Analysis of Financial Statements: Questions

Chapter 17
Analysis of Financial Statements

QUESTIONS
1. With comparative statements, financial statement items for two or more successive
accounting periods are placed side by side on a single statement, with the change in
each item expressed as both a dollar amount and a percent. Common-size
comparative statements express each financial statement item as a percent of some
base amount that is assigned a value of 100%.
2. Total assets (or equivalently, the total of liabilities plus equity) are assigned a value
of 100% on a common-size balance sheet. Net sales (revenues) are assigned a value
of 100% on a common-size income statement.
3. Financial reporting includes the entire process of preparing and issuing financial
information about a company. Financial statements are an important part of
financial reporting but they are less than the whole.
4. The nature of a company's business, the composition of its current assets, and the
turnover of its current assets are three important factors that should be considered
in deciding whether a current ratio is good or bad.
5. A 2-to-1 current ratio may not be adequate if the company's current assets consist of
a large proportion of slow-turning accounts, notes, and merchandise inventory. The
general nature of the business also may make the 2-to-1 rule of thumb inadequate.
6. Adequate working capital enables a company to carry sufficient inventories, meet
current debts, take advantage of cash discounts, and extend favorable terms to
customers. Working capital is a major factor in determining the short-term liquidity
position of a company.
7. When evaluated in light of a company's credit terms, the number of days' sales
uncollected indicates how quickly accounts receivable are converted into cash.
This provides information about the relevance of accounts receivable balances in
meeting the current obligations of the business.
8. A high accounts receivable turnover implies that accounts are collected quickly,
thereby providing cash that can be used to meet obligations. A high turnover also
means that a given sales volume can be supported with a lower investment in
accounts receivable.
McGraw-Hill Companies, Inc., 2005

Solutions Manual, Chapter 17
219
9. Users are interested in the capital structure of a company, as measured by debt and
equity ratios, for at least two reasons. First, as a company includes more debt in its
capital structure, the risk that it will be unable to meet interest and principal
payments increases. Second, the existence of debt introduces financial leverage. If
the company can earn a rate of return on its investments that exceeds the rate of
interest paid to creditors, the debt will increase the rate of return to stockholders.
10. Inventory turnover reflects on the efficiency of inventory management. That is, a
high inventory turnover means that a given sales volume can be supported with a
smaller investment in inventory. This insight into the speed with which inventory is
sold determines the relevance of the available inventory in meeting the current
obligations of the business, which is a focus of short-term liquidity.
11. Since management is responsible for a company's performance, all ratios that are
useful in evaluating a company are of some usefulness in assessing management
performance. Profit margin, total asset turnover, return on total assets, and return
on stockholders' equity are especially useful for assessing management's
responsibility for operating efficiently and profitably.
12. The ratio of pledged assets to secured liabilities must be interpreted with care
because the book value of the pledged assets is used in calculating the ratio, and
the book value is unlikely to always approximate the assets market value.
13. Almost all companies have some liabilities. Since total assets equals total liabilities
plus equity, total assets is almost always higher than common stockholders' equity.
Thus, the denominator in return on total assets is larger than common stockholders'
equity. Since the numerator is the same for both, and return on total assets has a
larger denominator, it yields a smaller percent. [Instructor note: A more complete
measure of return on assets would add back (Interest Expense x {1 Tax Rate}) to
net income in the numeratorreflecting the after-tax cost of debt. We leave the
rationale for this adjustment to advanced courses.]
14. Return on total assets (2003):
$33,478
($410,487 + $255,376)/2
= 10.1%
Return on total assets (2002):

$26,378
($255,376 + $171,493)/2
= 12.4%
15. Equity ratio (2002):

$47,525,236
$116,560,030
= 40.8%
Equity ratio (2001):

$55,064,502
$116,136,819
= 47.4%
16. Profit margin (2002):

$580,217,000
$4,090,970,000
= 14.2%

220
Fundamental Accounting Principles, 17th Edition
QUICK STUDY
Quick Study 17-1 (5 minutes)
1.
3.
5.
9.
Items not part of general-purpose financial statements:

Stock price information and analysis.
Management discussions and analysis of financial performance.
Company news releases.
Prospectus.

The four usual standards of comparisons are:
Intracompany. The company under analysis provides standards for
comparisons based on prior performance and relations between its
financial items.
Competitor. One or more direct competitors of the company under
analysis can provide standards for comparisons.
Industry. Industry statistics can provide standards of comparisons.
Published industry statistics are available from several services such as
Dun & Bradstreet, Standard and Poor's, and Moody's.
Guidelines (Rules of Thumb). General standards of comparisons can
develop from past experiences. Examples are the 2-to-1 level for the
current ratio or 1-to-1 level for the acid-test ratio.
All of these standards of comparisons are useful when properly applied. Yet,
analysis measures taken from a selected competitor or group of competitors
are often the best standards of comparisons. Also, intracompany and industry
measures are important parts of all analyses.
The standard that is least likely to provide a good basis for comparison is the
use of guidelines, or rules of thumb. Guidelines must be applied with care,
and then only if they seem reasonable in light of past experience and
industry's norms.

2005
2004
Dollar
Change
Percent
Change

221
Short-term investments..............
$217,800 $165,000
Accounts receivable...................
42,120
48,000
Notes payable..............................
57,000
0
$52,800
32%
(5,880)
-12.3%
57,000 (not calculable)

222

1.
2.
Common-size percents
2005
54.2%
($109,200 / $201,600)
2004
52.4%
($60,200 / $114,800)
Trend percents
2005
175.6%
($201,600 / $114,800)
2004
100.0%
(the given base amount)

1.
6.
2.
7.
3.
8.
4.
9.
5.
10.

1. Profit margin; Total asset turnover.
Return on total assets.
2. Accounts receivable turnover; Days' sales uncollected.
3. Working capital, also called net working capital.
Ratio
2005
2004
Change
1. Profit Margin Ratio................................ 8%
6%
2. Debt Ratio..............................................45%
40%
Unfavorable
3. Gross Margin Ratio...............................33%
45%
Unfavorable
4. Acid-test Ratio.......................................0.99
1.10
Unfavorable
5. Accounts Receivable Turnover............ 5.4
6.6
Unfavorable
6. Basic Earnings Per Share.....................

