Map 3rd Chapter 14 Se

Chapter 14
FINANCIAL STATEMENT ANALYSIS
LEARNING OBJECTIVES
LO 1 Explain the importance of analyzing financial LO 5 Calculate and apply operations management
statements and solvency ratios
LO 2 Conduct a horizontal and vertical analysis of LO 6 Calculate and apply capital market ratios
financial statements LO 7 Identify the limitations of financial statement
LO 3 Calculate and apply liquidity ratios analysis
LO 4 Calculate and apply profitability ratios
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Assessment Questions
AS-1 LO 1
What is financial analysis?
AS-2 LO 1
What is the Management’s Discussion and Analysis (MD&A) section in a company’s annual report?
AS-3 LO 4
What is the formula for gross profit margin?
AS-4 LO 4
What does gross profit margin tell us?
393
Chapter 14 Financial Statement Analysis
AS-5 LO 5
What is the formula for the times interest earned ratio?
AS-6 LO 5
Is it more preferable to have a higher or lower interest coverage ratio? Explain.
AS-7 LO 4
How do you calculate net profit margin?
AS-8 LO 4
What is the formula for return on equity?
AS-9 LO 4
For a particular company, if net income increased significantly from one year to the next, does this
guarantee that the return on equity will also increase? Explain.
AS-10 LO 4
What is the formula for return on assets?
AS-11 LO 4
What are some possible reasons why return on assets may have decreased from one period to the next?
394
Financial Statement Analysis Chapter 14
AS-12 LO 4
Suppose that Company A and Company B generate the same level of net income each period. However,
Company A is more capital-intensive than Company B. Which company will likely have the higher return on
assets?
AS-13 LO 3
What is the formula for the current ratio?
AS-14 LO 3
What does the current ratio tell you?
AS-15 LO 3
If current assets stay constant from one period to the next, but current liabilities increase, what will happen
to the current ratio?
AS-16 LO 3
What is the formula for the quick ratio?
AS-17 LO 5
What is the formula for the debt-to-equity ratio?
AS-18 LO 5
What is the formula for days’ sales outstanding?
395
AS-19 LO 5
What does days’ sales outstanding tell you?
AS-20 LO 5
How do you calculate accounts receivable turnover?
AS-21 LO 5
How is days’ sales in inventory calculated?
AS-22 LO 5
What is the formula for the inventory turnover ratio?
AS-23 LO 7
Why is it necessary to compare a company’s calculated ratios with industry benchmarks?
AS-24 LO 6
How is book value per common share calculated?
396
AS-25 LO 6
What does book value per common share tell us?
AS-26 LO 6
How is earnings per share calculated? And what does it tell us?
AS-27 LO 2
How does the base-year differ from the base-figure?
397
Application Questions Group A
AP-1A LO 4
Simply Mullet Company reported the following.

• Sales: $1,000,000
• Cost of Goods Sold: $700,000
• Operating Expenses: $400,000
• Income Tax Rate: 20%
Calculate the gross profit margin. Differentiate between gross profit margin and gross profit.
AP-2A LO 4 5
Trooper Nova Company reported the following.

Sales $2,000,000
Cost of Goods Sold 700,000
Operating Expenses 400,000
Interest Expense included in Operating Expenses 50,000
Income Taxes 40% of income before tax
Stockholders’ Equity (Average) $20,000,000
Required
a) Calculate net income.
b) Calculate the net profit margin.
c) Calculate the times interest earned
398
d) Calculate the return on equity. Banks are currently paying interest of 4% on deposits invested for two or
more years. Comment on the ratio.
AP-3A LO 3
All-You-Can-Buy Company reports current assets of $6,572, and current liabilities of $2,786. Calculate the
current ratio and the working capital.
AP-4A LO 3
Total current liabilities for Nicholson Restoration Company are $2,786. If cash is $2,000, short-term
investments are $3,000, long-term investments are $1,000 and accounts receivable is $1,200, calculate the
quick ratio.
AP-5A LO 4
The income statement of Ellen Corporation for the years 2018 and 2019 showed the following gross profit.
2019 2018
Net Sales $97,200 $80,000
Cost of Goods Sold 72,000 50,000
Gross Profit $25,200 $30,000
Required
a) Calculate the gross profit margins for both years.
399
b) In which year does Ellen Corporation have a better gross profit margin? Explain.
AP-6A LO 5
Kingston Company sells on credit, with the balance due in 30 days. The company’s DSO ratio has changed
from 60 days last year to 42 days this year. Are things getting better or worse? Explain the relationship
between the sales terms and DSO.
AP-7A LO 4 5
Presented below is the comparative income statement of Newton Company for 2019 and 2018.
Newton Company
Income Statement
For the Year Ended December 31
2019 2018
Sales $194,890 $108,345
Gross Profit 77,956 43,338
Operating Expenses
Administrative Expense 12,000 8,000
Selling Expense Expense 22,540 13,627
Total Operating Expenses 34,540 21,627
Other Income and Expenses
Interest Expense 1,248 580
Income before Income Tax Expense 42,168 21,131
Income Tax Expense 12,650 6,339
Net Income $29,518 $14,792
Required
a) Calculate the following ratios for both years.
2019 2018
Net Profit Margin
Times Interest Earned Ratio
400
b) In which year does the company have a better performance with respect to the ratios calculated in part
a)? Explain.
AP-8A LO 5
At the beginning of 2019, Acatela Corp. had inventory of $350,000. During the year, it purchased $220,000
worth of raw materials and sold $500,000 worth of inventory. Determine the inventory turnover ratio and
the days’ sales in inventory.
AP-9A LO 5
At the end of 2019, accounts receivable amounted to $200,000. At the beginning of the year, it was
$165,000. Net credit sales for the year amounted to $813,000 and net income was calculated to be
$229,000.
Determine the days’ sales outstanding ratio and the accounts receivable turnover ratio. Comment on the
ability of the company to enforce its credit policy of 60 days.
AP-10A LO 3
Selected financial data from Crew Company is provided below.

