Financial analysis test no.

1.What indicates the net profit ratio?

Ans:the firms capacity to face adverse economic conditions such as price competition,low
demand,etc.Higher the ratio, the better is the profitability.

2.We have the following two columns of assets and liabilities:

Liabilities $ Assets $

Equity share capital 150,000 Land &building 100,000

Reserve and surplus 50,000 Plant & machinery 80,000

Debentures 60,000 Goodwill 20,000

Trade creditors 6,000 Cash 5,000

Bills payable 5,000 ST Investment 15,000

Bank overdraft 5,000 Bills receivable 5,000

Outstanding expenses 1,000 Sundry debtors 22,000

Income tax payable 30,000 Less provision(2000) 20,000

Proposed dividends 10,000 Inventories 30,000

Work in progress 15,000

Total:

a)What are the current assets?

B)What are the current liabilities?

c)Current ratio=?

a)Current assets: cash,investments,bills receivable,sundry debtors,inventories and work-in progress

b)Current liabilities:trade creditors,bills payable,bank overdraft,outstanding expenses,income tax

payable and proposed dividends.

c)So we have:CA=5,000+15,000+22,000-2,000+30,000+15,000=90,000.

CL=6,000+5,000+5,000+1,000+3,000+10,000=30,000.

Current Ratio=CA/CL=3.0

CROSS-EXAM:

a)What are not current liabilities?Long-term assets.

b)Define : bank overdraft,debenture,Sundry debtors,goodwill.

a)Equity share capital,reserve and surplus,debentures.

LT assets:Land&Building,Plant&Machinery.

b)Bank overdraft:An overdraft is an extension of credit from a lending institution when an account
reaches zero.(account of a client).

An overdraft allows the individual to continue withdrawing money even if the account has no funds in it
or not enough to cover the withdrawal.

A debenture is a type of debt instrument that is not secured by physical assets or collateral.Debentures
are backed only by the general creditworthiness and reputation of the issuer.Usually issued by
governments and corporations to secure capital(increase the leverage).

Debentures are the most common form of long-term loans.

Debentures carry a lower interest rate and have a repayment date that is far in the future.

Sundry income:income generated from sources other than a companys normal income-generating
business operations.

Goodwill=intangible asset that arises as a result of the acquisition of one company by another for a
premium value.The value of a companys brand name, solid customer base, good customer relations,
good employee relations and any patent or proprietary technology.

3. a)Absolute liquid ratio(definition)

b)What is included in absolute liquid assets?

c)We have the following situation:

Liabilities $ Assets $
Share capital 500,000 Goodwill 50,000
Reserves 190,000 Plant & machinery 400,000
Bank overdraft 100,000 Trade investments 200,000
Sundry creditors 140,000 Marketable securities 150,000
Bills payable 50,000 Bills receivable 40,000
Outstanding expenses 10,000 Cash 45,000
Bank 30,000
Inventories 75,000
Find Absolute liquid ratio:

a)Abs. liquid ratio=Abs.liquid Assets/Current Liabilities

b)Cash+bank+marketable securities=Abs.liquid assets.

c)Abs.Liquid assets=45,000+30,000+150,000=225,000.

Current liabilities:bank overdraft,sundry creditors,bill payables,creditors for outstanding

expenses=100,000+140,000+50,000+10,000=300,000.
Abs.liquid ratio=225,000/300,000=0.75.

Exercise 4.

a)Quick ratio definition.

Given the following situation compute:

Liabilities $ Assets $
Equity share capital 2,00,000 Land & building 80,000
General reserve 90,000 Machinery 1,20,000
Sundry creditors 60,000 Cash 10,000
Bills payable 20,000 Bank 30,000
Bank overdraft 30,000 Stock 1,40,000
Provision for tax 5,000 Short-term investments 25,000
Proposed dividend 10,000 Sundry debtors
Outstanding salaries 5,000 Less provision 36,000
Long term loans 60,000 Bills receivable 10,000
Prepaid insurance 9,000
Preliminary expenses 20,000
b)Quick ratio

c)Current ratio.

a)Quick ratio=liquid assets/current liabilities.Provides a rough idea of the liquidity of a firm. The liquid
assets do not include inventories.

b)Quick Assets=Current Assets-(Stock+Prepaid expenses).

