Question

P3-19 Common-size statement analysis A common-size income statement for Creek Enterprises 2018 operations follows. Using the firm's 2019 income statement presented in Problem 3-16, develop the 2019 common-size income statement and compare it with the 2018 statement. Which areas require further analysis and investigation? Creek Enterprises Common-Size Income Statement for the Year Ended December 31, 2018 100.0% 65.9 34.1% Sales revenue ($35,000,000) Less: Cost of goods sold Gross profits Less: Operating expenses Selling expense General and administrative expenses Lease expense Depreciation expense Total operating expense Operating profits Less: Interest expense Net profits before taxes Less: Taxes (rate = 40%) Net profits after taxes Less: Preferred stock dividends Earnings available for common stockholders 12.7% 6.3 0.6 3.6 23.2% 10.9% 1.5 9.4% 3.8 5.6% 0.1 5.5%

Answer 1

2019 Common Size Income Statement

Particulars	Common Size (%)
Sale Revenue	100%
Less: Cost of goods sold	70%
Gross Profit	30%
Less: Operating Expenses
Selling Expense	10%
General and administrative expenses	6%
Lease expense	0.7%
Depreciation expense	3.3%
Total Operating Expenses	20%
Operating Profits	10%
Less: Interest Expense	3.3%
Net Profit before Tax	6.7%
Less: Taxes (rate = 40%)	2.7%
Net Profit after taxes	4%
Less: Preferred stock dividends	0.3%
Earnings avaliable for common shareholders	3.7%

Compared to 2018 common size income statement, we can see that thought the sales has decreased but the cost of goods sold for 2019 has increased by 4.1% which needs investigation.

The interest expense also needs to be invested and analyzed further as it has more than doubled compared to 2018.

Debt Analysis:

Debt Ratio = Total Debt/Total Assets where total debt doesn't include current liabilities

Debt Ratio = $20,000,000/$50,000,000 = 0.4

Industry average debt ratio = 0.51

Thus, as per the comparison the company has better debt profile since it has lower debt compared to the asset base.

Times Interest Earned Ratio = EBIT/Total Interest expense = Operating Profit/Total Interest Expense

= $3,000,000/$1,000,000 = 3 times

The industry average is 7.30 times which is much higher compared to Creek Enterprises ratio of 3 times.

This indicates that the operating Profit can only cover 3 times the interest payment.

Fixed Payment coverage ratio = (EBIT + Fixed Charges before Taxes) / (Fixed Charges before Taxes + Interest expense)

Here we will consider lease payments in the Fixed charges before taxes

Fixed Payment coverage ratio = ($3,000,000 + $200,000)/($200,000 + $1,000,000) = $3,200,000/$1,200,000 = 2.67

The industry average is 1.85 which suggests that Creek has a better performance metric compared to industry.

Overall Creek has all the performance metrics as better compared to industry except for times interest earned. But that ratio is also sufficient enough to serve its debt.