As at
December 31, 2019
Cash $75,000
Accounts Receivable $225,000
Merchandise Inventory $270,000
Short-Term Investments $40,000
Land and Building $500,000
Current Portion of Long-Term Debt $30,000
Accounts Payable $120,000
401
Required
a) Calculate the quick ratio.
b) What does Crew Company’s quick ratio suggest about the company’s performance?
AP-11A LO 5
Bo Kyung Company had a debt-to-equity ratio last year of 1.46. This year, the ratio is 2.0. Are things getting
better or worse? Explain your answer.
AP-12A LO 4 5
Presented below are select figures from the balance sheet of Edison Company for 2019 and 2018.
Edison Company
Balance Sheet
As at August 31
2019 2018
Total Assets $286,633 $203,311
Total Liabilities 119,006 69,873
Stockholders’ Equity 167,627 133,438
In 2019, Edison Company had sales of $413,000 and net income of $46,500. Calculate the ratios for 2019 as
indicated below.
Return on Assets
Asset Turnover
Debt‐to‐Equity
Debt‐to‐Total-Assets
402
AP-13A LO 6
Testa Inc. had a net income of $158,000 for the year ended December 31, 2019. The company does not
have any preferred stock and has 45,000 common shares outstanding for the entire year. During the year,
they paid out $20,000 in dividends. Assume the market price of each common share is $24, which happens
to be double of the book value per share.
Required
a) Calculate earnings per share.
b) Calculate the dividend yield.
c) Calculate the price-earnings ratio.
AP-14A LO 6
Freebird Inc. had a net income of $358,400 for the year ended September 30, 2019. The company does not
have any preferred stock and has 113,000 common shares outstanding for the entire year. During the year,
they paid out $60,000 in dividends. Stockholders’ equity is valued at $332,000. Assume the market price of
each common share at the company’s year end is $17 per share.
Required
403
d) Calculate the book value per common share.
Analysis
Book value per common share is rarely equal to the selling price of the share on the stock market. What are
some factors that could cause the market value to differ from the book value?
404
AP-15A LO 4
Below is select financial statement information for Rock Co. and Roll Inc.
Rock Co. Roll Inc.

Income Statement
Sales $348,500 $465,800
Gross Profit 242,208 305,099
Expenses
Salaries Expense 52,275 69,870
Depreciation Expense 34,850 46,580
Advertising Expense 17,425 23,290
Interest Expense 15,683 37,264
Total Expenses 120,233 177,004
Net Income $59,245 $44,251
Balance Sheet
Cash $14,850 $19,800
Accounts Receivable 25,000 22,500
Merchandise Inventory 34,500 43,125
Equipment 85,800 81,510
Total Assets $160,150 $166,935
Accounts Payable $27,500 $24,750

Unearned Revenue 17,800 19,580
Long-Term Liabilities 29,350 62,925
Stockholders' Equity 85,500 59,680
Total Liabilities and Stockholders’ Equity $160,150 $166,935
Required
a) Calculate the profitability ratios shown in the table below. For any ratios that require an average value
from the balance sheet accounts, just use the single figure provided for each company.
Rock Co. Roll Inc.

