio
3. Equity ratio 4. Debt ratio
5. Accounts receivable turnover rate 6. Inventory turnover rate
7. Gross profit rate 8. Earnings per share
9. Price earnings ratio 10. Book value per share

The data given below were taken from the financial statements of Hamza Corporation for years
2005 & 2006.
2005 2006
Current assets 220,000 264,000
Current liabilities 165,000 140,000
Cash sales 200,000 300,000
Credit sales 450,000 560,000
Cost of goods sold 450,000 500,000
Merchandise inventory 95,000 106,000
Quick assets 70,000 75,000
Accounts receivable 60,000 66,000
REQUIRED
Compute the following for 2005 & 2006.
1. Amount of working capital 2. Current ratio
3. Days of inventory turnover 4. Quick ratio
5. Days of receivable turnover 6. Rate of gross profit on sales
7. Days of operating cycle in 2006 only

The following data have been obtained from the financial statements of Mujahid & Co. for the
year ended December 31, 2006 and 2007:
2007 2006
Cash 28,750 20,000
Merchandise inventory 23,000 15,000
Prepaid expenses 5,200 7,500
Accounts payable 14,000 16,000
Notes payable 30,000 35,000
Accrued expenses 7,000 8,700
Net sales 205,000 240,000
Cost of goods sold 110,000 125,000
REQUIRED
Compute the following for 2006 and 2007:
(1) Amount of working capital (2) Current ratio
(3) Acid test ratio (4) Inventory turnover
(5) Receivable turnover (6) Gross profit rate
Page 97
Chapter # 6
Following comparative data has been taken from the records of Nuzhat & Company:
NUZHAT & COMPANY
COMPARATIVE INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2007 AND 2008
2008 2007
Net sales 1,200,000 850,000
Cost of sales (690,000) (510,000)
Gross profit 510,000 340,000
Operating Expenses:
Selling expense (120,000) (95,000)
General & administrative overheads (160,000) (130,000)
Income before interest & taxes (IBIT) 230,000 115,000
Financial charges (32,000) (24,000)
Income before tax 198,000 91,000
Income tax (29,700) (13,650)
Net income 168,300 77,350
Assets:
Non – Current Assets:
Property, plant and equipment 382,300 170,000
Intangible assets 150,000 120,000
Current Assets:
Inventories 70,000 70,000
Accrued financial income 70,000 60,000
Accounts receivables 190,000 110,000
Marketable securities 180,000 170,000
Cash and bank 120,000 198,000
Authorized Capital:
50,000 ordinary shares @ Rs.10 500,000 500,000
Share Capital
Ordinary share capital @ Rs.10 450,000 410,000
Retained earnings 368,300 200,000
Long Term Liabilities:
Bonds payable 135,000 125,000
Deferred income 20,000 ---
Current Liabilities:
Accrued expenses 75,000 70,000
Current maturity of deferred income 4,000 ---
REQUIRED
Compute the following ratios:
1. Current ratio for 2007 2. Quick ratio for 2008
3. Earnings per share for 2007 4. Book value per share for 2008.
5. Inventory turnover for 2007 and 2008 6. Receivable turnover for 2007 and 2008
7. Return on assets for 2007 and 2008
Page 98
Chapter # 6
Selected data from the financial statements of R. Company and M. Company are as follows:
R. Company M. Company
Total assets 400,000 300,000
Total liabilities 100,000 50,000
Sales (all on credit) 1,000,000 800,000
Average inventory 140,000 150,000
Average receivable 125,000 100,000
Gross profit as a percentage of sales 30% 25%
Net income as a percentage of sales 6% 5%
REQUIRED
Computation of the following for each company:-
1. Net income.
2. Net income as a percentage of shareholders’ equity.
3. Accounts receivable turnover and the average number of days required to collect the
receivable.
4. Inventory turnover and the average number of days required to turnover the inventory.
Question # 25: 1996 – Regular & 2012–Private (Advanced & Cost Accounting) – UOK
1. Find current liabilities when current ratio is 4:1 and current assets Rs.80,000.
2. Find current assets when current ratio is 3:1 and current liabilities Rs.40,000.
3. Find quick assets when quick ratio is 3:1 and current liabilities Rs.60,000.
4. Find total liabilities when debt ratio is 1:3 and total assets Rs.600,000.
5. Find out total capital when equity ratio is 5:8 and the total assets Rs.800,000.
6. Find cost of goods sold when inventory turnover is 20 times and average inventory
Rs.60,000.
7. Find net credit sales when accounts receivable turnover is ten times and average
accounts receivable Rs.80,000.
8. Find net sales when gross profit ratio is 1:3 and gross profit Rs.5,000.
The following items are taken from the financial statements of Imam Company Ltd. for the year
ended December 31, 1999:
Cash Rs.108,000
Accounts receivable (net) 300,500
Merchandise inventory 226,000
Accrued interest on notes receivable 4,500
10% notes receivable (current) 16,500
Advances from customers 1,500
Ordinary shares capital 400,000
Premium on ordinary shares 120,000
Sales (including cash sales of Rs.20,500/=) 1,220,500
Gross profit 520,500
Net income 250,000
Cash dividend declared 120,000
Other information is as under:
i) Shareholders’ equity (opening) was Rs.760,000/=.
ii) Market price per share is Rs.42/=.
iii) Merchandise inventory (opening) was Rs.90,000/=.
iv) Accounts receivable (opening) was Rs.102,500/=.
Page 99
Chapter # 6
REQUIRED
1. Operating expenses rate 2. Current ratio
3. Quick ratio 4. Dividend yield
5. Earnings per share 6. Price earnings ratio
7. Rate of return on ordinary shares 8. Accounts receivable turnover ratio
9. Inventory turnover ratio 10. Gross profit ratio

