Financial Statement Analysis

Question: Theater by Design and Show Cinemas are asking you to recommend their stock to your clients. Because Theater by Design and Show Cinemas earn about the same net income and have similar financial positions, your decision depends on their statement of cash flows, summarized as follows: 

Theater by Design Show Cinemas 

Net Cash Provided by Operating Activities \( 30,000 \) 70,000 

Cash Provided by (Used for) Investing Activities: 

Purchase of Plant Assets \( (20,000) \) (100,000) 

Sale of Plant Assets 40,000 20,000 10,000 (90,000) 

Cash Provided by (Used for) Financing Activities:

 Issuance of Common Stock 0 30,000 

Payment of Long-term Debt (40,000) 0 

Net Increase (Decrease) in Cash \( 10,000 \) 10,000 

Based on their cash flows, which company looks better? Give your reasons.

Match the different parts of the annual report with the appropriate description.

Monroe Corp. reported the following amounts on its balance sheet at December 31, 2018 and 2017:

2018, 2017

Cash and Receivables \( 35,000 \) 40,000

Merchandise Inventory 20,000 15,000

Property, Plant, and Equipment, Net 80,000 60,000

Total Assets \( 135,000 \) 115,000

Prepare a vertical analysis of Monroe Corp. for 2018 and 2017.

The financial statements of Ion Corporation include the following items:

Current Year Preceding Year

Balance Sheet:

Cash \( 6,000 \) 8,000

Short-term Investments 4,400 10,700

Net Accounts Receivable 21,600 29,200

Merchandise Inventory 30,800 27,600

Prepaid Expenses 6,000 3,600

Total Current Assets 68,800 79,100

Total Current Liabilities 53,200 37,200

Income Statement:

Net Sales Revenue $ 184,800

Cost of Goods Sold 126,000

Compute the following ratios for the current year:

7. Current ratio

8. Acid-test ratio

9. Inventory turnover

10. Gross profit percentage

Explaining financial statements

Caleb King is interested in investing in Orange Corporation. What types of tools should Caleb use to evaluate the company?

Question: What are the three main ways to analyze financial statements?

Verifine Corp. reported the following on its comparative income statement:

(In millions) 2019 2018 2017

Revenue \( 9,890 \) 9,690 $ 9,135

Cost of Goods Sold 6,250 6,000 5,890

Prepare a horizontal analysis of revenues and gross profit—both in dollar amounts

and in percentages—for 2019 and 2018.

Muscateer Corp. reported the following revenues and net income amounts:

(In millions) 2019 2018 2017 2016

Revenue \( 9,610 \) 9,355 \( 9,050 \) 8,950

Net Income 7,290 6,790 5,020 4,300

Requirements

1. Calculate Muscateer’s trend analysis for revenues and net income. Use 2016 as the

base year, and round to the nearest percent.

2. Which measure increased at a higher rate during 2017–2019?

Question: What is horizontal analysis, and how is a percentage change computed?

Question: What is trend analysis, and how does it differ from horizontal analysis?

Question: What is vertical analysis? What item is used as the base for the income statement? What item is used as the base for the balance sheet?

Describe a common-size statement and how it might be helpful in evaluating a company.

What is benchmarking, and what are the two main types of benchmarks in financialstatement analysis?

Briefly describe the ratios that can be used to evaluate a company’s ability to paycurrent liabilities.

Briefly describe the ratios that can be used to evaluate a company’s ability to sell merchandise inventory and collect receivables.

Briefly describe the ratios that can be used to evaluate a company’s ability to pay long-term debt.

Briefly describe the ratios that can be used to evaluate a company’s profitability.

Briefly describe the ratios that can be used to evaluate a company’s stock as an investment.

What are some common red flags in financial statement analysis?

Great Value Optical Company reported the following amounts on its balance sheet at

December 31, 2018 and 2017:

2018 2017

Cash and Receivables \( 80,640 \) 80,575

Merchandise Inventory 56,840 54,450

Property, Plant, and Equipment, Net 142,520 139,975

Total Assets \( 280,000 \) 275,000

Prepare a vertical analysis of Great Value’s assets for 2018 and 2017.

Data for Connor, Inc. and Alto Corp. follow:

Connor Alto

Net Sales Revenue \( 13,000 \) 22,000

Cost of Goods Sold 7,917 15,730

Other Expenses 4,342 5,170

Net Income \( 741 \) 1,100

Requirements

1. Prepare common-size income statements.

2. Which company earns more net income?

3. Which company’s net income is a higher percentage of its net sales revenue?

Evaluating current ratio

Requirements

1. Compute Accel’s Companies’ current ratio at May 31, 2018 and 2017.

2. Did Accel’s Companies’ current ratio improve, deteriorate, or hold steady during 2018?

Computing inventory, gross profit, and receivables ratios

Requirements

1. Compute the inventory turnover, days’ sales in inventory, and gross profit

percentage for Accel’s Companies for 2018.

2. Compute days’ sales in receivables during 2018. Round intermediate calculations to

three decimal places. Assume all sales were on account.

3. What do these ratios say about Accel’s Companies’ ability to sell inventory and

collect receivables?