Gross Profit Margin
Net Profit Margin
Return on Equity (ROE)
Return on Assets (ROA)
405
b) Based on the ratios from part a), which company would an investor be more likely to invest in?
AP-16A LO 3 4 5
Chicken Inc. and Egg Inc. are both in the toy retail business. All sales are on credit. Below is select financial
information for the current year.
Chicken Inc. Egg Inc.
Income Statement
Sales $150,000 $135,000
Expenses
Net Income $23,250 $16,470
Balance Sheet
Cash $40,850 $24,510
Equipment 85,800 51,480
Total Assets $176,150 $105,115
Accounts Payable 21,000 32,000

Total Liabilities and Stockholders’ Equity $176,150 $105,115
406
Required
a) Calculate each ratio listed below for each company and indicate which company is better for each one.
For any ratios that require an average value from the balance sheet accounts, just use the single figure
provided for each company.
Which company
Chicken Inc. Egg Inc.
is better?
Gross Profit Margin
Net Profit Margin
Asset Turnover
Current Ratio
Quick Ratio
Debt-to-Equity Ratio
Debt-to-Total-Assets Ratio
Days’ Sales Outstanding
Accounts Receivable Turnover
Days’ Sales in Inventory
Inventory Turnover
b) Examining all of the ratios, explain which company has a stronger financial position in regards to the
following categories.
i. Profitability
ii. Liquidity
iii. Managerial performance
iv. Solvency
407
AP-17A LO 3 4 5
The bookkeeper for Contigo Corporation has calculated several ratios for the past three fiscal years, shown
below.
Required
a) For each of the ratios, indicate whether the ratio is improving or weakening overall from the previous
years.
Contigo Corporation
Improving or
Ratio 2019 2018 2017
Weakening?
Gross Profit Margin 32.80% 31.50% 31.10%
Return on Common Stockholders’ Equity 18.04% 17.33% 17.11%
Times Interest Earned Ratio 11.60 12.10 12.20
Current Ratio 1.50 1.31 0.97
Quick Ratio 0.90 0.79 0.73
Debt-to-Equity Ratio 0.53 0.61 0.86
Days’ Sales Oustanding 31.50 31.20 30.80
Days’ Sales in Inventory 78.10 76.54 73.41
b) Contigo is looking at applying for a new bank loan. The bank will examine the ratios that focus on the
strength of Contigo’s cash flow to determine if they should approve the loan. Based on the information in
part a), would you recommend the bank to approve the bank loan? Why or why not?
AP-18A LO 2
Perform a horizontal analysis for Groff Inc. Use 2016 as the base year and comment on the results.
Groff Inc.
In Millions of Dollars
2019 2018 2017 2016
Sales Revenue 500 400 300 200
Net Income 166 158 144 120
Groff Inc.
2019 2018 2017 2016
Sales Revenue
Revenue Ratio
Net Income
Net Income Ratio
408
AP-19A LO 2
The following financial statements are taken from the records of Abaya Inc.
Abaya Inc.
Balance Sheet
As at December 31
2019 2018 2017
Current Assets
Cash $315,000 $325,000 $210,000
Accounts Receivable 140,000 198,000 92,000
Merchandise Inventory 411,000 397,000 428,000
Short-Term Investments 115,000 100,000 100,000
Total Current Assets 981,000 1,020,000 830,000
Noncurrent Assets 356,000 250,000 403,000
Total Assets $1,337,000 $1,270,000 $1,233,000
Current Liabilities 214,000 265,000 90,000
Long-Term Liabilities 22,000 150,000 100,000
Total Liabilities 236,000 415,000 190,000
Stockholders’ Equity 1,101,000 855,000 1,043,000
Total Liabilities and Stockholders’ Equity $1,337,000 $1,270,000 $1,233,000
Abaya Inc.
Income Statement
2019 2018 2017
Sales $701,000 $689,000 $514,000
Cost of Goods Sold 379,000 396,000 385,000
Gross Profit 322,000 293,000 129,000
Operating Expenses
Administrative Expense 28,050 15,780 16,100
Selling Expense 65,000 34,000 30,000
Total Operating Expenses 93,050 49,780 46,100
Interest Expense 18,600 12,600 8,500
Income before Income Tax Expense 210,350 230,620 74,400
Income Tax Expense 63,105 69,186 22,320
Net Income $147,245 $161,434 $52,080
Required
a) Use horizontal analysis techniques to compare the changes between the 2019 and 2018 balance sheet
items.
409
Abaya Inc.
Balance Sheet
As at December 31
2019 2018 $ Change % Change
Current Assets
Cash $315,000 $325,000
Short-Term Investments 115,000 100,000
Total Current Assets 981,000 1,020,000
Noncurrent Assets 356,000 250,000
Total Assets $1,337,000 $1,270,000
Current Liabilities 214,000 265,000

