Katie Fleming is a local photographer and currently operates her own business, Katies Custom Photography. She specializes in professional photographic services, film developing, camera repair, and sells camera and other photographic equipment. One of her strong market niches has been that she sells very high end cameras and accessories that cater primarily to the professional photographer. She is aware that most of the equipment she sells can be purchased on various web sites and through mail order outlets. The personal service she offers is what has kept her customer base. Her business has always been profitable with an annual sales growth, and as a result she has not spent much time concerned with what she might do to expand or grow her business. She is becoming concerned that her business needs to expand into other areas in case her sales begin to suffer because of the competition from other outlets.

Katie has just attended a seminar, and one of the speakers presented an opportunity that interested her. By adding a photo editing program to her computer, purchasing a higher quality printer, and obtaining some additional supplies and materials, she could expand her business to produce photo security identification badges, better known as photo ID badges. She would take the photos and then create the individual security badges. The badges could be just a photo ID, or they could also contain a magnetic strip on the back that could be programmed for various door opening and time keeping functions. This is a growing segment of the larger security services market that has grown exponentially in recent years. Potential markets were discussed at the seminar. It was mentioned that many smaller, local companies would like to increase their levels of security by having photo ID badges for their employees, but the cost to create them internally is prohibitive.

She also learned that there are many private security companies that use freelance photographers to take the pictures and create photo ID badges for their clients. This is less expensive for them than buying their own photographic equipment. The more she thought about this opportunity, the more she felt it would be a viable expansion to her current business. The issue is that she has no idea if this decision makes financial sense to her business or if she can afford the start up costs to enter this market. To further complicate the issue, while she was away at the seminar, the accountant that she has used and trusted since she started her business passed away. She knew that she could have conferred with her accountant and received the input she needed to make a financial decision such as this one, but now this help is not available to her.

To help her through this crisis, Katie opens the phone book and finds your name under the heading of Business Consulting Services. She calls you and briefly explains her situation, and you agree to meet with her to discuss the possibility of developing a working relationship to meet her accounting needs and provide management consulting services for her business. After meeting with her and gaining a better understanding of the history of her business, you both mutually decide that doing business together seems like a good idea.

PART 1

Katies previous accountant, after the end of year financial statements were prepared, always supplied her with several financial ratios. As part of the service, she would receive an explanation of what the various ratios were for the just completed year, if each of the ratios were trending positively or negatively from the previous year, and what she could do to improve them for the upcoming year.

One of the documents that Katie left with you was labeled "Financial Ratios." You can find a copy of this document in the Summary Paper Worksheets file with the same name. Using the four financial statements (income statement, retained earnings statement, balance sheet, and cash flows statement) also included in the Summary Paper Worksheets and information in the "EOY Misc. Notes" and the "Financial Ratios" worksheets just mentioned, supply the following information to Katie.

Step 1

Calculate the following ratios for the year just completed.

1. Current ratio
2. Acid test (Quick) ratio
3. Accounts receivable turnover
4. Days sales in receivables
5. Inventory turnover
6. Average days in inventory
7. Debt to equity ratio
8. Rate of return on assets (ignore interest expense)
9. Rate of return on common stockholders' equity (no preferred dividends)
10. Rate of return on net sales

Step 2

Using the information in the Financial Ratios worksheet as your base, identify for Katie if each of the above ratios you calculated indicate an improving or declining trend from the previous year.

1. Current ratio improved or declined?
2. Acid-test (Quick) ratio improved or declined?
3. Accounts Receivable turnover improved or declined?
4. Days sales in receivables improved or declined?
5. Inventory turnover improved or declined?
6. Average days in inventory improved or declined?
7. Debt to equity improved or declined?
8. Rate of return on assets improved or declined?
9. Rate of return on common stockholders' equity improved or declined?
10. Rate of return on net sales improved or declined?

Step 3

Whether you have identified an improving or declining trend, tell Katie one thing she could do to improve each of the ratios for the upcoming year.

