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		$3,091,000 $900,000
Current ratio		$3,091,000 $900,000
Quick ratio		$1,866,000 $900,000
Accounts receivable turnover		$8,270,000 [($714,000 + $740,000) 2]
Number of days' sales in receivables		[($714,000 + $740,000) 2] ($8,270,000 365)
Inventory turnover		$4,100,000 [($1,072,000 + $1,100,000) 2]
Number of days' sales in inventory		[($1,072,000 + $1,100,000) 2] ($4,100,000 365)
Ratio of fixed assets to long-term liabilities		$2,690,000 $1,690,000
Ratio of liabilities to stockholders' equity		$2,590,000 $4,015,000
Times interest earned		($983,100 + $127,000) $127,000

Feedback

Look for patterns in the computations and match them to ratios that are related to each other. Identify the amounts in the computations and consider how they are related to amounts in other computations.

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	$329000
Accounts receivable (net)	$714000
Inventory	$1072000
Prepaid expenses	$153000
Total current assets	$3091000
Long-term investments
Property, plant, and equipment (net)	$2690000
Total assets
Liabilities
Current liabilities	$900000
Long-term liabilities	$1690000
Total liabilities	$2590000
Stockholders' Equity
Preferred stock, $10 par
Common stock, $5 par
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity

Feedback

Identify the amounts in the Liquidity and Solvency Measures panel and the Profitability Measures panel that are balance sheet items and enter them accordingly.

Profitability Measures

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

Profitability Measures		Computations
Asset turnover		$8,270,000 [($5,781,000 + $5,591,000) 2]
Return on total assets		($796,380 + $127,000) [($6,605,000 + $6,415,000) 2]
Return on stockholders' equity		$796,380 [($4,015,000 + $3,814,250) 2]
Return on common stockholders' equity		($796,380 $65,000) [($3,527,500 + $3,386,400) 2]
Earnings per share on common stock		($796,380 $65,000) 250,000 shares
Price-earnings ratio		$35 $3.05
Dividends per share		$175,000 250,000 shares
Dividend yield		$0.70 $35

Feedback

Look for patterns in the computations and match them to ratios that are related to each other. Identify the amounts in the computations and consider how they are related to amounts in other computations. Note that two of the computations use shares.

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)
	20Y6			20Y5			Amount			Percentage
Sales		$			$7,277,000			$				%
Cost of goods sold		$-4100000			(3,444,000)			$656000			19	%
Gross profit		$			$3,833,000							%
Selling expenses		$			$(1,455,400)			$				%
Administrative expenses		(1,240,500)			(1,104,500)			$136000			12.3	%
Total operating expenses					$(2,559,900)							%
Operating income		$			$1,273,100			$				%
Other expense (interest)		$-127000			(120,600)			$64000				%
Income before income tax expense		$			$1,152,500			$				%
Income tax expense					(180,720)							%
Net income		$			$971,780							%