$1.24
$1.20
Favorable
Favorable

223
7. Inventory Turnover................................ 3.5
3.3
Favorable
8. Dividend Yield........................................ 1%
.8%
Favorable

224
EXERCISES
Exercise 17-1 (20 minutes)
2007
Sales........................................188
Cost of goods sold.................190
Accounts receivable..............191
2006
180
181
183
2005
168
171
174
2004
156
158
162
2003
100
100
100
Analysis: The trend in sales is positive. While this is better than no growth, one
cannot definitively say whether the sales trend is favorable without additional
information about the economic conditions in which this trend occurred such as
inflation rates and competitors performances.
Given the trend in sales, the comparative trends in both cost of goods sold and
accounts receivable are somewhat unfavorable. In particular, for the most recent
year, both are increasing at slightly faster rates (indexes for cost of goods sold is
190 and accounts receivable is 191) compared to sales (index is 188).

Answer: Net income decreased.
Supporting calculations: When the sum of each year's common-size cost of
goods sold and total expenses is subtracted from the common-size sales
percent, the net income percent is as follows:
2004 net income percent: 100.0 - 58.1 - 14.1 = 27.8% of sales
Next, notice that if 2004 sales are assumed to be $100, then sales for 2005 are
$103.20 and the sales for 2006 are $104.40. If the net income percents for the
three years are applied to these amounts, the net incomes are:
2004 net income: $100.00 x 27.8% = $27.80
2005 net income: $103.20 x 25.3% = $26.11
2006 net income: $104.40 x 23.3% = $24.33
This shows that net income decreased over the three-year period.

225

Sales....................................................
Cost of goods sold.............................
Gross profit.........................................
Operating expenses...........................
Net income..........................................
2005
100.0%
66.0
34.0
21.0
13.0%
2004
100.0%
52.4
47.6
19.4
28.2%
Analysis: Overall, this companys situation has worsened. This is evident from the
substantial decline in net income as a percent of sales for 2005 (13.0%) relative to
2004 (28.2%). The main culprit is the increase in cost of goods sold as a percent
of sales from 52.4% in 2004 to 66.0% in 2005. On a somewhat positive note, the
company has not experienced as large of an increase in operating expenses as a
percent of sales; from 19.4% in 2004 to 21.0% in 2005. Even more positive is the
companys level of sales increase from $535,000 in 2004 to $720,000 in 2005.

COMPARATIVE ANALYSIS REPORT
Titan has a greater amount of working capital. This by itself does not indicate
whether Titan is more capable of meeting its current obligations. However,
support is provided by the current ratio and acid-test ratio, which show Titan
is in a more liquid position than Silverado. This evidence does not mean that
Silverado's liquidity is inadequate. Such a conclusion would require more
information such as norms for the industry or its other competitors. Notably,
Silverado's acid-test ratios approximate the traditional rule of thumb (1 to 1).
This evidence also shows that Titan's working capital, current ratio, and acidtest ratio all increased dramatically over the three-year period. This trend
toward greater liquidity may be positive, but it can also suggest that Titan
holds an excess amount of highly liquid assets that typically earn low returns.
The accounts receivable turnover and inventory turnover indicate that
Silverado is more efficient in collecting its accounts receivable and in
generating sales from available inventory. However, these statistics also may
suggest that Silverado is too conservative in granting credit and investing in
inventory. This could have a negative impact on sales and net income. Titan's
ratios may be acceptable, but no definitive determination can be made without
having information on industry (or other competitors) standards.

226

COMPARATIVE ANALYSIS REPORT
Kent's profit margins are higher than Rolf's. However, Rolf has
significantly higher total asset turnover ratios. As a result, Rolf generates a
substantially higher return on total assets.
The trends of both companies include evidence of growth in sales, total
asset turnover, and return on total assets. However, Kent's rates of
improvement are better than Rolf's. These differences may result from the
fact that Kent is only three years old while Rolf is a somewhat more
established company. Kent's operations are considerably smaller than
Rolf's, but that will not persist many more years if both companies
continue to grow at their current rates.
To some extent, Rolf's higher total asset turnover ratios may result from
the fact that its assets may have been purchased years earlier. If the
turnover calculations had been based on current values, the differences
might be less striking. The relative ages of the assets also may explain
some of the difference in profit margins. Assuming Kent's assets are
newer, they may require smaller maintenance expenses.
Finally, Rolf successfully employed financial leverage in 2007. Its return on
total assets is 8.9% compared to the 7% interest rate it paid to obtain
financing from creditors. In contrast, Kent's return is only 5.8% as
compared to the 7% interest rate paid to creditors.

227

Sexton Company
Common-Size Comparative Balance Sheets
December 31, 2004-2006
2006
2005*
Cash....................................................................
5.9%
8.0%
2004*
9.9%
Accounts receivable, net.................................. 17.1
14.0
13.2
Merchandise inventory..................................... 21.5
18.5
14.2
1.9
2.1
1.1
Plant assets, net ............................................... 53.6
57.3
61.6
Total assets ....................................................... 100.0%
100.0%
100.0%
Accounts payable.............................................. 24.9%

Long-term notes payable secured by
mortgages on plant assets ........................... 18.8
16.9%
13.2%
23.0
22.1
Common stock, $10 par value.......................... 31.4
36.5
43.6
Retained earnings ............................................ 24.9
23.5
21.0
Total liabilities and equity.................................100.0%
100.0%
100.0%
Prepaid expenses..............................................
Column does not equal 100.0 due to rounding.
Analysis: Several observations can be made.

(1) Cash as a percent of assets has declinedthis is favorable provided sufficient
cash is available for operations.
(2) Accounts receivable have increased as a percent of assetsthis may be
unfavorable in that assets are tied up in an unproductive manner and there are
more assets at risk of uncollection; it could be favorable if increased sales
outweigh these costs and risks.
(3) Plant assets have declined as a percent of assetsthis is favorable if the
company is operating more efficiently; it could be unfavorable if the company is
downsizing due to poor performance.
(4) Accounts payable have markedly increased as a percent of assetsthis could
reveal liquidity constraints.
(5) Common stock has markedly declinedthis could reflect a stock buyback
program or other mechanisms to reduce shares outstanding.

228

1.
2.
Current ratio
2006:
$30,800 + $88,500 + $111,500 + $9,700

$128,900
= 1.87 to 1
2005:
$35,625 + $62,500 + $82,500 + $9,375

$75,250
= 2.52 to 1
2004:
$36,800 + $49,200 + $53,000 + $4,000

$49,250
= 2.90 to 1
Acid-test ratio
2006:
$30,800 + $88,500
$128,900
= 0.93 to 1
2005:
$35,625 + $62,500
$75,250
= 1.30 to 1
2004:
$36,800 + $49,200
$49,250
= 1.75 to 1
Analysis and Interpretation: Sexton's short-term liquidity position has

weakened over this three-year period. Both the current and acid-test ratios
show declining trends. Although we do not have information about the
nature of the company's business, the acid-test ratio shifts from 1.75 to 1
down to 0.93 to 1 and the current ratio shifts from 2.90 to 1 down to 1.87
to 1both suggest a potential liquidity problem. Still, we must recognize
that industry standards could show that the 2004 ratios were too high
(instead of 2006 ratios as being too low).