1. How can the current ratio be improved for the upcoming year?
2. How can the acid-test (quick) ratio be improved for the upcoming year?
3. How can the accounts receivable turnover be improved for the upcoming year?
4. How can the days sales in receivables be improved for the upcoming year?
5. How can the inventory turnover be improved for the upcoming year?
6. How can the average days in inventory be improved for the upcoming year?
7. How can the debt to equity ratio be improved for the upcoming year?
8. How can the rate of return on assets be improved for the upcoming year?
9. How can the rate of return on common stockholders' equity be improved for the upcoming year?
10. How can the rate of return on net sales be improved for the upcoming year?

PART 2

As part of the services you will offer Katie, you are going to provide her with an analysis of whether you believe she should or should not invest the necessary money to add the security badge preparation segment to her existing business. The driving force behind your opinion will be based on performing a break even analysis on this additional piece of business. Katie has supplied you with the information from the seminar identifying what the costs to start up and operate this new business would be. She also has determined what the selling price of the badges will be. You will find this information in the worksheet labeled "New Business Information". You have no reason to suspect that the information is incorrect. She also shared with you that if she decides to add this new business, she plans on borrowing the start-up funds.

For part 2 of your summary paper, complete the following:

Prepare a break even analysis for this additional business and answer the following questions.

1. What will be the break even point in number of ID Badges?
2. What will be the break even point in sales dollars?

In terms of financial leverage:

1. Give Katie two reasons to borrow the money.
2. Give Katie two reasons to not borrow the money.

Katie's Custom Photography Statement of Retained Earnings Year Ending December 31, 2017 Retained earnings, January 1, 2017 $64,340 Net Income for the Year Ending December 31, 2017 79,294 Dividends (22,000) Retained earnings, December 31, 2017 $121,634 EOY Misc Notes For Income Statement reporting purposes Net Sales consist of: Photography services revenue Merchandise revenue Selling Expense include: Wages Expense Depreciation expense - Photo developing equipment Photographic Services Expense include: Vehicle expenses Business related traveling expense Depreciation expense - Company vehicles Salaries expense Office Expense include: Utilities expense Income tax expense Depreciation expense - Office Equipment Rent expense To be used on the Statement of Cash Flows: During the year Long term assets sold Long term assets purchased 1500 8870 Notes paid off Additional long term debt 16750 7358 Account balances from 12-31-16 balance sheet Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Office supplies Prepaid rent Accounts payable Salaries payable Total Assets Common Stock Retained Earnings 15764 5216 24680 8200 4320 2765 875 9450 1890 136019 10000 64340 Katie's Custom Photography Balance Sheet December 31, 2017 ASSETS Current Assets Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Office supplies Prepaid rent Total Current Assets $ 42,563 20,489 30,800 8,767 2,365 1,987 1,100 $ 108,071 8,320 Property, Plant, and Equipment Company vehicles Less accumulated depreciation Office Equipment Less accumulated depreciation Photo developing equipment Less accumulated depreciation Total Property, Plant, and Equipment 19,060 10,740 16,800 10,000 38.780 15,200 6,800 23,580 38,700 Total Assets $ 146,771 LIABILITIES Current Liabilities Accounts payable Salaries payable 2,379 1,500 $ 3,879 Long-term Liabilities Notes payable 11,258 Total Liabilities 15,137 STOCKHOLDERS' EQUITY Common Stock Retained Earnings 10,000 121,634 Total Stockholders' Equity 131,634 Total Liabilities and Stockholders' Equity $ 146.771 Financial Ratios 2016 Current Ratio 22.3 Acid-test (Quick) Ratio 9.6 Accounts Receivable Turnover 22.6 Days Sales in Receivables 16.8 2.8 Inventory Turnover Avg. Days in Inventory 130 days Debt to Equity .18 times Rate of Return on Assets 62% 68% Rate of Return on Common Stockholders' Equity Rate of Return on Net Sales 37% Information associated with the potential new business: Initial start up cost: Printer: Computer software: Supplies: Training $18.685.00 $2.700.00 $1.615.00 $2.000.00 $25,000.00 (Included in depreciation and interest expenses shown below) Cost of borrowing the capital to pay for the start up costs: 7.00% Variable cost per Badge: Direct labor cost: Direct material cost: $2.67 per badge $1.08 per badge Additional fixed cost associated with the badges: Monthly depreciation on above identified start up costs: Increase in annual insurance premium: Increase in monthly advertising: Annual interest expense: $500.00 $650.00 $180.00 $1,750.00 Selling price per badge: $4.85 Katie's Custom Photography Adjusted Trial Balance December 31, 2017 Credit Debit 42563 20489 30800 8767 2365 1987 1100 19060 16800 38780 Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Office supplies Prepaid rent Company vehicles Office Equipment Photo developing equipment Accumulated depreciation - Company vehicles Accumulated depreciation - Office Equipment Accumulated depreciation - Photo developing equipment Accounts payable Salaries payable Notes payable (Long-term) Common Stock Retained Earnings Dividends Photography services revenue Merchandise revenue Other revenue Interest Income Cost of goods sold Wages expense Vehicle expenses Business related traveling expense Depreciation expense - Company vehicles Depreciation expense - Office Equipment Depreciation expense - Photo developing equipment Rent Expense Utilities expense Salaries expense Income tax expense Interest expense 10740 10000 15200 2379 1500 11258 10000 64340 22000 76876 179104 6700 3300 66450 37475 4480 5760 3580 2000 7600 6600 4865 42516 4900 460 Totals 391397 391397 Katie's Custom Photography Statement of Cash Flows For the Year Ended December 31, 2017 $79,294 13,180 Cash flows from operating activities Net income Adjustments to reconcile net income to net Depreciation expense Changes in current assets and current liabilities Increase in accounts receivable Increase in merchandise inventory Increase in prepaid expenses Decrease in store supplies Decrease in office supplies Decrease in accounts payable Decrease in salaries payable Total adjustments (15,273) (6,120) (792) 1,955 778 (7,071) (390) (13,733) $65,561 Net Cash from Operating Activity $ Cash flows from Investing Activity Sale of long term assets Purchase of long term assets Net Cash from Investing Activity 1,500 (8,870) $ (7,370) $ (16,750) 7,358 Cash flows from Financing Activities Notes paid off Additional long term debt Additional common stock Dividends Net cash from Financing Activity $ (22,000) $ (31,392) Net Increase (Decrease) in Cash $26,799 $ Cash balance end of period Less cash balance beginning of period Net change in Cash account 42,563 15,764 $ 26,799 Katie's Custom Photography Income Statement Year Ending December 31, 2017 Net Sales Cost of Goods Sold Gross Margin $ 255,980 66,450 189,530 Operating Expenses: Photographic Services Expense Selling Expense Office Expense Total Operating Expenses Income From Operations $ 56,336 45,075 18,365 119,776 $ 69,754 $ Other Revenues and Expenses Other Revenue Interest Income Less Interest Expense Excess of other expenses over other