Current Assets=cash,bank,stock,investments,sundry debtors,bills receivable and prepaid insurance;

CA=10,000+30,000+140,000+25,000+36,000+10,000+9,000=260,000

QA=260,000-(140,000+9,000)=111,000.

Current_Liabilities=sundry_creditors+bills_payable+bank_overdraft+provision_for_tax+proposed_divide
nd+outstanding_salaries=60,000+20,000+30,000+5,000+10,000+5,000=130,000.

Quick Ratio=Q.A./C.L.=111,000/130,000=0.85/1;

Current Ratio=260,000/130,000=2.

5)a)Inventory / Stock Turnover Ratio:definition and formula.

b)From the following particulars calculate (1) inventory turnover ratio and (2) Inventory conversion
period:

Cost of goods sold 450,000

Opening stock 125,000

Closing stock 175,000

Answer:

a)Inventory turnover ratio or stock turnover ratio = indicates the velocity with which stock of finished
goods is sold i.e. replaced.Generally it is expressed as number of times the average stock has been
turned over or rotate during the year.

Formula: COGS=Sales-Gross Profit/+ Gross Loss.

Inventory turnover ratio=COGS/Average_inventory_at_cost

Avg_inventory=(Opening_stock+Closing_stock)/2;

COGS(can be expressed also as )Opening stock+Net Purchases+Direct Expenses-Closing stock.

Other formulas can be used too(in absence of information):

Inventory_turnover_ratio=Net_sales/Average_inventory_at_cost or
Net_sales/Average_inventory_at_sell_price,Net_sales/Inventory.

b)Inventory turnover ratio=COGS/Avg_Inventory=450,000/(125,000+175,000)/2=3.

Inventory_conversion_period=No_of_days_in_year/Inventory_turnover_ratio=365/3=121.66(days)or
~122 days.

c)Give an interpretation of high turnover and low turnover respectively.

Answer:

High turnover suggests efficient inventory control,sound sales policies,trading in quality

goods,reputation in the market,better competitive capacity.

Exercise 6

a)Define debtors turnover ratio.

b) From the following particular calculate Receivables turnover ratio and average collection period

$
Annual total sales 4,950,000
Cash sales (included in above) 625,000
Sales returns 75,000
Opening balance of receivables (net) 360,000
Closing balance of receivables (net) 400,000
Provision for bad and doubtful debts (opening) 40,000
Provision for bad and doubtful debts (closing) 50,000
c)Creditors Turnovers Ratio(Payables Turnover ratio)

d) From the following figures calculate average age of creditors and creditor turn over ratio:

$
 Creditor (closing) 54200
Bills payable (closing) 5800
Total purchases 338000
Cash purchases 28500
Purchases returns 9500
Days of year 365
e)Working capital turnover ratio definition.

f) From the summarized balance sheet given below of a company calculate working capital turnover ratio.

2000 2001
$ $
Equity 124,000 122,000
Long term loans 110,000 80,000
Current liabilities 74,000 138,000

308,000 340,000

Fixed assets 208,000 198,000

Current assets 100,000 142,000

308,000 340,000

Your are informed that sales (net) during 2000 and 2001 amounted to $6,00,000 and $5,00,000
respectively and Gross profit for the two years was $80,400 and $60,801 respectively.

Working Notes:

Ascertaining cost of sales: 2000 2001

$ $
600,000 5,500,000
Loss gross profit 804,000 60,8000
Cost of sales
519,600 439,200

Ascertaining networking capital: 2000 2001

$ $
100,000 142,000
Current assets 100,000 142,000
Less current liabilities 74,000 138,000

Net working capital 26,000 4,000

a)Receivables turnover ratio=Annual_net_credit_sales/Avg_accounts_receivables

where Accounts_receivables=Trade debtors+Bill receivables.

b)Annual_credit_sales=4,950,000-625,000-75,000=4,250,000.

Average_receivables=(Opening_receivables+provision_opening+Closing_receivables+Provision_closing)
/2=(360,000+40,000+400,000+50,000)/2=850,000/2=425,000.

SO, receivables turnover ratio=Annual credit

sales(net)/Avg.account_receivables=4,250,000/425,000=10(times)

Receivables collection period=No_of_days_in_the_year/Receivable_turnover_ratio=365/10=36.5.

c)Payable turnover ratio=Annual net credit purchases/Average_accounts_payable;

Accounts_payable=Trade_creditors+Bills_payable;

d)Average_age_of_creditors=Average_accounts_payable x Days_of_year/Net_credit_purchases

Avg_account_payable=Creditor(closing)+Bills payable(closing)=54,200+5,800=60,000.

