Exam 7: Introduction to Financial Statement Analysis

Devlin Company Devlin Company Statement of Financial Position as of May 31 (in thousands) Assets year 7 year 6 Current assets Cash \ 45 \ 38 Trading securities 30 20 Accounts receivable (net) 68 48 Inventories 90 80 Prepaid expenses 22 30 Total current assets \ 255 \ 216 Investments, at equity 38 30 Property, plant, and equipment (net) 375 400 Intangible assets (net) 80 45 Total assets \ 748 \ 691 Liabilities and shareholders' equity Current liabilities Notes payable \ 35 \ 18 Accounts payable 70 42 Accrued expenses 5 4 Income taxes pavable 15 16 Total current liabilities 125 80 Long-term debt 35 35 Deferred taxes 3 2 Total liabilities \ 163 \ 117 Shareholders' equity Preferred stock, 6\%,\ 100 par value, cumulative 150 150 Common stock, \ 10 par value 225 195 Additional paid-in capital-common stock 114 100 Retained earmings 96 129 Total shareholders' equity \5 85 \5 74 Total liabilities and shareholders' equity \7 48 \6 91 Devlin Company Income Statement For the year ended May 31 (in thousands) Year 7 Year 6 Net sales \ 480 \ 460 Costs and expenses Cost of goods sold 330 315 Selling, general, and administrative 52 51 Interest expense 8 9 Income before taxes \ 90 \ 85 Income taxes 36 34 Net income \5 4 \5 1 (CMA adapted, Jun 97 #13) Refer to the Devlin Company example.Devlin Company's acid-test ratio at May 31, Year 7, was

Many firms sell to customers on account as a strategy to stimulate sales.Comparing accounts receivable turnovers over time or between firms requires an analysis of

A quick ratio approximately one-half of the current ratio is typical, although this varies by industry.

What are the steps in preparing pro forma financial statements?

The term financial leverage describes financing with debt and preferred stock to increase the potential return to the residual common shareholders' equity.

Financial statement ratios alone provide direct indicators of good or poor management.

The preparation of pro forma financial statements typically begins with the _____, followed by the _____ and then the _____.

Some analysts calculate the inventory turnover ratio by dividing sales, rather than cost of goods sold, by the average inventory.Using sales in the numerator will lead to correct measures of the inventory turnover ratio for calculating the average number of days that inventory is on hand until sale.

Devlin Company Devlin Company Statement of Financial Position as of May 31 (in thousands) Assets year 7 year 6 Current assets Cash \ 45 \ 38 Trading securities 30 20 Accounts receivable (net) 68 48 Inventories 90 80 Prepaid expenses 22 30 Total current assets \ 255 \ 216 Investments, at equity 38 30 Property, plant, and equipment (net) 375 400 Intangible assets (net) 80 45 Total assets \ 748 \ 691 Liabilities and shareholders' equity Current liabilities Notes payable \ 35 \ 18 Accounts payable 70 42 Accrued expenses 5 4 Income taxes pavable 15 16 Total current liabilities 125 80 Long-term debt 35 35 Deferred taxes 3 2 Total liabilities \ 163 \ 117 Shareholders' equity Preferred stock, 6\%,\ 100 par value, cumulative 150 150 Common stock, \ 10 par value 225 195 Additional paid-in capital-common stock 114 100 Retained earmings 96 129 Total shareholders' equity \5 85 \5 74 Total liabilities and shareholders' equity \7 48 \6 91 Devlin Company Income Statement For the year ended May 31 (in thousands) Year 7 Year 6 Net sales \ 480 \ 460 Costs and expenses Cost of goods sold 330 315 Selling, general, and administrative 52 51 Interest expense 8 9 Income before taxes \ 90 \ 85 Income taxes 36 34 Net income \5 4 \5 1 (CMA adapted, Jun 97 #16) Refer to the Devlin Company example.Devlin Company's asset turnover for the year ended May 31, Year 7, was

Many analysts use a common-size balance sheet, which expresses each balance sheet item as a percentage of total assets.

King Products Corporation King Products Corporation Statement of Financial Position (in thousands) June 30 Year 6 Year 5 Cash \ 60 \ 50 Marketable securities (at market) 40 30 Accounts receivable (net) 90 60 Inventories (at lower of cost or market) 120 100 Prepaid items 30 40 Total current assets \3 40 \2 80 Long-term investments (at cost) 50 40 Land (at cost) 150 150 Building (net) 160 180 Equipment (net) 190 200 Patents (net) 70 34 Gondwill (net) 40 26 Total long-term assets \6 60 \6 30 Total assets \1 ,000 \9 10 Notes payable \ 46 \ 24 Accounts payable 94 56 Accrued interest 30 30 ( Total current liabilities \1 70 \1 10 Notes payable, 10 \% due 12/31/ Year 12 20 20 Bonds payable, 12\% due 6/30/ Year 15 30 30 Total long-term debt \5 0 \5 0 Total liabilities \2 20 \1 60 Preferred stock- 5 \% cumulative, \ 100 par, non-participating, authorized, issued 200 200 and outstanding, 2,000 shares Common stock- \ 10 par, 40,000 shares authorized, 30,000 shares issued and 300 300 outstanding Additional paid-in capital--common 150 150 Retained earnings 130 100 Total shareholders' equity \7 80 \7 50 Total liabilities and shareholders' equity \1 ,000 \9 10 King Products Corporation Income Statement For the year ended June 30 (in thousands) Year 6 Net sales \ 600 Costs and expenses Cost of goods sold 440 Selling, general, and administrative 60 Interest expense 10 Income before taxes \ 90 Income taxes 45 Net income \4 5 (CMA adapted, Dec 96 #18) Refer to the King Products Corporation example.King Products Corporation's quick (acid test) ratio at June 30, Year 6, was

A mature, financially healthy company typically has a cash flow from operations to total liabilities ratio of

To study changes in ROA, the analyst can disaggregate ROA into the product of two other ratios:

What is the last step in preparing pro forma financial statements?

Four measures for assessing short-term liquidity risk are (1) Current ratio, (2) Quick ratio, (3) Cash flow from operations to current liabilities ratio, and (4) Working capital turnover ratios.

The total assets turnover ratio indicates

Explain how common-size balance sheets are used by analysts.

Discuss how the rate of return on common shareholders' equity is calculated.

Inventory turnover equals cost of goods sold divided by the average inventory during the period.

The return from investing in the shares of common stock has two components: cash dividends and the change in the market price of the common stock.