Measuring ability to pay liabilities

Requirements

1. Compute the debt ratio and the debt-to-equity ratio at May 31, 2018, for Accel’s

Companies.

2. Is Accel’s ability to pay its liabilities strong or weak? Explain your reasoning.

Measuring profitability

Requirements

1. Compute the profit margin ratio for Accel’s Companies for 2018.

2. Compute the rate of return on total assets for 2018.

3. Compute the asset turnover ratio for 2018.

4. Compute the rate of return on common stockholders’ equity for 2018.

5. Are these rates of return strong or weak? Explain your reasoning.

Computing EPS and P/E ratio

Requirements

1. Compute earnings per share (EPS) for 2018 for Accel’s. Round to the nearest cent.

2. Compute Accel’s Companies’ price/earnings ratio for 2018. The market price per

share of Accel’s stock is $12.50.

3. What do these results mean when evaluating Accel’s Companies’ profitability?

Old Mills’s income statement appears as follows (amounts in thousands):

Use the following ratio data to complete Old Mills’s income statement:

1. Inventory turnover is 3.70 (beginning Merchandise Inventory was \(810; ending

Merchandise Inventory was \)770).

2. Profit margin ratio is 14%.

Traditional Mills’s balance sheet appears as follows (amounts in thousands):

Use the following ratio data to complete Traditional Mills’s balance sheet.

1. Current ratio is 0.72.

2. Acid-test ratio is 0.36.

Data for Mulberry Designs, Inc. follow:

Requirements

1. Prepare a horizontal analysis of the comparative income statement of Mulberry

Designs, Inc. Round percentage changes to one decimal place.

2. Why did 2018 net income increase by a higher percentage than net sales

revenue?

Grand Oaks Realty’s net revenue & net income for the following five-year period using 2015 as the base year, follow:

Requirement:

1. Compute a trend analysis for the net revenue & net income. Round to the nearest full percent.

2. Which grew faster during the period, net revenue or the net income?

Theta Designs, Inc. has the following data:

Perform a vertical analysis of Theta Designs’s balance sheet for each year.

Preparing common-size income statements

Refer to the data presented for Mulberry Designs, Inc. in Exercise E15-13.

Requirements

1. Prepare a comparative common-size income statement for Mulberry Designs,

Inc. using the 2018 and 2017 data. Round percentages to one-tenth percent (three

decimal places).

2. To an investor, how does 2018 compare with 2017? Explain your reasoning.

Data for Research Enterprises follows: 

Compute the dollar amount of change and the percentage of change in Research Enterprises’ working capital each year during 2019 and 2018. What do the calculated changes indicate?

The financial statements of Valerie’s Natural Foods include the following items:

Compute the following ratios for the current year:

1. Current ratio

2. Cash ratio

3. Acid-test ratio

4. Inventory turnover

5. Day’s sales in inventory

6. Day’s sales in receivables

7. Gross profit percentage

Big Beautiful Photo Shop has asked you to determine whether the company’s ability to pay current liabilities and total liabilities improved or deteriorated during 2018. To answer this question, you gather the following data:

Compute the following ratios for 2018 and 2017, and evaluate the company’s ability to pay its current liabilities and total liabilities: 

a. Current ratio 

b. Cash ratio 

c. Acid-test ratio 

d. Debt ratio 

e. Debt to equity ratio

Micatin, Inc.’s comparative income statement follows. The 2017 data are given as needed.

Requirements 

1. Calculate the profit margin ratio for 2019 and 2018. 
2. Calculate the rate of return on total assets for 2019 and 2018.
3. Calculate the asset turnover ratio for 2019 and 2018. 
4. Calculate the rate of return on common stockholders’ equity for 2019 and 2018.
5. Calculate the earnings per share for 2019 and 2018. 
6. Calculate the 2019 dividend payout on common stock. Assume dividends per share for common stock are equal to \)1.13 per share. 
7. Did the company’s operating performance improve or deteriorate during 2019?

Data for Oxford State Bank follow:

Evaluate the common stock of Oxford State Bank as an investment. Specifically,

use the three stock ratios to determine whether the common stock has increased or decreased in attractiveness during the past year. Round to two decimal places.

The following data are adapted from the financial statements of Bridget’s Shops, Inc.:

Total Current Assets $ 1,216,000

Accumulated Depreciation 2,000,000

Total Liabilities 1,540,000

Preferred Stock 0

Debt Ratio 55%

Current Ratio 1.60

Prepare Bridget’s condensed balance sheet as of December 31, 2018.

Net sales revenue, net income, and common stockholders’ equity for Eyesight Mission Corporation, a manufacturer of contact lenses, follow for a four-year period.

 Requirements

1. Compute trend analyses for each item for 2017–2019. Use 2016 as the base year, and round to the nearest whole percent.

2. Compute the rate of return on common stockholders’ equity for 2017–2019, rounding to three decimal places.

The Klein Department Stores, Inc. chief executive officer (CEO) has asked you tocompare the company’s profit performance and financial position with the averages for the industry. The CEO has given you the company’s income statement and balance sheet as well as the industry average data for retailers.