Stockholders’ Equity 1,101,000 855,000
Total Liabilities and Stockholders’ Equity $1,337,000 $1,270,000
b) Using 2017 as a base year, provide a horizontal analysis of sales, gross profit, operating expenses and net
income.
2019 2018 2017
Sales
Gross Profit
Operating Expenses
Net Income
410
c) Perform a vertical analysis of income statement for 2019, 2018 and 2017 and state all of the income
statement items as a percentage of net sales.
Abaya Inc.
Income Statement
2019 2018 2017
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Administrative Expense
Selling Expense
Total Operating Expenses
Interest Expense
Income before Income Tax Expense
Income Tax Expense
Net Income
411
AP-20A LO 2
Perform a vertical analysis (use Sales as the base) for Hiltonia Inc. Comment on the results. Note that figures
are in millions of dollars.
Hiltonia Inc.
2019 2018
Sales $210 $250
COGS 150 200
Gross Profit 60 50
Selling Expenses 5 4
Salaries 2 2
Rent 5 5
Total Expenses 12 11
Income before Tax 48 39
Taxes (35%) 16.8 13.65
Net Income $31.2 $25.35
Hiltonia Inc.
2019 % of Sales 2018 % of Sales
Sales
COGS
Gross Profit
Selling Expenses
Salaries
Rent
Total Expenses
Income before Tax
Taxes (35%)
Net Income
412
AP-21A LO 3 4 5 6
The income statements and balance sheets for Fallon Inc. are shown below for the last three fiscal years.
Fallon Inc.
Income Statement
For the Year Ended
2019 2018 2017
Sales $360,000 $324,000 $342,000
Gross Profit 252,000 234,900 256,500
Expenses
Operating Expense 54,000 48,600 51,300
Depreciation Expense 36,000 32,400 34,200
Advertising Expense 18,000 16,200 17,100
Total Expenses 114,800 104,850 111,100
Income before Income Tax Expense 137,200 130,050 145,400
Income Tax Expense 72,000 64,800 68,400
Net Income $65,200 $65,250 $77,000
Fallon Inc.
Balance Sheet
At the Year Ended
2019 2018 2017
Cash $63,650 $39,750 $36,000
Equipment 110,000 104,500 83,600
Total Assets $250,650 $216,750 $186,600
Accounts Payable $52,800 $44,000 $35,200

Current Portion of Long-Term Debt 8,500 8,500 8,500
Long-Term Debt 68,000 76,500 85,000
Common Stock 66,000 57,600 57,000
Retained Earnings 55,350 30,150 900
Total Liabilities and Stockholders’ Equity $250,650 $216,750 $186,600
Other Information
1) Fallon Inc. has an unlimited number of shares authorized. The following number of common shares
were outstanding in each year for the entire year: 2019—50,000, 2018—48,000, 2017—47,000.
2) The following dividends were paid: $40,000 in 2019, $36,000 in 2018 and $38,000 in 2017.
413
Required
a) Calculate the following ratios for Fallon Inc. for 2018 and 2019, and state whether the ratio improved or
weakened in 2019.
Improved or
2019 2018
Weakened
Gross Profit Margin
Net Profit Margin
Asset Turnover
Current Ratio
Quick Ratio
Inventory Turnover
Book Value per Common Share
Earnings per Share
b) Fallon Inc. has a credit policy of 30 days. That is, it expects all customers to pay their bills within 30
days from sale. Comment on the company’s ability to enforce this policy.
Analysis
Comment on the company’s ability to cover its short-term debt obligations.
414
AP-22A LO 4
The stockholders’ equity section of Adora Corporation’s balance sheet as at December 31, 2018 and 2019 is
presented below.
2019 2018
Stockholders’ Equity
Paid-In Capital
Preferred stock, $7, noncumulative, 10,000 shares authorized,
1,000 shares issued and outstanding $100,000 $100,000
Common stock, unlimited shares authorized,
50,000 shares issued and outstanding 500,000 500,000
Total Paid-In Capital 600,000 600,000
Retained Earnings 338,000 300,000
Total Stockholders’ Equity 938,000 900,000
Both preferred and common stock do not have par value. There were no changes in the number of shares
of preferred and common stock during 2018 and 2019. Adora announced and paid preferred dividends of
$7 per share and common dividends of $0.50 per share in 2019. Its net income in 2019 was $70,000.
Required
a) Calculate Adora’s return on equity for 2019. Round your answer to two decimal places.
b) Calculate Adora’s return on common stockholders’ equity for the year 2019. Round your answer to two
decimal places.
415
Application Questions Group B
AP-1B LO 4
Gross profit increased from $300,000 in 2018, to $400,000 in 2019. Gross profit margin decreased from 30%
in 2018, to 28% in 2019. Comment on whether or not the company’s profitability improved or deteriorated.
AP-2B LO 4 5
Sou Heng Company reported the following financial information at the end of 2019.
Sales Revenue $2,110,000

