Question

Mastery Problem: Financial Statement Analysis

Liquidity and Solvency Measures

Your friend, another accountant, has bet you that with your knowledge of accounting and just the computations for common analytical measures, you can figure out many aspects of a company's financial statements. You take the bet!

Match each computation to one of the liquidity and solvency measures in the table. (Hint: Begin by looking for simple computations and identifying the amounts in those computations. Look for other measures that use those amounts.)

Liquidity and Solvency Measures		Computations
Working capital		$3,093,000 – $840,000
Current ratio		$3,093,000 ÷ $840,000
Quick ratio		$1,866,000 ÷ $840,000
Accounts receivable turnover		$8,270,000 ÷ [($714,000 + $740,000) ÷ 2]
Number  of days' sales in receivables		[($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)
Inventory turnover		$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2]
Number of days' sales in inventory		[($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)
Ratio of fixed assets to long-term liabilities		$2,690,000 ÷ $1,690,000
Ratio of liabilities to stockholders' equity		$2,530,000 ÷ $4,077,000
Times interest earned		($983,100 + $127,000) ÷ $127,000

Feedback

Look for patterns in the computations and match them to ratios that are related to each other. Identify the amounts in the computations and consider how they are related to amounts in other computations.

Balance Sheet

Use the following balance sheet form to enter amounts you identify from the computations on the Liquidity and Solvency Measures part. You will identify other amounts for the balance sheet on the Profitability Measures part. If you have a choice of two amounts, assume the first amount in the ratio is for the end of the year. Compute any missing amounts.

Balance Sheet December 31, 20Y6
Assets
Current assets:
Cash	$823,000
Marketable securities
Accounts receivable (net)
Inventory
Prepaid expenses
Total current assets	$
Long-term investments
Property, plant, and equipment (net)
Total assets	$
Liabilities
Current liabilities	$
Long-term liabilities
Total liabilities	$
Stockholders' Equity
Preferred stock, $10 par	$
Common stock, $5 par
Retained earnings
Total stockholders' equity	$
Total liabilities and stockholders' equity	$

Feedback

Identify the amounts in the Liquidity and Solvency Measures panel and the Profitability Measures panel that are balance sheet items and enter them accordingly.

Profitability Measures

Match each computation to one of the profitability measures in the table.

Profitability Measures		Computations
Asset turnover		$8,270,000 ÷ [($5,783,000 + $5,593,000) ÷ 2]
Return on total assets		($796,380 + $127,000) ÷ [($6,607,000 + $6,417,000) ÷ 2]
Return on stockholders' equity		$796,380 ÷ [($4,077,000 + $3,873,150) ÷ 2]
Return on common stockholders' equity		($796,380 – $65,000) ÷ [($3,589,500 + $3,445,920) ÷ 2]
Earnings per share on common stock		($796,380 – $65,000) ÷ 250,000 shares
Price-earnings ratio		$35 ÷ $3.05
Dividends per share		$175,000 ÷ 250,000 shares
Dividend yield		$0.70 ÷ $35

Feedback

Look for patterns in the computations and match them to ratios that are related to each other. Identify the amounts in the computations and consider how they are related to amounts in other computations. Note that two of the computations use shares.

Comparative Income Statement

Use the following comparative income statement form to enter amounts you identify from the computations on the Liquidity and Solvency Measures part and on the Profitability Measures part. Compute any missing amounts and complete the horizontal analysis columns. Enter percentages as decimal amounts, rounded to one decimal place. When rounding, look only at the figure to the right of one decimal place. If < 5, round down and if ≥ 5, round up. For example, for 32.048% enter 32.0%. For 32.058% enter 32.1%.

