I MICHIGAN LELJSlr-alESE SCHUDL WMBA 501 PRINCIPLES OF FINANCIAL REPORTING THE BRIGHTON FLOOR STORE PRELIMINARY OBSERVATIONS The initial observation on the balance sheet is the presence of negative numbers for cash in each of the last two quarters. Typically we think of all assets, especially cash, as having positive balances. Literally, a negative cash balance implies the company is overdrawn on its checking account on that date. The company has written more checks than it has made deposits to cover. From a nancial reporting perspective, a negative cash balance should be reclassied as a current liability. The company \"owes\" the bank the decit balance and needs to deposit the funds ASAP... i.e, before checks begin to bounce. However, the nancial reporting treatment of the negative cash balance is of much less concern than the fact that the bank account is overdrawn. Technically, it can be illegal to overdraw an account in this manner. And obviously, the company isn't managing cash well to be in this situation. Before performing classic ratio analysis on the nancial statements it us useful to note one unusual feature of the income statement. The \"bottom line\" is identied as \"operating income\" rather than \"net income\" and excludes any provision for income taxes. In fact, interest has been deducted in the determination Of operating income rather than deducted \"below the line\" as a non-operating expense. Taxes have been excluded because their company is a Subchapter S corporation (or a partnership, perhaps) which does not directly pay income taxes , but rather, has its prot included on the individual tax returns of Ed and Tom. One way or another, however, someone will be paying taxes on the company's prot. To make a fair comparison with any publicly available benchmarks of protability using net income we would want to make a provision for taxes (probably about 40%) on the income statement of BFS. Under these assumptions we would transform BFS income statements to: Second Quarter First Quarter Year Ending 2015 2015 December 31: 2014 Operating Income $1 15 $1 16 $3 85 Net Income $56 $57 $183 1. DELIVERABLE REQUIREMENTS Compare the performance of Brighton Floor Stores with a store where I recently bought some carpet for my son's bedroom, namely Home Depot (results based on a recent annual report led with the SEC). Attached you will nd a handy list of ratio formulas that you should carry with you for the rest of your life! They should correspond to those discussed in your online video. Return on Assets 19.9% Return on Equity 19.2% Return on Sales 6.6% Gross Prot Percentage 31.8% Asset Turnover 1.89 Inventory Turnover 4.8 Debt to Equity .54 Feel free to compute any other ratios for Brighton Floor Store that you think would be diagnostic in your analysis of their performance, but you need not compare them to Home Depot. As you can probably tell by their magnitudes, the ratios for Home Depot are based upon annual income statement data. Analyze their negative cash balance by preparing a statement of cash ows for each of the two quarters ending March 31, 2015 and June 30, 2015. Use this information to identify the company's cash ows from operations, cash flows om investing activities and cash ows from nancing activities during each of these two quarters. You may assume that Brighton Floor Stores is a Subehapter S Corporation and hence does not pay income taxes. Using the results of the above analysis, prepare a list of recommendations for the management of Brighton Floor Store comment on their feasibility and purpose. RATIO Return on Sales Operating Margin Gross Margin Percentage I MICHIGAN ROSS SCHOOL OF BUSINESS MEASURING PROFITABILITY Pro [It Margins FORMULA Net Income Net Sales Earnings Before Interest and Taxes Net Sales Net Sales - Cost of Goods Sold Net Sales Returns FORMULA PURPOSE To measure the overall protability of the rm. To measure the operating protability of the rm. To measure the percentage of sales available for other expenses and prot. PURPOSE Return on Equity Return on Assets w Shareholders' Equity Earnings Before Interest and Taxes Total Assets To measure the annual percentage return to shareholders. To measure the operating earning power of the rm's assets to compare with the overall cost of capital. MEASURING SHORT-TERM LIQUIDITY Balance Sheet Liquidity RATIO FORMULA PURPOSE Current Assets To measure the current ability Current Ratio Current Liabilities to meet short-term obligations. To measure the ability to meet Quick Ratio or Cash + Receivables + Securities short-term obligations with Acid-Test Ratio Current Liabilities the most liquid assets. Activity / Efficiency RATIO FORMULA PURPOSE To measure the volume of Asset Turnover Net Sales sales generated by the firm's Total Assets assets in place. Cost of Goods Sold To measure how quickly the Inventory Turnover Inventory firm is selling its inventory. Average Collection Period Accounts Receivable To measure how quickly the DS Average Daily Sales firm is collecting receivables. Accounts Payable Accounts Payable To measure how long the firm Payment Period Average Daily Purchases is taking to pay suppliers.MEASURING DEBT BURDENS Leverage / Gearing RATIO FORMULA PURPOSE To measure the extent to Debt to Equity Total Debt (Liabilities) Total Shareholders' Equity which the firm uses debt as a source of financing. To measure the extent to Debt to Assets Total Debt (Liabilities) which the firm uses debt as a Total Assets source of financing. Payment Coverage RATIO FORMULA PURPOSE Times Interest Earned Earnings before Interest and Taxes To measure the safety cushion Interest Expense to cover interest payments.ONLY REQUIRED TO ANSWER QUESTION# 2 OF THE DELIVERABLE: -L.E. STATEMENT OF CASH FLOW: 2. Analyze their negative cash balance by preparing a statement of cash flows for each of the two quarters ending March 31, 2015 and June 30, 2015. Use this information to identify the company's cash flows from operations, cash flows from investing activities and cash flows from financing activities during each of these two quarters. You may assume that Brighton Floor Stores is a Subchapter S Corporation and hence does not pay income taxes