Net_credit_purchases=Total_purchases-Cash_purchases-Purchases_returns=338,000-28,500-
9,500=300,000.

Creditors_turnover_ratio=Net_credit_purchases/Avg_accounts_payable=300,000/60,000=5.

Average_age_of_creditors=Average_accounts_payable/Net_credit_payables * Days of
year=60,000/300,000 * 365=73 days.

e)Working_capital_turnover_ratio=Cost of sales/Average net working capital

Where cost of sales = Opening stock + Net purchases + Direct expends Closing stock.

Net working capital = Current assets Current liabilities

Average of networking capital = (closing + opening)/2

f)Average networking capital for the year

(2001)=(Opening+Closing)/2=(26,000+4,000)/2=30,000/2=15,000.

Working capital turnover ratio (2000) = Cost of sales/Net working capital = 519,000/26,000 = 20 times
(approximately).

Working capital turnover ratio (2001) = Cost of sales/Average networking capital = 439,200/15,000 = 29
times(approx.)

Exercise 7

a)Operating profit formulas and operating ratio formulas:

b)

Particulars $ Particulars $
Sales less returns 400,000 Selling expenses 25,000
Gross profit 140,000 Income from investment 1,000
Administration expenses 35,000 Loss on account of fire 2,000

a)Operating profit ratio = Gross Profit Operating expenses = Net sales Operating costs = Net sales
(Cost of goods sold + Administrative and office expenses + Selling and distribution exp.) = Net profit
+Non-operating expenses Non-operating incomes.

Operating profit ratio = Operating profit / Net Sales

b)Operating profit = 140,000 (35,000 + 25,000) =140,000 60,000 = 80,000.

Operating profit ratio = 80,000 / Sales_less_returns x 100 =80,000 / 400,000 x 100 = 20%.

EXTRA:

1.If Net sales =$300,000 and operating costs = $100,000 find the operating profit ratio.

Op.Profit ratio = (300,000-100,000)/300,000=2/3=66%.

2.If Sales = 150,000, Returns on sales= 30,000 and Admin expenses = 35,000,Selling exp = 25,000 find

Operating profit ratio.

Solution:

Operating_profit_ratio=[Net_sales-(Admin+selling exp)]/Net_sales=[150,000-30,000-
(35,000+25,000)]/(150,000-30,000)=60,000/120,000 = 50%.

Exercise 8

a)Operating Ratio formula and definition.

b) From the following details, calculate the operating ratio:

Cost of goods sold 600,000

Operating Expenses 40,000
Sales 820,000
Sales returns 20,000
Answers:

a)Operating ratio=[(COGS+Operating expenses)/Net sales]*100

where COGS=Opening stock + Net purchases + Manufacturing expenses Closing stock OR

Net sales Gross profit.

Operating expenses = Office and administrative expenses + Selling and distributing expenses.

b)Op.ratio=(600,000+40,000)/(820,000-20,000) * 100 =640,000/800,000 * 100 = 80%

EXTRA:

If opening stock = 300,000$ , closing stock = 200,000$, net purchases= 35,000$, manufacturing
expenses= 45,000$ and sales=500,000$, sales returns = 20,000$,admin expenses=40,000$ and selling
expenses = 10,000$ find operating ratio.

Answer:

COGS=300,000-200,000+35,000+45,000=180,000$

Op.expenses= 40,000+10,000=50,000$.

Net sales=480,000$.

Op.ratio=(180,000+50,000)/480,000 * 100 = 23/48 *100=47.91%.

EXERCISE 9

a)Expenses ratios(definition and formulas).

b)The following is the trading and profit and loss account of a Private LtD. Company.

