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 $840,000
Current ratio		$3,091,000 $840,000
Quick ratio		$1,866,000 $840,000
Accounts receivable turnover		$8,260,000 [($714,000 + $740,000) 2]
Number of days' sales in receivables		[($714,000 + $740,000) 2] ($8,260,000 365)
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		$2,530,000 $4,075,000
Times interest earned		($976,800 + $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	fill in the blank af79da0c6ffaf8f_1
Accounts receivable (net)	fill in the blank af79da0c6ffaf8f_2
Inventory	fill in the blank af79da0c6ffaf8f_3
Prepaid expenses	fill in the blank af79da0c6ffaf8f_4
Total current assets	$fill in the blank af79da0c6ffaf8f_5
Long-term investments	fill in the blank af79da0c6ffaf8f_6
Property, plant, and equipment (net)	fill in the blank af79da0c6ffaf8f_7
Total assets	$fill in the blank af79da0c6ffaf8f_8
Liabilities
Current liabilities	$fill in the blank af79da0c6ffaf8f_9
Long-term liabilities	fill in the blank af79da0c6ffaf8f_10
Total liabilities	$fill in the blank af79da0c6ffaf8f_11
Stockholders' Equity
Preferred stock, $10 par	$fill in the blank af79da0c6ffaf8f_12
Common stock, $5 par	fill in the blank af79da0c6ffaf8f_13
Retained earnings	fill in the blank af79da0c6ffaf8f_14
Total stockholders' equity	$fill in the blank af79da0c6ffaf8f_15
Total liabilities and stockholders' equity	$fill in the blank af79da0c6ffaf8f_16

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		$8,260,000 [($5,781,000 + $5,591,000) 2]
Return on total assets		($791,340 + $127,000) [($6,605,000 + $6,415,000) 2]
Return on stockholders' equity		$791,340 [($4,075,000 + $3,871,250) 2]
Return on common stockholders' equity		($791,340 $65,000) [($3,587,500 + $3,444,000) 2]
Earnings per share on common stock		($791,340 $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

$fill in the blank 34c27fffbff1fd1_1

$7,267,000

$fill in the blank 34c27fffbff1fd1_2

fill in the blank 34c27fffbff1fd1_3

%

Cost of goods sold

fill in the blank 34c27fffbff1fd1_4

(3,444,000)

fill in the blank 34c27fffbff1fd1_5

fill in the blank 34c27fffbff1fd1_6

%

Gross profit

$fill in the blank 34c27fffbff1fd1_7

$3,823,000

$fill in the blank 34c27fffbff1fd1_8

fill in the blank 34c27fffbff1fd1_9

%

Selling expenses

$fill in the blank 34c27fffbff1fd1_10

$(1,453,200)

$fill in the blank 34c27fffbff1fd1_11

fill in the blank 34c27fffbff1fd1_12

%

Administrative expenses

(1,239,000)

(1,103,000)

fill in the blank 34c27fffbff1fd1_13

fill in the blank 34c27fffbff1fd1_14

%

Total operating expenses

$fill in the blank 34c27fffbff1fd1_15

$(2,556,200)

$fill in the blank 34c27fffbff1fd1_16

fill in the blank 34c27fffbff1fd1_17

%

Operating income

$fill in the blank 34c27fffbff1fd1_18

$1,266,800

$fill in the blank 34c27fffbff1fd1_19

fill in the blank 34c27fffbff1fd1_20

%

Other expense (interest)

fill in the blank 34c27fffbff1fd1_21

(120,600)

fill in the blank 34c27fffbff1fd1_22

fill in the blank 34c27fffbff1fd1_23

%

Income before income tax expense

$fill in the blank 34c27fffbff1fd1_24

$1,146,200

$fill in the blank 34c27fffbff1fd1_25

fill in the blank 34c27fffbff1fd1_26

%

Income tax expense

fill in the blank 34c27fffbff1fd1_27

(179,460)

fill in the blank 34c27fffbff1fd1_28

fill in the blank 34c27fffbff1fd1_29

%

Net income

$fill in the blank 34c27fffbff1fd1_30

$966,740

$fill in the blank 34c27fffbff1fd1_31

fill in the blank 34c27fffbff1fd1_32

%

Feedback

For missing amounts, review their definitions in your text. Changes in the horizontal analysis may be increases or decreases.

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.

Net income has decreased significantly from 20Y5 to 20Y6, even though sales has increased. However, cost of goods sold has also increased , which slowed the increase in gross profit . In addition, selling expenses has increased at a faster rate. The company appears to be struggling .

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