Mastery Problem: Financial Statement Analysis

Liquidity and Solvency Measures

Your friend, another accountant, has bet you that with your knowledge of accounting and just the computations for common analytical measures, you can figure out many aspects of a company's financial statements. You take the bet!

Match each computation to one of the liquidity and solvency measures in the table. (Hint: Begin by looking for simple computations and identifying the amounts in those computations. Look for other measures that use those amounts.)

Liquidity and Solvency Measures Computations

Working capital

Current ratio

Quick ratio

Accounts receivable turnover

Number of days' sales in receivables

Inventory turnover

Number of days' sales in inventory

Ratio of fixed assets to long-term liabilities

Ratio of liabilities to stockholders' equity

Times interest earned

Balance Sheet

Use the following balance sheet form to enter amounts you identify from the computations on the Liquidity and Solvency Measures part. You will identify other amounts for the balance sheet on the Profitability Measures part. If you have a choice of two amounts, assume the first amount in the ratio is for the end of the year. Compute any missing amounts.

Balance Sheet December 31, 20Y6

Assets

Current assets:

Cash$823,000

Marketable securities

Accounts receivable (net)

Inventory

Prepaid expenses

Total current assets$

Long-term investments

Property, plant, and equipment (net)

Total assets$

Liabilities

Current liabilities$

Long-term liabilities

Total liabilities$

Stockholders' Equity

Preferred stock, $10 par$

Common stock, $5 par

Retained earnings

Total stockholders' equity$

Total liabilities and stockholders' equity$

Profitability Measures

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

Profitability Measures Computations

Asset turnover

Return on total assets

Return on stockholders' equity

Return on common stockholders' equity

Earnings per share on common stock

Price-earnings ratio

Dividends per share

Dividend yield

Comparative Income Statement

Use the following comparative income statement form to enter amounts you identify from the computations on the Liquidity and Solvency Measures part and on the Profitability Measures part. Compute any missing amounts and complete the horizontal analysis columns. Enter percentages as decimal amounts, rounded to one decimal place. When rounding, look only at the figure to the right of one decimal place. If < 5, round down and if 5, round up. For example, for 32.048% enter 32.0%. For 32.058% enter 32.1%.

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

Increase/(Decrease)

20Y620Y5AmountPercentage

Sales $ $7,257,000 $ %

Cost of goods sold (3,444,000) %

Gross profit $ $3,813,000 $ %

Selling expenses $ $(1,451,000) $ %

Administrative expenses (1,237,500) (1,101,500) %

Total operating expenses $ $(2,552,500) $ %

Operating income $ $1,260,500 $ %

Other expense (interest) (120,600) %

Income before income tax expense $ $1,139,900 $ %

Income tax expense (178,200) %

Net income $ $961,700 $ %

Final Questions

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

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

has decreased significantly from 20Y5 to 20Y6, even though has increased. However, has also , which slowed the increase in . In addition, has increased at a faster rate. The company appears .

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