Requirements

1. Prepare a vertical analysis for Klein for both its income statement and balance sheet.

2. Compare the company’s profit performance and financial position with the averagefor the industry.

Consider the data for Klein Department Stores presented in Problem P15-24A.

Requirements

1. Prepare a common-size income statement and balance sheet for Klein. The first column of each statement should present Klein’s common-size statement, and the second column, the industry averages.

2. For the profitability analysis, compute Klein’s

1. gross profit percentage and
2. profit margin ratio. Compare these figures with the industry averages. Is Klein’s profit performance better or worse than the industry average?

3. For the analysis of financial position, compute Klein’s 

1. current ratio and
2. debt to equity ratio. Compare these ratios with the industry averages.

Assume the current ratio industry average is 1.47, and the debt-to-equity industry average is 1.83. Is Klein’s financial position better or worse than the industry averages?

Determining the effects of business transactions on selected ratios Financial statement data of Style Traveler Magazine include the following items:

Requirements 

2.  Compute the three ratios after evaluating the effect of each transaction that follows. Consider each transaction separately

1. Purchased merchandise inventory of \)49,000 on the account. 
2. Borrowed \(127,000 on a long-term note payable.
3. Issued 2,000 shares of common stock, receiving cash of \)107,000. 
4. Received cash on account, $5,000.

Using ratios to evaluate a stock investment 

Comparative financial statement data of Sanfield, Inc. follow:

 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: 

1. Current ratio 
2. Cash ratio 
3. Times-interest-earned ratio 
4. Inventory turnover 
5. Gross profit percentage 
6. Debt to equity ratio 
7. Rate of return on common stockholders’ equity 
8. Earnings per share of common stock 
9. Price/earnings ratio

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.

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:

Selected balance sheet and market price data at the end of the current year:

Selected balance sheet data at the beginning of the current year:

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.

Completing a comprehensive financial statement analysis 

In its annual report, ABC Athletic Supply, Inc. includes the following five-year financial summary:

Requirements 

Analyze the company’s financial summary for the fiscal years 2014–2018 to decide whether to invest in the common stock of ABC. Include the following sections in your analysis. 

1. Trend analysis for net sales revenue and net income (use 2014 as the base year). 
2. Profitability analysis. 
3. Evaluation of the ability to sell merchandise inventory. 
4. Evaluation of the ability to pay debts. 
5. Evaluation of dividends. 
6. Should you invest in the common stock of ABC Athletic Supply, Inc.? Fully explain your final decision

Net sales revenue, net income, and commonA stockholders’ equity for Azbel Mission Corporation, a manufacturer of contact lenses, follow for a four-year period.

Requirements

1. Compute trend analyses for each item for 2017–2019. Use 2016 as the base year,and round to the nearest whole percent.

2. Compute the rate of return on common stockholders’ equity for 2017–2019, rounding to three decimal places.

The Randall Department Stores, Inc. chief executive officer (CEO) has asked you to compare the company’s profit performance and financial position with the averages for the industry. The CEO has given you the company’s income statement and balance sheet as well as the industry average data for retailers.

Requirements 

Compare the company’s profit performance and financial position with the average for the industry

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 

1. Prepare a common-size income statement and balance sheet for Randall. The first column of each statement should present Randall’s common-size statement, and the second column, the industry averages. 
2. For the profitability analysis, compute Randall’s (a) gross profit percentage and (b) profit margin ratio. Compare these figures with the industry averages. Is Randall’s profit performance better or worse than the industry average? 
3. For the analysis of financial position, compute Randall’s (a) current ratio and (b) debt to equity ratio. Compare these ratios with the industry averages. Assume the current ratio industry average is 1.47, and the debt to equity industry average is 1.83. Is Randall’s financial position better or worse than the industry averages?

Determining the effects of business transactions on selected ratios

Financial statement data of Modern Traveler’s Magazine include the following items:

Requirements 

2. Compute the three ratios after evaluating the effect of each transaction that follows. Consider each transaction separately. 

a. Purchased merchandise inventory of \)42,000 on account. 

b. Borrowed \(121,000 on a long-term note payable. 

c. Issued 5,000 shares of common stock, receiving cash of \)103,000. 

d. Received cash on account, $5,000.

Using ratios to evaluate a stock investment

Comparative financial statement data of Garfield, Inc. follow:

1. Market price of Garfield’s common stock: \)69.36 at December 31, 2018, and $38.04 at December 31, 2017. 

2. Common shares outstanding: 14,000 on December 31, 2018 and 12,000 on December 31, 2017 and 2016. 

3. All sales are on credit.

Requirements 

1. Compute the following ratios for 2018 and 2017: 

a. Current ratio 

b. Cash ratio 

c. Times-interest-earned ratio 

d. Inventory turnover 

e. Gross profit percentage 

f. Debt to equity ratio

g. Rate of return on common stockholders’ equity 

h. Earnings per share of common stock 

i. Price/earnings ratio 

2. Decide (a) whether Garfield’s ability to pay debts and to sell inventory improved or deteriorated during 2018 and (b) whether the investment attractiveness of its common stock appears to have increased or decreased.