229

1.
2.
3.
4.
Days' sales uncollected

2006:
$88,500
x 365 = 48.0 days
$672,500
2005:
$62,500
x 365 = 43.0 days
$530,000
Accounts receivable turnover

2006:
$672,500
($88,500 + $62,500)/2
= 8.9 times
2005:
$530,000
($62,500 + $49,200)/2
= 9.5 times
Inventory turnover
2006:
$410,225
= 4.2 times
($111,500 + $82,500)/2
2005:
$344,500
($82,500 + $53,000)/2
= 5.1 times
Days sales in inventory

2006:
2005:
$111,500
$410,225
x 365 = 99 days
$82,500
x 365 = 87 days
$344,500
Analysis and Interpretation: The number of days' sales uncollected has

increased and the accounts receivable turnover has declined. Also, the
inventory turnover has decreased and days sales in inventory has
increased. While none of these changes in ratios that occurred from 2005
to 2006 appear dramatic, it seems that Sexton is becoming less efficient in
managing its inventory and in collecting its receivables.

230

1. Debt and equity ratios
2006
2005
Total liabilities and debt ratio

$128,900 + $97,500.......................
$226,40
0
43.7%
$75,250 + $102,500.......................
$177,750
39.9%
Total equity and equity ratio

$162,500 + $129,100.....................
291,600
56.3
$162,500 + $104,750.....................
_______
____
Total liabilities and equity...............

$518,00
267,250
100.0%
60.1
$445,000 100.0%
0
2. Pledged assets to secured liabilities
2006: $277,500 / $97,500 = 2.8 to 1
2005: $255,000 / $102,500 = 2.5 to 1
3. Times interest earned
2006: ($34,100 + $8,525 + $11,100) / $11,100 = 4.8 times
2005: ($31,375 + $7,845 + $12,300) / $12,300 = 4.2 times
Analysis and Interpretation: Sexton added debt to its capital structure
during 2006, with the result that the debt ratio increased from 39.9% to
43.7%. However, the book value of pledged assets is well above secured
liabilities (2.8 to 1 in 2006 and 2.5 to 1 in 2005), and the increased
profitability of the company allowed it to increase the times interest earned
from 4.2 to 4.8 times. Apparently, the company is able to handle the
increased debt. However, we should note that the debt increase is entirely
in current liabilities, which places a greater stress on short-term liquidity.

231

1.
Profit margin
2006: $34,100 / $672,500 = 5.1%
2005: $31,375 / $530,000 = 5.9%
2.
3.
Total asset turnover

2006:
$672,500
= 1.4 times
($518,000 + $445,000)/2
2005:
$530,000
= 1.3 times
($445,000 + $372,500)/2
Return on total assets

$34,100
2006: ($518,000 + $445,000)/2
= 7.1%
$31,375
2005: ($445,000 + $372,500)/2
= 7.7%
Analysis and Interpretation: Sexton's operating efficiency appears to be

declining because the return on total assets decreased from 7.7% to 7.1%.
While the total asset turnover favorably increased slightly from 2005 to
2006, the profit margin unfavorably decreased from 5.9% to 5.1%. The
decline in profit margin indicates that Sexton's ability to generate net
income from sales has declined.

232

1.
2.
Return on common stockholders' equity

2006:
$34,100
($291,600 + $267,250)/2
= 12.2%
2005:
$31,375
($267,250 + $240,750)/2
= 12.4%
Price-earnings ratio, December 31

2006: $15 / $2.10 = 7.1
2005: $14 / $1.93 = 7.3
3.
Dividend yield
2006: $0.30 / $15 = 2.0%
2005: $0.15 / $14 = 1.1%
Analysis and interpretation

The companys return on common stockholders equity is good, but not
great. A 12% return makes it an acceptable investment provided its risk
is not to high.
The companys price-earnings ratio is somewhat low. This suggests
that the market does not have high expectations about future earnings
or growth of this company.
The dividend yield is on the low side. Thus, this stock would likely be
classified as a growth stockhowever, the price-earnings ratio
suggests that the market does not perceive a highly likelihood of
growth.

233
PROBLEM SET A
Problem 17-1A (60 minutes)
Part 1
Current ratio:
December 31, 2006: $48,480 / $20,200 = 2.4 to 1

December 31, 2005: $37,924 / $19,960 = 1.9 to 1
December 31, 2004: $50,648 / $19,480 = 2.6 to 1
Part 2
BENNINGTON COMPANY
Common-Size Comparative Income Statements
For Years Ended December 31, 2006, 2005, and 2004
2006
2005
2004
100.00%
100.00%
Cost of goods sold.....................................60.20
62.50
64.00
Gross profit.................................................39.80
37.50
36.00
Selling expenses........................................14.12
13.80
13.20
Administrative expenses........................... 9.04
8.80
8.25
Total expenses...........................................23.16
22.60
21.45
Income before taxes..................................16.64
14.90
14.55
Income taxes.............................................. 3.10
3.05
2.95
11.85%
11.60%
Sales............................................................
100.00%
Net income..................................................13.54%

234
Problem 17-1A (Concluded)

Part 3
BENNINGTON COMPANY
Balance Sheet Data in Trend Percents
December 31, 2006, 2005, and 2004
2006
2005
2004
Assets
Current assets..................................
95.72%
74.88%
100.00%
Long-term investments....................
0.00
13.44
100.00
Plant assets......................................
157.89
168.42
100.00
Total assets.......................................
124.34
120.70
100.00
Liabilities and Equity

Current liabilities..............................
103.70% 102.46%
100.00%
Common stock.................................
133.33
133.33
100.00
Other contributed capital.................
150.00
150.00
100.00
Retained earnings............................
116.91
104.94
100.00
Total liabilities and equity................
124.34
120.70
100.00
Part 4
Significant relations revealed
Benningtons selling expenses, administrative expenses, and income taxes
took larger portions of each sales dollar in 2005 than 2004. However, because
the cost of goods sold took a smaller portion in 2005, some efficiency was
gained. In 2006 these trends continued. Selling expenses, administrative
expenses, and income taxes continued to take a greater portion of each sales
dollar while the gross profit portion continued to improve.
Bennington expanded its plant assets in 2005, financing the expansion
through the sale of long-term investments, through a reduction in working
capital (the current ratio decreased from 2.6 to 1 to 1.9 to 1), and perhaps
through the sale of a small amount of stock. As to the stock increase, it is not
possible to tell from these two statements whether the company sold shares
or declared a stock dividend. In either case, the increase in retained earnings
during 2005 indicates that net income was larger than the reductions from
cash (and perhaps stock) dividends. In 2006, cash dividends were paid.