Cost of Goods Sold $740,000
Operating Expenses $394,000
Interest Expense included in Operating Expenses $53,000
Income Tax Expense 38% of income
Stockholders’ Equity (Average) $18,000,000
Required
a) Calculate net income.
b) Calculate the net profit margin.
c) Calculate the times interest earned.
d) Calculate the return on equity.
416
AP-3B LO 3
Goliath Gardening Services Ltd. reports current assets of $6,261, and current liabilities of $2,925. Calculate the
current ratio and the working capital. Comment on the company’s ability to cover short-term obligations.
AP-4B LO 3
Selected financial data from Jai Home Company is provided below.
Cash $85,000
Accounts Receivable $233,000
Merchandise Inventory $267,000
Short‐Term Investments $50,000
Land and Building $464,000
Current Portion of Long-Term Debt $36,000
Accounts Payable $117,000
Required
a) Calculate the quick ratio.
b) True or False? The quick ratio calculated in part a) shows that Jai Home Company is likely to meet its short‐term
cash obligations.
AP‐5B LO 4
The income statement for Ellen Corporation for the years 2018 and 2019 showed the following information.
2019 2018
Sales Revenue $98,000 $66,000
Cost of Goods Sold $77,000 $43,000
Gross Profit $21,000 $23,000
Required
a) Calculate the gross profit margins for both years.
417
b) In which year does Ellen Corporation have a better gross profit margin?
AP-6B LO 5
At the end of 2019, accounts receivable for Genuine Interiors amounted to $210,000. At the beginning
of the year, it was $200,000. Net credit sales for the year amounted to $900,000 and net income was
calculated to be $205,000.
Determine the days’ sales outstanding ratio and the accounts receivable turnover ratio.
Analysis
Generally, a lower days’ sales outstanding (DSO) is desirable, since it means collections are happening faster
for the company. Is there any drawback to getting the DSO extremely low, such as to only two or three
days?
AP-7B LO 4 5
Presented below is the comparative income statement of JeansWear Company for 2019 and 2018.
JeansWear Company
Income Statement
For the Year Ended January 31
2019 2018
Sales $184,794 $107,933
Operating Expenses
Administrative Expense 9,770 4,485
Selling Expense 22,000 16,000
Total Operating Expenses 31,770 20,485
Net Income $25,292 $12,493
418
Required
a) Calculate the following ratios for both years.
2019 2018
Net Profit Margin
b) In which year does the company have a better performance with respect to the net profit margin calculated in
part a)?
AP-8B LO 5
At the beginning of 2019, Percolate Corp. had inventory of $337,000. During the year, it purchased $210,000
worth of raw materials and sold $505,000 worth of inventory. Determine the inventory turnover ratio and
the days’ sales in inventory. Comment on the company’s ability to sell its inventory, which has a shelf-life of
90 days.
AP-9B LO 5 7
Below is the past annual information for Java Time Inc. All sales are on credit.
2019 2018 2017 2016

Sales $44,500 $46,280 $47,900 $55,085
Sales Discounts 2,003 2,083 2,155 2,479
Net Sales 42,498 44,197 45,744 52,606
Accounts Receivable 6,130 5,885 5,649 5,084
Required
a) Calculate the following ratios for 2017, 2018 and 2019.
2019 2018 2017

b) Are the ratios improving or weakening? What could the company do to better control these ratios?
419
AP-10B LO 3
Information from Silky Company’s year-end financial statements is as follows.

2019 2018
Current Assets $200,000 $210,000
Current Liabilities 100,000 90,000
Net Sales 830,000 880,000
Operating Income 50,000 55,000
Required
a) Calculate the current ratio for both years.
b) In which year does Silky Company have a better current ratio? Explain.
AP-11B LO 4
Selected information for the Universal Company is as follows.
December 31
2019 2018 2017
Common Stock $840,000 $648,000 $550,000
Retained Earnings 370,000 248,000 150,000
Net Income for the Year 240,000 122,000 98,000
Required
a) Calculate the return on equity ratio for 2019 and 2018.
420
b) Has the Universal Company’s performance improved in 2019? Explain using the return on equity ratio.
AP-12B LO 5
Below is selected financial information for Swingline Inc.
2019 2018 2017 2016

Ending Inventory 4,850 5,626 5,723 6,014
Cost of Goods Sold 68,950 72,398 65,503 71,708
Required
a) Calculate the following ratios for 2019, 2018 and 2017.
2019 2018 2017

Inventory Turnover
b) Are the ratios improving or weakening? What could the company do to better control these ratios?
AP-13B LO 6
Bluebird Inc. had a net income of $387,400 for the year ended August 31, 2019. The company does not
have any preferred stock and has 125,000 shares of common stock outstanding for the entire year. During
the year, they paid out $60,000 in dividends. Assume the market price of each common share at the
company’s year end is $12 per share.
Required
421
AP-14B LO 6
Below is select financial statement information for Beta Corp. and Gamma Inc. in 2019.
Beta Corp. Gamma Inc.

Net Income $157,840 $246,850
Stockholders' Equity
Preferred Stock $8,740 $74,055
Common Stock 102,596 160,453
Total Stockholders’ Equity 118,688 238,863
Number of Common Shares Outstanding 10,820 12,400
Both Beta and Gamma declared preferred dividends in 2019. For Beta, the total preferred dividends were
equal to 5% of net income; for Gamma, they were equal to 8% of net income.
Required
a) Calculate the following ratios for each company.
Beta Corp. Gamma Inc.

Book Value per Common Share
Earnings per Share (EPS)
422
b) Based on the ratios from part a), which company would an investor be more likely to invest in?
AP-15B LO 3 4 5
Below is select financial statement information for Alpha Inc. and Delta Corp.
Alpha Inc. Delta Corp.

