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 $3,095,000 - $880,000 Current ratio $3,095,000 = $880,000 Quick ratio $1,866,000 = $880,000 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 $2,570,000 - $4,039,000 V Times interest earned ($976,800 + $127,000) = $127,000 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, 2016 Assets Current assets: Cash $823,000 329,000 Marketable securities Accounts receivable (net) 714,000 Inventory 1,072,000 Prepaid expenses 157,000 Total current assets 3,095,000 Long-term investments 824,000 Property, plant, and equipment (net) 2,690,000 Total assets $ 6,609,000 Liabilities Liabilities Current liabilities Long-term liabilities 1,690,000 Total liabilities Stockholders' Equity Preferred stock, $10 par $ 487,500 Common stock, $5 par 1,250,000 Retained earnings Total stockholders' equity 4 Total liabilities and stockholders' equity $ Profitability Measures Match each computation to one of the profitability measures in the table. Profitability Measures Computations Asset turnover $8,260,000 = [($5,785,000 + $5,595,000) = 2] Return on total assets ($791,340 + $127,000) = [($6,609,000 + $6,419,000) = 2] Return on stockholders' equity $791,340 = [($4,039,000 + $3,837,050) = 2] Return on common stockholders' equity ($791,340 - $65,000) = [($3,551,500 + $3,409,440) = 2] Earnings per share on common stock ($ 791,340 - $65,000) = 250,000 shares Price-earnings ratio $35 = $3.05 V Dividends per share $175,000 + 250,000 shares Dividend yield $0.70 = $35 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 up. For example, for 32.048% enter 32.0%. For 32.058% enter 32.1%. Comparative Income Statement For the Years Ended December 31, 2016 and 2085 Increase/(Decrease) 2016 2015 Amount Percentage Sales $7,267,000 $ % Cost of goods sold (3,444,000) % Gross profit $3,823,000 % $(1,453,200) % Selling expenses Administrative expenses (1,239,000) (1,103,000) % Total operating expenses $(2,556,200) % Operating income $1,266,800 % Other expense (interest) (120,600) % Income before income tax expense $1,146,200 % Income tax expense (179,460) % Net income $966,740 % 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 2075 to 2046, 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 company's stock? Yes