235

Part 1
SUGU COMPANY
Income Statement Trends
For Years Ended December 31, 2006-2000
2006
2005
2004
2003
2002
2001
2000
Sales......................................192.5% 168.6% 153.4% 140.6% 131.2% 122.0% 100.0%

Cost of goods sold...............235.8
191.8
165.0
144.4
134.2
125.5
100.0
Gross profit...........................131.0
135.7
136.8
135.1
126.9
117.0
100.0
Operating expenses.............265.6
207.8
190.6
140.6
121.9
120.3
100.0
Net income............................ 50.5
92.5
104.7
131.8
129.9
115.0
100.0
2000
SUGU COMPANY
Balance Sheet Trends
December 31, 2006-2000
2006
2005
2004
2003
2002
2001
Cash....................................... 68.7%
88.9%
92.9%
94.9%
99.0%
97.0%
Accounts recble., net...........233.0
244.7
221.4
169.9
149.5
141.7
100.0
Merchandise inventory........337.5
245.4
214.4
181.0
162.3
137.9
100.0
Other current assets............242.1
221.1
126.3
231.6
200.0
200.0
100.0
100.0
100.0
100.0
100.0
Plant assets, net...................257.0
256.2
224.5
126.5
130.7
116.4
100.0
Total assets...........................247.3
222.9
196.0
144.4
138.6
124.0
100.0
Current liabilities..................411.8
346.3
227.2
189.0
164.0
155.1
100.0
Long-term liabilities.............306.2
266.7
259.5
120.5
123.1
133.3
100.0
Common stock.....................156.3
156.3
156.3
131.3
131.3
100.0
100.0
Other contrib. capital...........156.3
156.3
156.3
112.5
112.5
100.0
100.0
Retained earnings................262.7
230.8
191.7
176.3
162.1
145.0
100.0
Total liabilities & equity.......247.3
222.9
196.0
144.4
138.6
124.0
100.0
Long-term investments.......
100.0%

236

237
Problem 17-2A (concluded)

Part 2
Analysis and Interpretation
The statements and the trend percent data indicate that the company
significantly expanded its plant assets in 2004. Prior to that time, the
company enjoyed increasing gross profit and net income.
Sales grew steadily for the entire period of 2000 to 2006. However,
beginning in 2004, cost of goods sold and operating expenses increased
dramatically relative to sales, resulting in a significant reduction in net
income.
In 2006, net income was only 50.5% of the 2000 base year amount.
At the same time that net income was declining, assets were increasing.
This indicates that Sugu was becoming less efficient in using its assets to
generate income.
The short-term liquidity of the company continued to decline. Accounts
receivable did not change significantly for the period of 2004 to 2006, but
cash steadily declined and inventory sharply increased as did current
liabilities.

238

Transaction
Current
Assets
Quick
Assets
Current
Liabilities
Beginning*
$650,000
$286,000
$260,000
2.50
1.10 $390,000
May 2
+ 75,000
_______
+ 75,000
____
____
_______
725,000
286,000
335,000
2.16
0.85
390,000
+103,000
+103,000
- 58,000
_______
_______
____
____
_______
770,000
389,000
335,000
2.30
1.16
435,000
+ 19,000
+ 19,000
- 19,000
- 19,000
_______
____
____
_______
770,000
389,000
335,000
2.30
1.16
435,000
- 21,000
- 21,000
- 21,000
____
____
_______
749,000
368,000
314,000
2.39
1.17
435,000
+0
+0
_______
____
____
_______
Bal.
749,000
368,000
314,000
2.39
1.17
435,000
May 22
_______
_______
+ 40,000
____
____
_______
Bal.
749,000
368,000
354,000
2.12
1.04
395,000
- 40,000
- 40,000
- 40,000
____
____
_______
709,000
328,000
314,000
2.26
1.04
395,000
+ 75,000
+ 75,000
+ 75,000
____
____
_______
784,000
403,000
389,000
2.02
1.04
395,000
+ 90,000
+ 90,000
________
____
____
_______
874,000
493,000
389,000
2.25
1.27
485,000
May 29
- 165,000
- 165,000
________
____
____
_______
Bal.
$709,000
$328,000
$389,000
1.82
0.84
$320,000
Bal.
May 8
Bal.
May 10
Bal.
May 15
Bal.
May 17
May 26
Bal.
May 27
Bal.
May 28
Bal.
Current Acid-Test
Ratio
Ratio
Working
Capital
*Beginning balances
Current assets (given).............................................
$650,000
Current liabilities ($650,000 / 2.50).........................
260,000
Quick assets ($260,000 x 1.10)................................
286,000

239

1.
Current ratio
$9,000 + $7,400 + $28,200 + $3,500 + $31,150 + $1,650
$16,500 + $2,200 + $2,300
2.
Acid-test ratio
$9,000 + $7,400 + $28,200 + $3,500
$16,500 + $2,200 + $2,300
3.
x 365 = 33.2 days
Inventory turnover
$229,150
($32,400 + $31,150)/2
5.
= 7.2 times

$31,150
$229,150
6.
= 2.3 to 1

$28,200 + $3,500
$348,600
4.
= 3.9 to 1
x 365 = 49.6 days
Ratio of pledged assets to secured liabilities

$152,300 / $62,400 = 2.4 to 1
7.
Times interest earned

$66,950 / $3,100 = 21.6 times
8.
Profit margin ratio

$48,050
$348,600
= 13.8%

240

9.

$348,600
= 1.7 times
($233,200 + $182,400)/2
10.

$48,050
= 23.1%
($233,200 + $182,400)/2
11.

$48,050
= 35.4%
($149,800 + $121,300)/2

241

Part 1
Ryan Company
Priest Company
a. Current ratio
$150,440
$60,340 = 2.5 to 1
$233,050
$92,300 = 2.5 to 1
$63,000
$60,340
$95,600
$92,300
b. Acid-test ratio
= 1.0 to 1
= 1.0 to 1
c. Accounts receivable turnover

$660,000
($36,400 + $8,100 + $28,800)/2 = 18.0 times
$780,200
($56,400 + $6,200 + $53,200)/2 = 13.5 times
d. Inventory turnover
$485,100
($83,440 + $54,600)/2 = 7.0 times
$532,500
($131,500 + $106,400)/2 = 4.5 times
e. Days sales in inventory

$83,440
$485,100 x 365 = 62.8 days
$131,500
x 365 = 90.1 days
$532,500
f. Days' sales uncollected

$36,400 + $8,100
x 365 = 24.6 days
$660,000
$56,400 + $6,200
$780,200
x 365 = 29.3 days
Short-term credit risk analysis: Ryan and Priest have essentially equal current
ratios and equal acid-test ratios. However, Ryan both turns its merchandise
and collects its accounts receivable more rapidly than does Priest. On this
basis, Ryan probably is the better short-term credit risk.