Income Statement
Sales $105,000 $87,000
Expenses
Net Income $11,550 $11,136
Balance Sheet
Cash $18,525 $24,700
Equipment 66,800 63,460
Total Assets $132,125 $139,355

Current Portion of Long-Term Debt 8,304 1,324
Long-Term Debt 27,680 8,825
Stockholders' Equity 34,811 66,449
Total Liabilities and Stockholders' Equity $132,125 $139,355
423
Required
a) Calculate the liquidity and solvency ratios as shown in the table below.
Alpha Inc. Delta Corp.

Current Ratio
Quick Ratio
b) Which company has stronger liquidity and solvency ratios? Which company would a bank prefer to
provide lending to based on the calculations in part a)?
AP-16B LO 7
The following information is available for three different companies within the same industry.
Company A Company B Company C

Cash $7,800 $7,020 $10,530
Prepaid Expenses 1,500 1,350 3,025
Total Current Assets $29,050 $26,145 $37,218

Deferred Revenue 7,500 7,875 8,250
Current Portion of Long-Term Debt 15,800 16,590 17,380
Total Current Liabilities $27,600 $28,980 $30,360
424
Required
a) Calculate the current and quick ratios for each company listed below. Which company has the strongest
and weakest liquidity?
Company A Company B Company C
Current Ratio
Quick Ratio
b) Is the current ratio adequate for each company? Explain.
c) Is the quick ratio adequate for each company? Explain.
Analysis
All three companies are public companies and thus prepare their financial statements in accordance
to GAAP. Does this mean that all values on their financial statements can be compared without further
investigation into how the values were calculated?
425
AP-17B LO 3 4 5
The most recent income statements and balance sheets for Midland Company are shown below.
Midland Company
Income Statement
For the Year Ended
2019 2018
Sales (on Credit) $600,000 $540,000
Gross Profit 348,000 324,000
Expenses
Net Income $12,600 $27,000
Midland Company
Balance Sheet
At the Year Ended
2019 2018
Cash $76,540 $41,400
Equipment 110,000 158,000
Total Assets $296,540 $298,550

Long-Term Debt 60,000 60,000
Common Stock 50,000 50,000
Total Liabilities and Stockholders' Equity $296,540 $298,550
426
Required
a) Calculate the following ratios for Midland Company for its 2019 fiscal year.
Industry Average Midland Company

Gross Profit Margin 40.0%
Net Profit Margin 5.0%
Return on Equity (ROE) 8.0%
Return on Assets (ROA) 6.9%
Quick Ratio 1.2
Debt-to-Equity Ratio 0.75
Days’ Sales Outstanding 40.0
Inventory Turnover 6.1
b) Perform some ratio analysis to determine how Midland Company has performed in 2019 compared to
the industry average.
AP-18B LO 2
Perform a horizontal analysis for Mazzic Inc. Use 2016 as the base year.
Mazzic Inc.
2019 2018 2017 2016
Revenue $469 $331 $292 $197
Revenue Percentage of 2016 Base-Year
Net Income $258 $223 $178 $84
Net Income Percentage of 2016 Base-Year
AP-19B LO 2
The following financial statements are taken from the records of Jade Inc.
Required
a) Use horizontal analysis techniques to compare the changes between 2019 and 2018 balance sheet
items.
427
Jade Inc.
Balance Sheet
As at October 31
2019 2018 $ Change % Change
Current Assets
Cash $318,300 $319,400
Short‐Term Investments 116,500 104,700
Total Current Assets 966,900 1,009,000
Noncurrent Assets 527,850 318,900
Total Assets $1,494,750 $1,327,900
Current Liabilities $258,200 $224,600

Stockholders’ Equity 1,109,650 993,800
Total Liabilities and Equity $1,494,750 $1,327,900
b) Perform a vertical analysis of the income statement for 2019 and state all the income statement items as a
percentage of net sales.
Jade Inc.
Income Statement
For the Year Ended October 31
2019 2019
Sales $700,800
Cost of Goods Sold 373,800
Gross Profit 327,000
Expenses
Advertising 4,400
Utilities 8,200
Rent 4,300
Salaries and Wages 47,000
Depreciation 34,530
Interest 7,620
Total Expenses 106,050
Income before Income Tax Expense 220,950
Income Tax Expense 55,100
Net Income $165,850
428
Analysis
Analyze the strengths and weaknesses of Jade’s financial position based on the above horizontal and
vertical analyses.
AP-20B LO 4 7
The financial information at December 31, 2019 for two similar companies is shown below.
Shaken Inc. Stirred Inc.
Balance Sheet
Average Total Assets $80,000 $50,000
Average Stockholders’ Equity 30,000 45,000
Income Statement
Sales 100,000 68,000
Expenses
Advertising Expense $20,000 $5,000
Rent Expense 10,000 -
Net Income $11,000 $9,500
Which company performed better during the year? Use relevant ratios to support your answer.
Shaken Inc. Stirred Inc.
Gross Profit Margin
Net Profit Margin
Asset Turnover
Return on Equity
Return on Assets
429
Analysis
The comparison between these two companies assumes they are following the same accounting standards
(GAAP or IFRS). What impact, if any, would there be on the comparison if one followed GAAP and the other
followed IFRS?
AP-21B LO 3 4 5 6
The income statements and balance sheets for Hathaway Inc. are shown below for the last three fiscal years.
All sales are on credit.
Hathaway Inc.
Income Statement
For the Year Ended
2019 2018 2017
Sales $800,000 $720,000 $760,000
Gross Profit 540,000 432,000 494,000
Expenses
Operating Expense 320,000 216,000 342,000
Depreciation Expense 64,000 72,000 76,000
Advertising Expense 80,000 72,000 114,000
Total Expenses 474,000 370,000 542,000
Income (Loss) before Income Tax Expense (Benefit) 66,000 62,000 (48,000)
Income Tax Expense Benefit 29,700 27,900 (21,600)
Net Income (Loss) $36,300 $34,100 ($26,400)
430
Hathaway Inc.
Balance Sheet
At the Year Ended
2019 2018 2017
Cash $234,400 $149,600 $80,000
Equipment 110,000 174,000 246,000
Total Assets $564,400 $495,600 $443,200