Comparative Income Statement For the Years Ended December 31, 20Y6 and 20Y5
							Increase/(Decrease)
	20Y6			20Y5			Amount			Percentage
Sales		$			$7,277,000			$				%
Cost of goods sold					(3,444,000)							%
Gross profit		$			$3,833,000			$				%
Selling expenses		$			$(1,455,400)			$				%
Administrative expenses		(1,240,500)			(1,104,500)							%
Total operating expenses		$			$(2,559,900)			$				%
Operating income		$			$1,273,100			$				%
Other expense (interest)					(120,600)							%
Income before income tax expense		$			$1,152,500			$				%
Income tax expense					(180,720)							%
Net income		$			$971,780			$				%

Answer 1

Part 1
Balance Sheet	Amount	Remarks
Cash	823000	Given
Marketable Securities	329000	(refer working 3)
Accounts Receivable	714000	(refer working 2)
Inventory	1072000	(refer working 4)
Prepaid Expense	155000	(refer working 5)
Total Current Assets	3093000	(refer working 1)
Long term Investment	824000	(refer working 9)
Property plant & Equipment (net)	2690000	(refer working 6)
Total Assets	6607000	(refer working 8)
Liabilities
Current Liabilities	840000	(refer working 1)
Long term Liabilities	1690000	(refer working 6)
Total Liabilities	2530000	(refer working 7)
Shareholder's equity	4077000	(refer working 7)
Total Liabilties Shareholders Equity	6607000	Sum of Total Liabilities and Shareholder's Equity

	Working
1	Working Capital is Current assets minus current Liabilities
	Current Assets	3093000
	Current Liabilities	840000
2	Accounts receivable Turnover Ratio = Credit Sales/ Average Receivables
	Accounts receivable Turnover Ratio = 8270000/ (714000+740000)/2
	Credit Sales = 8270000
	Closing Receivables = 714000
	Opening Receivables = 740000
3	Quick ratio = 1866000 / 840000
	Quick ratio = (Cash + Marketable Securities+ Accounts Receivables)/ Current Liabilities
	Cash + Marketable Securities+Accounts Receivable = 1866000
	823000+ Marketable Securities + 714000= 1866000
	Marketable Securities = 1866000-823000-714000
	Marketable Securities = 329000
4	Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory
	Inventory Turnover Ratio= 4100000/(1072000+1100000)/2
	Cost of Goods sold= 4100000
	Closing Inventory=1072000
	Opening Inventory= 1100000
5	Total Current Assets = 3093000
	We have all the compnents of current assets except Prepaid Assets
	Cash + Marketable Securities+Accounts Receivable+Inventory + Prepaid Assets = 3093000
	823000+329000+714000+1072000+Prepaid Assets = 3093000
	Prepaid assets = 3093000-823000-329000-714000-1072000
	Prepaid assets = 157000
6	Fixed Assets to Log term Liabiilties ratio = Fixed Assets/ Long term liabilities
	Fixed Assets to Log term Liabiilties ratio = 269000/1690000
	Fixed Assets = 2690000
	Long term Liabilities= 1690000
7	Ratio of laibiilties to Stockholder's Equity = Total Liabilities/Stockholders Equity
	Ratio of laibiilties to Stockholder's Equity = 2530000/4077000
	Total Liabilities = 2530000
	Stockholder's Equity = 4077000
8	As Total Assets = Total Liabilities + Shareholder's Equity
	Total Liabilties & Shareholder's Equity = 6607000
	Total Assets = 6607000
9	Long term investment = Total assets-total current assets - propert plant & equipment
	Long term investment = 6607000-3093000-2690000
	Long term investment = 824000

Part2 Income Statement
Particulars	20Y6	20Y5	Increase/ Decrease	%age	Remarks
Sales	8250000	7277000	973000	13.4%	Refer Working 2
Cost of Goods Sold	-4100000	-3444000	-656000	19.0%	Refer Working 4
Gross profit	4150000	3833000	317000	8.3%
Selling Expense	0	-1455400	1455400	-100.0%
Administrative	-1240500	-1104500	-136000	12.3%
Total operating expense	-1799400	-2559900	760500	-29.7%
Operating Income	1110100	1273100	-163000	-12.8%
Other expense (Interest)	-127000	-120600	-6400	5.3%	Refer Working 10
Income before income taxes	983100	1152500	-169400	-14.7%	Refer Working 10
Income tax expense	-186720	-180720	-6000	3.3%
Net Income	796380	971780	-175400	-18.0%
Working 10
Times interest earned ratio= Earnings before interest/Interest
Times interest earned ratio= (983100+127000)/127000
Interest = 127000
Income before Tax = 983100