242

Part 2
Ryan Company
Priest Company
a. Profit margin ratio

$67,770
$660,000 = 10.3%
$105,000
= 13.5%
$780,200
b. Total asset turnover

$660,000
($434,440 + $388,000)/2 = 1.6 times
$780,200
= 1.7 times
($536,450 + $372,500)/2
c. Return on total assets

$67,700
($434,440 + $388,000)/2 = 16.5%
$105,000
($536,450 + $372,500)/2
= 23.1%
d. Return on common stockholders' equity

$67,770
($294,300 + $269,300)/2 = 24.0%
$105,000
= 32.8%
($344,150 + $295,600)/2
e. Price-earnings ratio
$25
$1.94
= 12.9
$25
$2.56
= 9.8
$1.50
$25
= 6.0%
f. Dividend yield
$1.50
$25
= 6.0%
Investment analysis: Priest's profit margin ratio, total asset turnover, return
on total assets, and return on common stockholders' equity are all higher than
Ryan's. Although the companies pay the same dividend, Priest's priceearnings ratio is lower. All of these factors suggest that Priest's stock is likely
the better investment.

243
PROBLEM SET B
Problem 17-1B (60 minutes)
Part 1
Current ratio:
December 31, 2006: $55,860 / $23,370 = 2.4 to 1

December 31, 2005: $33,660 / $20,180 = 1.7 to 1
December 31, 2004: $37,300 / $17,500 = 2.1 to 1
Part 2
SAWGRASS CORPORATION
Common-Size Comparative Income Statements
For Years Ended December 31, 2006, 2005, and 2004
2006
Sales............................................................
100.00%
2005
2004
100.00%
100.00%
Cost of goods sold.....................................55.00
52.20
46.41
Gross profit.................................................45.00
47.80
53.59
Selling expenses........................................11.85
12.45
13.12
Administrative expenses........................... 8.89
9.35
11.53
Total expenses...........................................20.74
21.80
24.65
Income before taxes..................................24.26
26.00
28.94
Income taxes.............................................. 2.53
2.94
2.97
23.06%
25.97%
Net income..................................................21.73%
* Some totals do not reconcile due to rounding.

244
Problem 17-1B (Concluded)

Part 3
SAWGRASS CORPORATION
Balance Sheet Data in Trend Percents
December 31, 2006, 2005, and 2004
2006
2005
2004
Assets
Current assets............................................
149.76%
90.24%
100.00%
Long-term investments............................. 0.00
23.28
100.00
Plant assets................................................
142.26
143.33
100.00
Total assets.................................................
131.63
117.16
100.00
Liabilities and Equity

Current liabilities........................................
133.54% 115.31%
100.00%
Common stock...........................................
125.00
125.00
100.00
Other contributed capital..........................

120.73
120.73
100.00
Retained earnings......................................
137.40
112.09
100.00
Total liabilities and equity.........................

131.63
117.16
100.00
Part 4
Significant relations revealed
Sawgrass's cost of goods sold took a larger percent of sales each year.
Selling and administrative expenses and income taxes took a somewhat
smaller portion each year, but not enough to offset the effect of cost of goods
sold. As a result, income became a smaller percent of sales each year.
The large expansion of plant assets in 2005 was financed by a reduction in
current assets, an increase in current liabilities, a large reduction in long-term
investments, and apparently by a stock sale. One effect of this plan was to
reduce the current ratio. However, the current ratio recovered in 2006. This
apparently resulted from profits, limiting the amount of dividends paid, and
the liquidation of long-term investments.

245

Part 1
DEUCE COMPANY
Income Statement Trends
For Years Ended December 31, 2006-2000
2006
2005
2004
2003
2002
2001
2000
Sales...................................... 68.8% 74.0%
76.0%
81.3%
87.5%
90.6% 100.0%
Cost of goods sold............... 78.3
81.3
82.1
86.3
91.7
93.8
100.0
Gross profit........................... 59.2
66.7
70.0
76.3
83.3
87.5
100.0
Operating expenses............. 73.6
81.6
84.8
90.4
96.0
97.6
100.0
Net income............................ 43.5
50.4
53.9
60.9
69.6
76.5
100.0
2002
2001
2000
DEUCE COMPANY
Balance Sheet Trends
December 31, 2006-2000
2006
2005
2004
2003
Cash..................................... 58.6% 62.1% 72.4% 75.9% 86.2% 89.7% 100.0%

Accounts recble., net........... 80.0
84.0
86.7
89.3
93.3
96.0
100.0
Merchandise inventory........ 78.8
81.8
84.8
85.9
88.9
90.9
100.0
Other current assets............ 80.0
80.0
86.7
93.3
93.3
100.0
100.0
Long-term investments....... 26.0
20.0
16.0
100.0
100.0
100.0
100.0
Plant assets, net...................115.8
116.9
118.6
88.1
90.4
92.7
100.0
Total assets........................... 86.5
87.9
90.1
88.5
91.5
93.7
100.0
Current liabilities.................. 51.1
54.1
65.2
66.7
74.1
92.6
100.0
Long-term liabilities............. 32.8
44.0
52.8
55.2
73.6
81.6
100.0
Common stock.....................100.0
100.0
100.0
100.0
100.0
100.0
100.0
Other contrib. capital...........100.0
100.0
100.0
100.0
100.0
100.0
100.0
Retained earnings................212.5
197.5
177.5
162.5
137.5
106.3
100.0

246
Total liabilities & equity....... 86.5
87.9
90.1
88.5
91.5
93.7
100.0

247

Part 2
Analysis and Interpretation
The statements and the trend percent data show that sales declined every
year. However, cost of goods sold did not fall as rapidly as sales. As a
result, gross profit fell more rapidly than sales.
Operating expenses fell less rapidly than gross profit, so the final result
was that net income fell to 43.5% of the base year.
Management was not able to reduce costs and expenses fast enough to
keep up with the sales decline.
Although the profits decreased during these years, the company did
continue to earn a net income.
It appears that the cash generated from operations was used primarily to
reduce both current and long-term liabilities.
The company made a large expansion of its plant assets during 2004,
financing this expansion primarily through the liquidation of long-term
investments.