Unearned Revenue 21,000 23,100 18,900
Long-Term Debt 50,000 50,000 50,000
Common Stock 85,500 60,000 55,000
Retained Earnings 353,300 317,000 282,900
Total Liabilities and Stockholders' Equity $564,400 $495,600 $443,200
Other Information
Hathaway Inc. has an unlimited number of shares authorized; the following common shares were
outstanding in each year for the entire year: 2019—60,000, 2018—40,000, 2017—30,000.
Required
a) Calculate the following ratios for Hathaway Inc. for 2018 and 2019, and state whether the ratio
improved or weakened in 2019.
Improved or
2019 2018
Weakened
Gross Profit Margin
Net Profit Margin
Current Ratio
Quick Ratio
Inventory Turnover
Book Value Per Common Share
Earnings Per Share
b) The owner of Hathaway Inc. is pleased to see that the company has started generating profits again
and assumes that profitability must be improving. Perform some ratio analysis to determine if the
owner’s assumption is correct or not. Explain.
431
Analysis
What does the company’s inventory turnover ratio indicate/suggest?
AP-22B LO 4
The following information is extracted from the financial statements of Knight Inc. and Emperor Corp.
Knight Emperor
Sales Revenue $600,000 $400,000
Net Income 70,000 35,000
Average Total Assets 1,600,000 1,000,000
Average Total Liabilities 650,000 200,000
Average Total Stockholders’ Equity 950,000 800,000
Average Preferred Stock 40,000 150,000
Total preferred dividends declared and paid during the year 3,200 9,000
Total common dividends declared and paid during the year 6,000 4,900
Required
a) Calculate net profit margin for both companies.
b) Calculate return on equity for both companies.
c) Calculate return on common stockholders’ equity for both companies.
d) Calculate return on assets for both companies.
432
e) Based on all the ratios calculated in parts a) to d), which company’s common stock is more attractive to
potential investors?
433
Case Study
CS-1 LO 3 4 5
Suppose that you have decided to invest some money in the stock market. After some research online, you
come across the financial statements of Yong Wireless Limited. Before you can make a decision to invest in
the company, you will need to calculate some key financial ratios and then analyze them. The statements
are presented below.
Yong Wireless Limited

Consolidated Balance Sheet (in thousands)
As at February 28
2019 2018
Assets
Cash $1,550,861 $835,546
Short-Term Investments 360,614 682,666
Accounts Receivable 2,800,115 2,269,845
Other Current Assets 479,455 371,129
Total Current Assets 5,812,656 4,841,586
Long-Term Investment 958,248 720,635
Property, Plant and Equipment 1,956,581 1,334,648
Intangible Assets 1,476,924 1,204,503
Total Assets $10,204,409 $8,101,372
Liabilities
Accrued Liabilities 1,638,260 1,238,602
Income Taxes Payable 95,650 361,460
Other Current Liabilities 82,247 66,950
Total Current Liabilities 2,431,777 2,115,351
Total Liabilities 2,601,746 2,227,244
Stockholders' Equity
Common Stock 2,113,146 2,208,235
Retained Earnings 5,489,517 3,665,893
Stockholders' Equity 7,602,663 5,874,128
Liabilities and Stockholders' Equity $10,204,409 $8,101,372
434

Consolidated Income Statement (in thousands)
For the Year Ended February 28
2019 2018
Revenue $14,953,224 $11,065,186
Cost of Sales 8,368,958 5,967,888
Gross Profit 6,584,266 5,097,298
Operating Expenses
Research and Development 964,841 684,702
Selling, Marketing and Admin 1,907,398 1,495,697
Amortization Expense 310,357 194,803
Litigation Expense 163,800 0
Total Operating Expenses 3,346,396 2,375,202
Income from Operations 3,237,870 2,722,096
Investment Income 28,640 78,267
Income before Income Tax Expense 3,266,510 2,800,363
Net Income $2,457,144 $1,892,616