revenues 6,700 3,300 460 $ 9,540 Net Income $ 79,294 Katie's Custom Photography Statement of Retained Earnings Year Ending December 31, 2017 Retained earnings, January 1, 2017 $64,340 Net Income for the Year Ending December 31, 2017 79,294 Dividends (22,000) Retained earnings, December 31, 2017 $121,634 EOY Misc Notes For Income Statement reporting purposes Net Sales consist of: Photography services revenue Merchandise revenue Selling Expense include: Wages Expense Depreciation expense - Photo developing equipment Photographic Services Expense include: Vehicle expenses Business related traveling expense Depreciation expense - Company vehicles Salaries expense Office Expense include: Utilities expense Income tax expense Depreciation expense - Office Equipment Rent expense To be used on the Statement of Cash Flows: During the year Long term assets sold Long term assets purchased 1500 8870 Notes paid off Additional long term debt 16750 7358 Account balances from 12-31-16 balance sheet Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Office supplies Prepaid rent Accounts payable Salaries payable Total Assets Common Stock Retained Earnings 15764 5216 24680 8200 4320 2765 875 9450 1890 136019 10000 64340 Katie's Custom Photography Balance Sheet December 31, 2017 ASSETS Current Assets Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Office supplies Prepaid rent Total Current Assets $ 42,563 20,489 30,800 8,767 2,365 1,987 1,100 $ 108,071 8,320 Property, Plant, and Equipment Company vehicles Less accumulated depreciation Office Equipment Less accumulated depreciation Photo developing equipment Less accumulated depreciation Total Property, Plant, and Equipment 19,060 10,740 16,800 10,000 38.780 15,200 6,800 23,580 38,700 Total Assets $ 146,771 LIABILITIES Current Liabilities Accounts payable Salaries payable 2,379 1,500 $ 3,879 Long-term Liabilities Notes payable 11,258 Total Liabilities 15,137 STOCKHOLDERS' EQUITY Common Stock Retained Earnings 10,000 121,634 Total Stockholders' Equity 131,634 Total Liabilities and Stockholders' Equity $ 146.771 Financial Ratios 2016 Current Ratio 22.3 Acid-test (Quick) Ratio 9.6 Accounts Receivable Turnover 22.6 Days Sales in Receivables 16.8 2.8 Inventory Turnover Avg. Days in Inventory 130 days Debt to Equity .18 times Rate of Return on Assets 62% 68% Rate of Return on Common Stockholders' Equity Rate of Return on Net Sales 37% Information associated with the potential new business: Initial start up cost: Printer: Computer software: Supplies: Training $18.685.00 $2.700.00 $1.615.00 $2.000.00 $25,000.00 (Included in depreciation and interest expenses shown below) Cost of borrowing the capital to pay for the start up costs: 7.00% Variable cost per Badge: Direct labor cost: Direct material cost: $2.67 per badge $1.08 per badge Additional fixed cost associated with the badges: Monthly depreciation on above identified start up costs: Increase in annual insurance premium: Increase in monthly advertising: Annual interest expense: $500.00 $650.00 $180.00 $1,750.00 Selling price per badge: $4.85 Katie's Custom Photography Adjusted Trial Balance December 31, 2017 Credit Debit 42563 20489 30800 8767 2365 1987 1100 19060 16800 38780 Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Office supplies Prepaid rent Company vehicles Office Equipment Photo developing equipment Accumulated depreciation - Company vehicles Accumulated depreciation - Office Equipment Accumulated depreciation - Photo developing equipment Accounts payable Salaries payable Notes payable (Long-term) Common Stock Retained Earnings Dividends Photography services revenue Merchandise revenue Other revenue Interest Income Cost of goods sold Wages expense Vehicle expenses Business related traveling expense Depreciation expense - Company vehicles Depreciation expense - Office Equipment Depreciation expense - Photo developing equipment Rent Expense Utilities expense Salaries expense Income tax expense Interest expense 10740 10000 15200 2379 1500 11258 10000 64340 22000 76876 179104 6700 3300 66450 37475 4480 5760 3580 2000 7600 6600 4865 42516 4900 460 Totals 391397 391397 Katie's Custom Photography Statement of Cash Flows For the Year Ended December 31, 2017 $79,294 13,180 Cash flows from operating activities Net income Adjustments to reconcile net income to net Depreciation expense Changes in current assets and current liabilities Increase in accounts receivable Increase in merchandise inventory Increase in prepaid expenses Decrease in store supplies Decrease in office supplies Decrease in accounts payable Decrease in salaries payable Total adjustments (15,273) (6,120) (792) 1,955 778 (7,071) (390) (13,733) $65,561 Net Cash from Operating Activity $ Cash flows from Investing Activity Sale of long term assets Purchase of long term assets Net Cash from Investing Activity 1,500 (8,870) $ (7,370) $ (16,750) 7,358 Cash flows from Financing Activities Notes paid off Additional long term debt Additional common stock Dividends Net cash from Financing Activity $ (22,000) $ (31,392) Net Increase (Decrease) in Cash $26,799 $ Cash balance end of period Less cash balance beginning of period Net change in Cash account 42,563 15,764 $ 26,799 Katie's Custom Photography Income Statement Year Ending December 31, 2017 Net Sales Cost of Goods Sold Gross Margin $ 255,980 66,450 189,530 Operating Expenses: Photographic Services Expense Selling Expense Office Expense Total Operating Expenses Income From Operations $ 56,336 45,075 18,365 119,776 $ 69,754 $ Other Revenues and Expenses Other Revenue Interest Income Less Interest Expense Excess of other expenses over other revenues 6,700 3,300 460 $ 9,540 Net Income $ 79,294