248

Transaction
Current
Assets
Quick
Assets
Current
Liabilities
Current
Ratio
Beginning*
$280,000
$120,000
$100,000
2.80
1.20
$180,000
June 1
+101,000
+101,000
- 62,000
________
________
____
____
_______
319,000
221,000
100,000
3.19
2.21
219,000
+ 78,000
+ 78,000
- 78,000
- 78,000
________
____
____
_______
319,000
221,000
100,000
3.19
2.21
219,000
________ +130,000
____
____
_______
Bal.
June 3
Bal.
June 5
Bal.
June 7
Bal.
June 10
Bal.
June 12
Bal.
June 15
Bal.
+130,000
Acid-Test
Ratio
Working
Capital
449,000
221,000
230,000
1.95
0.96
219,000
+ 90,000
+ 90,000
+ 90,000
____
____
_______
539,000
311,000
320,000
1.68
0.97
219,000
+180,000
+180,000
_______
____
____
_______
719,000
491,000
320,000
2.25
1.53
399,000
- 280,000
- 280,000
________
____
____
_______
439,000
211,000
320,000
1.37
0.66
119,000
________ ________ + 60,000
____
____
_______
439,000
211,000
380,000
1.16
0.56
59,000
+0
+0
________
____
____
_______
439,000
211,000
380,000
1.16
0.56
59,000
- 11,000
- 11,000
- 11,000
____
____
_______
428,000
200,000
369,000
1.16
0.54
59,000
June 30
- 60,000
- 60,000
- 60,000
____
____
_______
Bal.
$368,000
$140,000
$309,000
1.19
0.45
59,000
June 19
Bal.
June 22
Bal.
*Beginning balances
Current assets (given).............................................
$280,000
Current liabilities ($280,000 / 2.80).........................
100,000
Quick assets ($100,000 x 1.20)................................
120,000

249

1.
Current ratio
$5,100 + $5,900 + $11,100 + $2,000 + $12,500 + $1,000
$10,500 + $2,300 + $1,600
2.
Acid-test ratio
$5,100 + $5,900 + $11,100 + $2,000
$10,500 + $2,300 + $1,600
3.
= 2.6 to 1
= 1.7 to 1

$11,100 + $2,000 x 365 = 22.2 days
$215,500
4.
Inventory turnover
$136,100
= 9.4 times
($12,500 + $16,400)/2
5.

$12,500 x 365 = 33.5 days
$136,100
6.
Ratio of pledged assets to secured liabilities

$72,900 / $25,000 = 2.9 to 1
7.
Times interest earned

$29,200 / $1,200 = 24.3 times
8.
Profit margin ratio

$25,800 = 12.0%
$215,500

250

9.

$215,500
= 2.1 times
($110,500 + $95,900)/2
10.

$25,800
= 25.0%
($110,500 + $95,900)/2
11.

$25,800
($71,100 + $61,300)/2
= 39.0%

251

Part 1
Loud Company
Clear Company
a. Current ratio
$215,200
$92,500 = 2.3 to 1
$218,100
$99,000 = 2.2 to 1
$114,700
$92,500 = 1.2 to 1
$122,000
$99,000 = 1.2 to 1
b. Acid-test ratio
c. Accounts (and notes) receivable turnover

$395,600
= 4.7 times
($79,100 + $13,600 + $74,200)/2
$669,500
= 8.4 times
($72,500 + $11,000 + $75,300)/2
d. Inventory turnover
$292,600
($88,800 + $107,100)/2 = 3.0 times
$482,000
($84,000 + $82,500)/2
= 5.8 times
e. Days sales in inventory

$88,800
$292,600 x 365 = 110.8 days
$84,000
$482,000
x 365 = 63.6 days
f. Days' sales uncollected

$79,100 + $13,600
x 365 = 85.5 days
$395,600
$72,500 + $11,000
x 365 = 45.5 days
$669,500
Short-term credit risk analysis: Loud and Clear have nearly equal current
ratios and equal acid-test ratios. However, Clear both turns its merchandise
and collects its accounts receivable much more rapidly than Loud. On this
basis, Clear probably is the better short-term credit risk.

252

Part 2
Loud Company
Clear Company
a. Profit margin ratio

$35,850
$395,600 = 9.1%
$63,700
$669,500
= 9.5%
b. Total asset turnover

$395,600
($394,100 + $385,400)/2
= 1.02 times
$669,500
= 1.46 times
($472,400 + $445,000)/2
c. Return on total assets

$35,850
($394,100 + $385,400)/2
= 9.2%
$63,700
= 13.9%
($472,400 + $445,000)/2
d. Return on common stockholders' equity

$35,850
($206,600 + $186,100)/2
= 18.3%
$63,700
($278,100 + $254,700)/2
= 23.9%
e. Price-earnings ratio
$25
$1.33 = 18.8
$25
= 11.2
$2.23
f. Dividend yield
$3
$25 = 12.0%
$3
= 12.0%
$25
Investment analysis: Clear's profit margin, total asset turnover, return on total
assets, and return on common stockholders' equity are all higher than Loud's.
Also, Clear has a lower price-earnings ratio, while paying the same dividend.
These factors indicate that Clear stock is likely the better investment.

253
SERIAL PROBLEM
Serial Problem, Success Systems (45 minutes)
1. Gross margin with services revenue
Gross margin
= Total revenue Cost of goods sold
= $43,853 - $14,052 = $29,801
Gross margin ratio = $29,901 / $43,853 = 68.2%
Gross margin without services revenue
Gross margin
= Net (goods) sales Cost of goods sold
= $18,693 - $14,052 = $4,641
Gross margin ratio = $4,641 / $18,693 = 24.8%
Profit margin ratio
2. Current ratio
Acid-test ratio
3. Debt ratio
Equity ratio
= $18,686 / $43,853 = 42.6%

= $105,209 / $20,875 = 5.0
= ($77,845 + $22,720) /$20,875 = 4.8
= $20,875 / $129,909 = 16.1%
= $109,034/$129,909 = 83.9%
4. Current assets are 81% of total assets ($105,209/$129,909)

Long-term assets are 19% of total assets ($24,700/$129,909).