Summary of the Statement of Cash Flows (in thousands)
For the Year Ended February 28
2019 2018
Net Cash Provided by Operations $3,034,874 $1,451,845
Net Cash Used by Investing ($1,470,127) ($1,823,523)
Net Cash Used by Financing ($849,432) $22,826
Net Increase (Decrease) in Cash $715,315 ($348,852)
Required
a) Calculate the following ratios for Yong Wireless Limited for 2019 and 2018. For any ratios that require an
average (i.e. ROE), use the closing balance for the year.
2019 2018
Gross Profit Margin
Net Profit Margin
Return on Equity
Return on Assets
Asset Turnover
Current Ratio
Quick Ratio
435
b) Based on the figures you calculated, has the company shown improvement in 2019 over 2018? Would
you invest in Yong Wireless Limited? Explain.
CS-2 LO 3 4 5
The following information has been taken from the financial statements of Ivory Inc.
Ivory Inc.
Current Assets, December 31, 2019 $175,000
Total Assets, January 1, 2019 500,000
Total Assets, December 31, 2019 575,000
Current Liabilities, December 31, 2019 75,000
Total Liabilities, December 31, 2019 175,000
Stockholders’ Equity, January 1, 2019 300,000
Stockholders’ Equity, December 31, 2019 400,000
Net Sales 900,000

Depreciation Expense 10,000
Interest Expense 20,000
Income Tax Expense 25,000
Net Income 40,000
Required
a) Given the data for Ivory Inc., calculate the following ratios for 2019 (round to two decimal places). The
company’s ratios for 2018 are given for comparison.
Ratio 2018
i) Current Ratio 3.5
ii) Times Interest Earned Ratio 5.40
iii) Debt-to-Equity 25.00%
iv) Return on Assets 12.50%
v) Return on Equity 20.20%
vi) Net Profit Margin 8.60%
436
Ratio 2019
b) Using 2019 as a comparison, discuss whether the company improved or deteriorated in its ability to
(i) pay current liabilities as they come due, (ii) meet its long-term debt obligations and (iii) profitability.
Be sure to make reference to specific ratios in your answers.
437
Critical Thinking
CT-1 LO 7
Financial statement analysis is performed on historical information. Since the past cannot be changed,
calculating financial ratios is of no use. What management and investors are really interested in is the
future, specifically the future profitability of a company. Discuss.
438

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Chapter 14

FINANCIAL STATEMENT ANALYSIS

What is financial analysis?

What is the formula for gross profit margin?

What does gross profit margin tell us?

What is the formula for the times interest earned ratio?

Is it more preferable to have a higher or lower interest coverage ratio? Explain.

How do you calculate net profit margin?

What is the formula for return on equity?

What is the formula for return on assets?

What is the formula for the current ratio?

What does the current ratio tell you?

What is the formula for the quick ratio?

What is the formula for the debt-to-equity ratio?

What is the formula for days’ sales outstanding?

What does days’ sales outstanding tell you?

How do you calculate accounts receivable turnover?

How is days’ sales in inventory calculated?

What is the formula for the inventory turnover ratio?

Why is it necessary to compare a company’s calculated ratios with industry benchmarks?

How is book value per common share calculated?

What does book value per common share tell us?

How does the base-year differ from the base-figure?

Application Questions Group A

Simply Mullet Company reported the following.

Trooper Nova Company reported the following.

b) Calculate the net profit margin.

c) Calculate the times interest earned

a) Calculate the gross profit margins for both years.

Net Income $29,518 $14,792

Selected financial data from Crew Company is provided below.

b) Calculate the dividend yield.

c) Calculate the price-earnings ratio.

a) Calculate earnings per share.

b) Calculate the dividend yield.

c) Calculate the price-earnings ratio.

d) Calculate the book value per common share.

Rock Co. Roll Inc.

Accounts Payable $27,500 $24,750

Rock Co. Roll Inc.

Accounts Payable 21,000 32,000

iii. Managerial performance

Noncurrent Assets 356,000 250,000

Total Assets $1,337,000 $1,270,000

Current Liabilities 214,000 265,000

Stockholders’ Equity 1,101,000 855,000

Total Liabilities and Stockholders’ Equity $1,337,000 $1,270,000

Accounts Payable $52,800 $44,000 $35,200

Application Questions Group B

Sales Revenue $2,110,000

b) Calculate the net profit margin.

c) Calculate the times interest earned.

d) Calculate the return on equity.

Selected financial data from Jai Home Company is provided below.

a) Calculate the quick ratio.

2019 2018 2017 2016

Accounts Receivable 6,130 5,885 5,649 5,084

2019 2018 2017

Information from Silky Company’s year-end financial statements is as follows.