Details $ Details $
Stock in hand 76,250 Sales 500,000
Purchases 315,250 Stock in hand 98,000
Carriage and freight 2,000
Wages 5,000
Gross profit c/d 200,000

598,500 598,500

Administrative expenses 101,000 Gross profit b/d 200,000

Finance expenses 7,000 Non-operating incomes:
Selling and distribution 12,000 Interest on 1,500
expenses securities
Non-operating expenses: Dividend on shares 3,750
loss on sale of 350 Profit on sale of 750 6,000
securities shares
1,650 2,000
Provision for
legal suit

Net profit 84,000

You are required to calculate:

Administrative expenses ratio

Finance expenses ratio
Selling and distribution expenses ratio
Non-operating expenses ratio
Answers:

a)Ratio of material used to Sales = Direct material cost/Net sales * 100

Ratio of labor to Sales = Direct Labor cost / Net sales * 100

Ratio of Factory overheads to sales = Factory expenses / Net sales *100

Ratio of office and admin expenses to sales

Ratio of selling and distribution expenses to sales

The sum of these ratios will give the operating ratio.

b)Administrative_expense_ratio = (Administration expenses / Net sales)*100 =

(101,000/500,000)*100 = 20.2 %

Finance expenses ratio = Finance expense /Net sales *100 =7,000/500,000 *100=1.4%

Selling and distribution ratio = 12,000/500,000 * 100 = 2.4%.

Non-operating expenses ratio = 2,000/500,000 * 100 =0.4%.

Exercise 10

a)Define debt-equity ratio or debt-to net-worth ratio.

b) From the following calculate the Debt-equity ratio.

$
10,000 Equity shares @ $10 each. 100,000

General reserve 45,000

Accumulated profit 30,000

Debentures 75,000

Sundry trade creditors 40,000

Outstanding expenses 10,000

Answers:

a)Total long term debts/Shareholders equity.It describes the relationship between borrowed funds
and internal owners funds.Total long term debts excludes liabilities.

Shareholders funds include:1)ordinary share capital,2)Credit balance of P&L account and free
reserves,etc. but deduction should be made for fictitious assets if any in the balance sheet.

Shareholders funds/Net worth = Owners equity Fictitious assets.

Another version of Debt-Equity ratio is Long-term loans/Total long term funds where long-term
funds=Long-term loans+Equity.
 b)D/E ratio = Total long term debts/Shareholder equity =
75,000/(100,000+45,000+30,000)=75,000/175,000 = 3/7.

Remark: short-term debts=40,000+10,000=50,000.

Interpretation:

Every three dollars of long-term debts are being by an investment of seven dollars by the
owners.The safety margin for creditors is more than double.

Debt-Equity ratio = External equity / Internal equity

Which is Debentures+Sundry trade creditors+Outstanding expenses/Equity capital+General

reserve+Accumulated profits=(75,000+40,000+10,000)/(100,000+45,000+30,000)=125,000/175,000=5:7

Interpretation: Outsiders investment of $5 is matched well by owners investment of $7.

Debt-Equity ratio = Total long-term loans/Total long-term funds

=Debenture / Equity capital + General Reserve + Profits +Debentures.

=75,000/100,000 + 45,000+30,000+75,000 = 3:10.

Here every 10 dollars of long-term funds include seven dollars of owners and three dollars of outsiders.

Exercise 11

a)Interest coverage ratio

b) From the following, calculate interest coverage ratio.

$
9% Mortgage loan 1,000,000
7.5% Debentures 1,200,000
Net profit (after tax) 972,000
Income tax rate 50 %
c)Solvency ratio

d)If total reserves =$5000, Capital = $15,000 find reserves to capital ratio.

e)Capital gearing ratio.Definition,formula,significance.

f) From the balance sheet given below calculate the proprietary ratio.

Balance Sheet

Liabilities $ Assets $
Equity share capital 300,000 Fixed assets 200,000
Reserves & surplus 50,000 Current assets 100,000
Debentures 100,000 Good will 50,000
Creditors 50,000 Investment 150,000

500,000 500,000

a)Debt service ratio = interest coverage ratio = EBIT/Fixed interest charges

This ratio shows how many times the interest charges are covered by the earnings. Debt service ratios is
also known as interest coverage ratio.

b)i)Interest payable:

(1,000,000 * 9/100)+(1,200,000 * 7,5/100)=90,000+90,000=180,000

ii)Tax liability:

Tax rate=50%

Profit after tax=972,000; Tax amount = [972,000/(100-50)]x50=972,000.

iii)Profit before Interests and Tax:

=Profit after Tax + Tax + Interest = 972,000 + 972,000 +180,000 = 2,124,000 $

c)Solvency ratio = Total liabilities / Total assets;

