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		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Current ratio		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Quick ratio		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Accounts receivable turnover		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Number  of days' sales in receivables		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Inventory turnover		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Number of days' sales in inventory		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Ratio of fixed assets to long-term liabilities		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Ratio of liabilities to stockholders' equity		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000
Times interest earned		$3,091,000 – $860,000$3,091,000 ÷ $860,000$1,866,000 ÷ $860,000$8,270,000 ÷ [($714,000 + $740,000) ÷ 2][($714,000 + $740,000) ÷ 2] ÷ ($8,270,000 ÷ 365)$4,100,000 ÷ [($1,072,000 + $1,100,000) ÷ 2][($1,072,000 + $1,100,000) ÷ 2] ÷ ($4,100,000 ÷ 365)$2,690,000 ÷ $1,690,000$2,550,000 ÷ $4,055,000($983,100 + $127,000) ÷ $127,000

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	fill in the blank 4aa52e01effe05a_1
Accounts receivable (net)	fill in the blank 4aa52e01effe05a_2
Inventory	fill in the blank 4aa52e01effe05a_3
Prepaid expenses	fill in the blank 4aa52e01effe05a_4
Total current assets	$fill in the blank 4aa52e01effe05a_5
Long-term investments	fill in the blank 4aa52e01effe05a_6
Property, plant, and equipment (net)	fill in the blank 4aa52e01effe05a_7
Total assets	$fill in the blank 4aa52e01effe05a_8
Liabilities
Current liabilities	$fill in the blank 4aa52e01effe05a_9
Long-term liabilities	fill in the blank 4aa52e01effe05a_10
Total liabilities	$fill in the blank 4aa52e01effe05a_11
Stockholders' Equity
Preferred stock, $10 par	$fill in the blank 4aa52e01effe05a_12
Common stock, $5 par	fill in the blank 4aa52e01effe05a_13
Retained earnings	fill in the blank 4aa52e01effe05a_14
Total stockholders' equity	$fill in the blank 4aa52e01effe05a_15
Total liabilities and stockholders' equity	$fill in the blank 4aa52e01effe05a_16

Profitability Measures

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

Profitability Measures		Computations
Asset turnover		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Return on total assets		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Return on stockholders' equity		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Return on common stockholders' equity		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Earnings per share on common stock		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Price-earnings ratio		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Dividends per share		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35
Dividend yield		$8,270,000 ÷ [($5,781,000 + $5,591,000) ÷ 2]($796,380 + $127,000) ÷ [($6,605,000 + $6,415,000) ÷ 2]$796,380 ÷ [($4,055,000 + $3,852,250) ÷ 2]($796,380 – $65,000) ÷ [($3,567,500 + $3,424,800) ÷ 2]($796,380 – $65,000) ÷ 250,000 shares$35 ÷ $3.05$175,000 ÷ 250,000 shares$0.70 ÷ $35

Comparative Income Statement For the Years Ended December 31, 20Y6 and 20Y5

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

$fill in the blank bc5945fb202c039_1

$7,277,000

$fill in the blank bc5945fb202c039_2

fill in the blank bc5945fb202c039_3

%

Cost of goods sold

fill in the blank bc5945fb202c039_4

(3,444,000)

fill in the blank bc5945fb202c039_5

fill in the blank bc5945fb202c039_6

%

Gross profit

$fill in the blank bc5945fb202c039_7

$3,833,000

$fill in the blank bc5945fb202c039_8

fill in the blank bc5945fb202c039_9

%

Selling expenses

$fill in the blank bc5945fb202c039_10

$(1,455,400)

$fill in the blank bc5945fb202c039_11

fill in the blank bc5945fb202c039_12

%

Administrative expenses

(1,240,500)

(1,104,500)

fill in the blank bc5945fb202c039_13

fill in the blank bc5945fb202c039_14

%

Total operating expenses

$fill in the blank bc5945fb202c039_15

$(2,559,900)

$fill in the blank bc5945fb202c039_16

fill in the blank bc5945fb202c039_17

%

Operating income

$fill in the blank bc5945fb202c039_18

$1,273,100

$fill in the blank bc5945fb202c039_19

fill in the blank bc5945fb202c039_20

%

Other expense (interest)

fill in the blank bc5945fb202c039_21

(120,600)

fill in the blank bc5945fb202c039_22

fill in the blank bc5945fb202c039_23

%

Income before income tax expense

$fill in the blank bc5945fb202c039_24

$1,152,500

$fill in the blank bc5945fb202c039_25

fill in the blank bc5945fb202c039_26

%

Income tax expense

fill in the blank bc5945fb202c039_27

(180,720)

fill in the blank bc5945fb202c039_28

fill in the blank bc5945fb202c039_29

%

Net income

$fill in the blank bc5945fb202c039_30

$971,780

$fill in the blank bc5945fb202c039_31

fill in the blank bc5945fb202c039_32

%

Final Questions

Your accountant friend reveals that the company whose information you have been working on is actually a company he is thinking of investing in. What advice and insight do you have for your friend?

Using only the information from your horizontal analysis of the comparative income statement, complete the following sentences.

Net incomeSalesCost of goods soldOther expense (interest)

 has decreased significantly from 20Y5 to 20Y6, even though 

net incomesalescost of goods soldselling expenses

 has increased. However, 

net incomesalescost of goods sold

 has also 

increaseddecreasednot changed

, which slowed the increase in 

gross profitnet incomesalestotal operating expenses

. In addition, 

selling expensesincome tax expenseother expense (interest)

 has increased at a faster rate. The company appears 

to be strugglingto be too heavilyleveragedto be a good investmentto be taking the right stepsto be growing

.

Based on these observations, do you recommend that your friend invest in this company’s stock? 

YesNo