254
Reporting in Action
BTN 17-1
1. Trend percents for selected income statement accounts

2003
2002
2001
Revenues.............................................................. 163%
131%
100%
Operating expenses (costs of sales).................. 152
126
100
General and administrative expenses................ 144
137
100
Income taxes (provision for income taxes)......... 235
178
100
Net income............................................................ 227
179
100
2. Common-size percents for asset categories and accounts

2003
2002
Total current assets............................................. 34.4%
39.9%
Property and equipment, net............................... 49.3
44.1
Intangible assets.................................................. 11.9
6.5
Accrued expenses................................................ 5.1
10.5
3. For 2002 and 2003, the trend percents for operating expenses (costs of
sales) are slightly less than that for revenues. These comparisons show
that Krispy Kremes costs of sales are being effectively controlled and not
growing faster than revenues. However, the trend percents for general and
administrative expenses (137) exceed that for revenues (131) in 2002.
Moreover, for 2002 and 2003, income taxes were markedly higher than
revenue growth. On the other hand, a positive sign was that bottom line
net income grew faster than top line revenue in both 2002 and 2003.
The common-size percent figures show a shift away from current assets
(34.4% in 2003 vs. 39.9% in 2002) toward more property and equipment
assets (49.3% in 2003 vs. 44.1% in 2002) and intangible assets (11.9% in
2003 vs. 6.5% in 2002).
4. Answers depend on the financial statement information obtained.

255
Comparative Analysis
BTN 17-2
1.
Key figures ($ thousands)
Krispy Kreme
Cash and equivalents............7.8%
$32,203
Tastykake
0.2%
282
Accounts receivable, net....... 8.4
34,373
17.9
20,882
Inventories.............................. 5.9
24,365
5.8
6,777
Retained earnings..................24.9
102,403
22.8
26,622
Costs of sales*.......................77.6
381,489
68.5
111,187
Income taxes.......................... 4.3
21,295
2.2
3,573
Revenues (and sales)............

100.0
491,549
100.0
162,263
Total assets.............................
100.0
410,487
100.0
116,560
* Krispy Kremes costs of sales are titled operating expenses.
2. Krispy Kreme incurred income taxes at 4.3% of revenues. This is

greater than that of Tastykake, which incurred income taxes at 2.2% of
its net sales.
3. Krispy Kremes retained earnings makeup a greater percent of its
assets (24.9%) as compared to Tastykake (22.8%).
4. Krispy Kremes costs of sales percent is higher at 77.6% compared to
Tastykakes 68.5%.
Therefore, Krispy Kreme has the lower gross margin ratio on sales
(22.4%) versus Tastykake (31.5%).
5. Krispy Kreme has only a slightly higher percent of total assets in the
form of inventory at 5.9%, compared to Tastykakes 5.8%.

256
Ethics Challenge
BTN 17-3
1. The CEO appears to have selectively chosen from the 11 available

ratios to present only the ones that show trends that are favorable to
the company. (However, some analysts may not interpret a decline in
selling expenses as a percent of revenue as positive since it might
imply a scaling back on advertising or promotion campaigns.) The
CEOs motivation might be to make her performance, or the companys,
or both, appear better than it is in the eyes of the analysts.
2. The consequences of this action by the CEO might be mixed. It is likely
that the analysts will ask other questions that may reveal some
negative trends such as the trends in return and profit margins. The
CEOs actions may become transparent to the analysts as they
discover the presence of less favorable trends through their questions.
If discovered, such a disclosure ploy by the CEO will not reflect
favorably on the company. Both the CEO and the company are likely to
suffer losses in reputation and credibility.
Even if the CEO is able to succeed with this strategy in the short term,
once the financial statements are issued all users can compile
additional ratio information and see that some of the trends are
unfavorable to the company. This is likely to damage the credibility of
the CEO.
Communicating in Practice
BTN 17-4
There is no set solution to this activity. Each teams memorandum will vary
based on the industry and companies chosen for analysis. (Instructor:
Consider making a transparency of each teams memorandum for use in a
classroom discussion of the findings.)

257
Taking It to the Net

($ thousands)
BTN 17-5
As of 12/31/2002
As of 12/31/2001
1. Profit margin ratio.................

$42,815 / $953,067 = 4.5% $(92,788)/$717,422 = (12.9)%
2. Gross profit ratio...................
$790,186/ $953,067 = 82.9% $560,421 / $717,422 = 78.1%
3. Return on total
$42,815 / ([$2,790,181 +
$(92,788) / ([2,379,346 +
assets...................................
$2,379,346]/2) = 1.66%
$2,269,576]/2) = (3.99)%
4. Return on common
$42,815 / ([$2,262,270 +
$(92,788) / ([$1,967,017 +
stockholders equity..............
$1,967,017]/2) = 2.02%
$1,896,914]/2) = (4.81)%
5. Basic earnings per
share.....................................
$0.07
$(0.16)
Analysis and Interpretation: Yahoo turned its previous negative

profitability into positive territory in 2002this is evident from its return
and per share figures.
Teamwork in Action
BTN 17-6
Part 1
Team reports should look something like the following:
Horizontal Analysis
Horizontal analysis is comparing a companys financial statement amounts
across time. We compare data from comparative statements that are
horizontally aligned; that is, we compare the same items from one period to
another period. The change disclosed by the comparison is generally
expressed as a dollar amount and/or as a percent. For instance, we
compare sales of one period to sales of another and determine the dollar
amount of the increase or decrease. We also determine the percent of
increase or decrease in sales that this change represents. This type of
comparison is generally completed on a line-by-line basis for both income
statement and balance sheet items (and sometimes for other financial
statements).
Example: Sales: 2005, $240,000; 2006, $300,000. Horizontal analysis of
sales yields a $60,000 increase or 25% increase in sales. (Computation is
defined as: Amount of change / Base year [or $60,000/$240,000].)
258
Teamwork in Action (Concluded)

If a horizontal comparison is made over a number of periods, the
comparisons are made to corresponding amounts in a selected period
called the base period. Each subsequent periods amount is compared to
the base period. The change is expressed as a percent of the base period.
This is commonly referred to as trend analysis.
Vertical Analysis
Vertical analysis is comparing a company's financial statement amounts to
a base amount. Usually this base amount is a total or aggregate amount.
An income statement's base is usually total revenue and a balance sheet's
base is usually total assets. We analyze what percent of the total (or base)
the individual statement items represent.
Example: Total assets for the period being analyzed = $500,000 (base
number). Cash balance is $100,000. Cash is computed to be 20% of total
assets. (Computation is defined as: Individual amount / Aggregate amount
[or $100,000/$500,000].)
Part 2
Explanations of the four categories or areas of ratio analysis follow:
a. Liquidity analysis measures the availability of resources to meet shortterm cash requirements. Efficiency analysis measures how productive a
company is in using its assets.
b. Solvency analysis measures a company's long-run financial viability and
its ability to cover long-term obligations.
c. Profitability analysis measures a company's ability to generate an
adequate return on invested capital.
d. Market analysis measures the companys returns (for example, EPS and
dividend) relative to its market price.
Note: Students will select various ratios to illustrate these categories. Use
Exhibit 17.16 to verify the category, measurement, and use of each ratio.
Part 3
Each team member presents results to the entire team.