Pakistan Digitech Company’s comparative balance sheets and income statement for the year
2006 follows:
PAKISTAN DIGITECH COMPANY
COMPARATIVE BALANCE SHEET
Assets: 2006 2005
Cash 140,000 100,000
Inventory 500,000 430,000
Plant & equipment 1,900,000 1,400,000
Less: Accumulated depreciation 650,000 540,000
Long-term investment 700,000 900,000
Total 2,820,000 2,500,000
Liabilities & Equities:
Accrued liabilities 100,000 120,000
Taxes payable 490,000 490,000
Debentures payable 500,000 400,000
Ordinary share capital 800,000 700,000
Retained earnings 670,000 540,000
Total 2,820,000 2,500,000
PAKISTAN DIGITECH COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2006
Sales 2,300,000
Less: Cost of goods sold 1,200,000
Gross margin 1,100,000
Less: Operating expenses 700,000
Net operating profit 400,000
Gain on sale of long-term investment 50,000
Income before taxes 450,000
Less: Income taxes 140,000
Net income 310,000
Additional Information:
Dividends of Rs.180,000 declared and paid during the year. The gain on sale of long-term
investments was from the sale of investments for Rs.250,000 in cash. The investments had an
original cost of Rs.200,000. There was retirement or disposal of plant and equipment during the
year.
REQUIRED
Compute the following ratios for the year 05 and 06.
1. Current ratio 2. Acid test ratio
3. Inventory turnover 4. Return on total assets
5. Return on shareholder’s equity 6. Debt-to-equity ratio
7. Accounts receivable turnover
Page 100
Chapter # 6
(a) The data shown below is taken from the comparative balance sheets of Maqsood Ali &
Co.:
2009 2010
Cash 16,000 30,000
Marketable securities 20,000 10,000
Inventories 60,000 75,000
Plant & equipment 80,000 90,000
Intangible assets 25,000 20,000
TOTAL 248,000 284,000
Current liabilities 60,000 80,000
REQUIRED
(a) From the data above calculate for 2009 and 2010:
(i) Working capital (ii) Current ratio (iii) Acid test ratio
(b) Compute rupee and percentage changes in 2010 as compare to 2009 for current assets
and current liabilities.
(c) Compute ratio of cash to current liabilities for 2009 and 2010.
(b) The average inventory of XY Co. as cost price is Rs.40,000. Sales for 2011 were made at
20% above cost and totaled Rs.300,000.
REQUIRED
(i) What was the inventory turnover rate?
(ii) What is the average age of inventory?

a) On March 1, 2012 the amount of current liabilities of a company was Rs.40,000 which is
2/3 of current assets. During the month the company purchased furniture Rs.26,500 by paying
cash Rs.12,000 and issuing a six month note for the balance.
REQUIRED
Compute current ratio on March 31, 2012. No other transaction has been taken place during the
month except mentioned above.
b) Umar & Co. supplied the following information:

Account balances on July 1, 2008:
Accounts receivable Rs.70,000; Accounts payable Rs.60,000; Accrued operating expenses
Rs.50,000 and Merchandise inventory Rs.28,000.
During the year the following transactions took place:
Sales return Rs.9,000; Returned goods to suppliers Rs.40,000; Discount allowed to customers
Rs.15,000; Discount received from suppliers Rs.2,000; Collection from customers Rs.80,000 and
payment to suppliers Rs.50,000.
Account balances on June 30, 2009:
Accounts receivable Rs.250,000; Accounts payable Rs.90,000; Accrued operating expenses
Rs.56,000 and Merchandise inventory Rs.20,000.
REQUIRED
Compute the following: (Suppose all sales and purchases were on credit).
(a) Inventory turn over (b) Receivable turn over
(c) Rate of net income on sales (d) Rate of operating expenses on sales
Page 101
Chapter # 6
HO HO CORPORATION
Balance Sheet
As on December 31, 1992
(In thousands of rupees)
Current Assets: Liabilities:
Cash ? Current liabilities ?
Accounts receivable (net) ? Long term debt 8% interest ?
Inventory ?
Total current assets ? Total liabilities ?
Plant Assets: Stockholders’ Equity:
Equipment 1,800 Capital stock Rs.10 par 1,000
Less: Accum. depreciation (300) 1,500 Retained earnings 200
Total shareholders’ equity 1,200
Total assets ? Total equities ?
HO HO CORPORATION
Income Statement
For the period ended December 31, 1992
(In thousands of rupees)
Net sales ?
Cost of goods sold ?
Gross profit on sales (25% on net sales) ?
Operating expenses ?
Operating income (10% of net sales) ?
Interest expense 84
Income before income tax ?
Income tax – 40% of income before income tax ?
Net income Rs. 180
Additional Information:
1. The equity ratio 40%, the debt ratio was 60%.
2. The only interest expense was on the long term debt.
3. The beginning inventory was Rs.500,000; the inventory turnover was 4.8 times.
4. The current ratio was 2 to 1. The quick ratio was 1.07 to 1.
5. The beginning balance in accounts receivable was Rs.280,000. The accounts receivable
turnover for the year was 12.8 times. All sales were made on account.
REQUIRED
a) Complete the financial statements by use of available information.
b) Give all computations of amounts appearing in the balance sheet and income statement.
Page 102

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Chapter 6

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Chapter # 6

Analysis of Financial Statement

SYLLABUS ACCORDING TO UNIVERSITY OF KARACHI:

WHAT THE EXAMINER USUALLY ASK?

FINANCIAL STATEMENT ANALYSIS

LIQUIDITY LEVERAGE ACTIVITY INVESTORS PROFITABILITY

Working capital = Current assets – Current liabilities

QUICK RATIO (ACID TEST RATIO)

Quick assets = Current assets – Inventory – Prepaid expenses

DEBT TO EQUITY RATIO

ACCOUNTS RECEIVABLE TURNOVER

Net credit sales

Accounts receivable (beg) + Accounts receivable (end)

Cost of goods sold

Inventory (beg) + Inventory (end)

ACCOUNTS PAYABLE TURNOVER

Net credit purchases

Accounts payable (beg) + Accounts payable (end)

Operating cycle = Inventory turnover in days + Receivable turnover in days

Inventory turnover in days + Accounts receivable turnover

NET PROFIT PERCENTAGE

Profit before Interest and Tax X 100

GROSS PROFIT PERCENTAGE

Gross profit X 100

COST OF GOODS SOLD PERCENTAGE

OPERATING EXPENSES PERCENTAGE

RATE OF RETURN ON ASSETS

Net profit X 100

Net sales X 100

Total assets (beg) + Total assets (end)

Net income X 100

EARNINGS PER SHARE (EPS)

PRICE EARNINGS RATIO

Market price per share

BOOK VALUE PER SHARE

DIVIDEND PER SHARE

Cash dividend declared

Dividend per share X 100

RETURN ON CAPITAL EMPLOYED (ROCE)

2. Computation of Debt Ratio:

3. Computation of Equity Ratio:

4. Computation of Current Ratio:

5. Computation of Inventory Turnover:

6. Computation of Receivable Turnover:

Computation of Net Income:

7. Computation of Rate of Net Income:

8. Computation of Earnings Per Share:

Computation of Number of Shares:

9. Computation of Price Earnings Ratio:

10. Computation of Total Days of Operating Cycle:

11. Computation of Quick Ratio:

12. Computation of Operating Expense Rate:

13. Computation of Gross Profit Rate:

14. Computation of Cost of Goods Sold Rate:

15. Computation of Rate of Return on Assets:

16. Computation of Assets Turnover:

17. Computation of Rate of Return on Shareholders’ Equity:

18. Computation of Book Value Per Share:

Question # 2: 2002 – Regular & Private (Advanced Accounting) – UOK

Question # 4: 2010 – Regular (Advanced & Cost Accounting) – UOK

Question # 7: 2013 – Private (Advanced & Cost Accounting) – UOK

Question # 8: 2011 – Private (Advanced & Cost Accounting) – UOK

Question # 9: 2001 – Regular & Private (Advanced Accounting) – UOK