259
Business Week Activity
BTN 17-7
1. Short-selling is the practice of contracting to sell a stock at a given

price. If the price falls below that level, you buy the stock, deliver it, and
pocket the difference. People that short a stock believe that the
stocks price will decline from its current levels in the near future. Here
is an example of short-selling. Say that you identify a stock currently
priced in the market at $20 per share. You believe the stocks price will
decline in the near future. You contract to sell the stock at $15 per
share. You wait until the price falls to $10, buy the stock at $10, and
deliver it for sale per the terms of the short contract. You would gain a
$5 profit in this case.
2. Tom Taulli (writer) outlines several basic strategies for short-sellers.
a. Use financial statement analysis to identify red flags (items of
concern) on the balance sheet.
b. Listen to company conference calls to learn more about the current
condition of the company.
c. Study macro factors of the industry and watch for signs that growth
is starting to diminish.
d. Use technical analysis to chart stock price and volume.
3. Taulli watches the balances (levels) of accounts receivables and
inventory. He compares the percentage changes in these accounts to
the percentage change (growth rate) of sales. If sales are growing
slower than accounts receivable and inventory, Taulli regards this as a
sign of trouble for the company.
4. Even if your financial analysis of a stock is accurate you may still lose
money in the stock market if you short the stock. As Taulli explains
markets may act irrationally and investors can lose money.
5. Taulli says that the PE ratio can be volatile and can be easily
manipulated by earnings management. Taulli states that he prefers to
study and compare the cash flow statement to the income statement
since cash flows are arguably not as easily manipulated by managers as
earnings.

260
Entrepreneurial Decision
BTN 17-8
1. No. Although the current ratio improved over the three-year period, the
acid-test ratio declined and accounts receivable and merchandise
inventory turned more slowly. These conditions indicate that an increasing
portion of the current assets consisted of accounts receivable and
inventories from which current liabilities could not be paid.
2. No. The decreasing turnover of accounts receivable indicates the company
is collecting its receivables more slowly.
3. No. Sales are increasing and accounts receivable are turning more slowly.
Either or both of these trends would produce an increase in accounts
receivable, even if the other remained unchanged.
4. Yes. To illustrate, if sales are assumed to equal $100 in 2003, the sales
trend shows that they would equal $125 in 2004 and $137 in 2005. Then,
dividing each sales figure by its ratio of sales to plant assets would give
$33.33 for plant assets in 2003 ($100/ 3.0), $37.88 in 2004 ($125/ 3.3) and
$39.14 in 2005 ($137/ 3.5).
5. No. The percent of return on equity declines from 12.25% in 2003 to 9.75%
in 2005.
6. The dollar amount of selling expenses increased in 2004 and decreased
sharply in 2005. Again assuming sales figures of $100 in 2003, $125 in 2004,
and $137 in 2005, and multiplying each by its selling expense to net sales
ratio gives $15.30 of selling expenses in 2003, $17.13 in 2004, and $13.43 in
2005.
Hitting the Road
BTN 17-9
One possible strategy to fulfill the requirements of this assignment is:

Assume that a $37,500 salary will be earned upon graduation at age 25.
Also, assume that the level of investment will be at 8% of your salary (or
$3,000 annually) starting at age 25. By starting at age 25 there will be 40
annual compounding periods until age 65.
If the annual amount invested does not change and you earn 10% for 40
years, then the investment will grow to $1,327,779 ($3,000 x 442.593 from
Table B.4) at age 65. The $1,000,000 goal can also be reached at age 65 if
the investment earns 9% ($3,000 x 337.882 = $1,013,646).

261
Global Decision
BTN 17-10
Instructor note: Student answers will vary.
Five differences in annual reports or Websites between Grupo Bimbo

and Krispy Kreme (or Tastykake) include:
1. Grupo Bimbos Website is presented in both Spanish and English.
Users can select language preference by clicking on a tab on the
homepage. The default language is Spanish.
2. Grupo Bimbos statements are denominated in Pesos. Krispy Kreme
and Tastykake report in dollars.
3. Grupo Bimbo prepares its statements in accordance with accounting
standards that are generally accepted in Mexico. Krispy Kreme and
Tastykake prepare statements in accordance with U.S. GAAP.
4. Krispy Kreme and Tastykake prepare a Statement of Cash Flows.
Grupo Bimbo prepares a Statement of Changes in Financial Position.
5. Grupo Bimbos results are attested to by a shareholder examiner and
external auditors. Krispy Kreme and Tastykake have only one
attestation report included, that of the external auditors.

262

Analysis of Financial Statements: Questions

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Chapter 17

Analysis of Financial Statements

McGraw-Hill Companies, Inc., 2005

Return on total assets (2002):

15. Equity ratio (2002):

Equity ratio (2001):

16. Profit margin (2002):

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Items not part of general-purpose financial statements:

Quick Study 17-2 (10 minutes)

Quick Study 17-3 (15 minutes)

McGraw-Hill Companies, Inc., 2005

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Quick Study 17-4 (10 minutes)

(the given base amount)

Quick Study 17-5 (10 minutes)

Quick Study 17-6 (5 minutes)

1. Profit Margin Ratio................................ 8%

3. Gross Margin Ratio...............................33%

5. Accounts Receivable Turnover............ 5.4

6. Basic Earnings Per Share.....................

McGraw-Hill Companies, Inc., 2005

7. Inventory Turnover................................ 3.5

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Exercise 17-2 (25 minutes)

McGraw-Hill Companies, Inc., 2005

Exercise 17-3 (25 minutes)

Exercise 17-4 (30 minutes)

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Exercise 17-5 (30 minutes)

McGraw-Hill Companies, Inc., 2005

Exercise 17-6 (20 minutes)

Accounts receivable, net.................................. 17.1

Merchandise inventory..................................... 21.5

Plant assets, net ............................................... 53.6

Total assets ....................................................... 100.0%

Accounts payable.............................................. 24.9%

Common stock, $10 par value.......................... 31.4

Retained earnings ............................................ 24.9

Total liabilities and equity.................................100.0%

Column does not equal 100.0 due to rounding.

Analysis: Several observations can be made.

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Exercise 17-7 (25 minutes)

$30,800 + $88,500 + $111,500 + $9,700

$35,625 + $62,500 + $82,500 + $9,375

$36,800 + $49,200 + $53,000 + $4,000

Analysis and Interpretation: Sexton's short-term liquidity position has

McGraw-Hill Companies, Inc., 2005

Exercise 17-8 (25 minutes)

Days' sales uncollected

Accounts receivable turnover

Days sales in inventory

Analysis and Interpretation: The number of days' sales uncollected has

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Exercise 17-9 (25 minutes)

Total liabilities and debt ratio