We recall now a previous example:

Liabilities $ Assets $
Equity share capital 200,000 Land & building 80,000
General reserve 90,000 Machinery 120,000
Sundry creditors 60,000 Cash 10,000
Bills payable 20,000 Bank 30,000
Bank overdraft 30,000 Stock 140,000
Provision for tax 5,000 Short-term investments 25,000
Proposed dividend 10,000 Sundry debtors
Outstanding salaries 5,000 Less provision 36,000
Long term loans 60,000 Bills receivable 10,000
Prepaid insurance 9,000
Preliminary expenses 20,000
Solvency ratio = (200,000 + 90,000 + 60,000 + 20,000 + 30,000 + 5,000 + 10,000
+5,000+60,000)/(80,000+120,000+10,000+30,000+140,000+25,000+36,000+10,000+9,000+20,000)=

= 480,000/480,000=1.

d)Reserves to capital ratio = Reserves/Capital = 5,000/15,000=1:3.

e)Capital gearing ratio = Equity/Fixed cost bearing securities, where Equity = Equity share capital + Free
reserves + Profits and Loss account credit balance
Fixed cost bearing securities = Debentures + Long term loans;

Significance:

Capital gearing must be carefully planned. It relates to rate of earnings of business, where,as long as rate
of business is higher than the cost of interest /dividend bearings securities the equity shareholders gain
on the strength of their equity.

f) Proprietary ratio = Proprietors funds / Total assets.

Proprietors funds = share capital + reserves and surplus =300,000 + 50,000=350,000.

350,000
Total assets = 500,000 =>Proprietary ratio = 500,000 = 0.7.

350,000 5
If we exclude goodwill from total assets then Proprietary ratio = = .
500,00050,000 9

Exercise 12

Sales 2,520,000 Other Current Assets 760,000

Cost of sale 1,920,000 Fixed Assets 1,440,000
Net profit 360,000 Net worth 1,500,000
Inventory 800,000 Debt. 900,000
Current Liabilities 600,000
Find : a)Gross profit Ratio.b)Net profit Ratio;c)Return on Total Assets;d)Inventory Turnover;e)Working
Capital Turnover;f)Net Worth to Debt

a)GP ratio = (GP/Sales) * 100 = (Sales Cost_of_sale)/Sales * 100 = 600,000 /2,520,000 * 100

b)Net profit ratio = NP / Sales *100 = 360,000 /2,520,000 * 100 = 14.2857%

c)ROA = Net_Profit / Total Assets = 360,000 / (760,000+1,440,000+800,000)=360,000 / 3,000,000 =12%.

Total Assets=Other current Assets+Fixed Assets+Inventory;

d)Inventory Turnover = Cost_of_sale / Inventory = 1,920,000/800,000 = 2.4 times

Exercise 13

a)Define ROA.

b) We have the following asset situation :

Assets $
Land & building 80,000
Machinery 120,000
Cash 10,000
Bank 30,000
Stock 140,000
Short-term investments 25,000
If the net income is $500,000, compute ROA.

c)If the beginning value of assets is $1,000,000 and ending value of assets is $2,000,000 and the net
income is 10,000,000 $ find ROA.

d)The value of total assets in 2016 is described as below:

1-Jan-16 $1,000,000
1-Apr-16 $1,250,000
1-Jul-16 $1,750,000
1-Sep-16 $2,150,000
31-Dec-
16 $1,950,000
Compute ROA if the net income = 3.5mn $.

a)ROA =

b)Total assets = 80,000 + 120,000 +10,000 + 30,000 +140,000 + 25,000 = 405,000.

Net income = 500,000 so ROA = 500,000 /405,000 = 1.234568.

c)ROA = 10,000,000/(1,000,000+2,000,000)/2=10,000,000/1,500,000 = 10/1.5 =6.66

d)ROA=3,500,000/average(Assets)=2.16.

Exercise 14

a)Define ROE.

b)Johns Tool Company reported net income of $100,000 and issued preferred dividends of $10,000.

John also had 10,000, $5 par common shares outstanding during the year.What is ROE?

Answer:

a)ROE = Net income / Shareholders equity.

$100,000$10,000 90,000
b)ROE = 10000 $5
= 50,000 = 1.8.

C) Return on Investment (definition). Difference between ROE and ROI.

ROI = (Investment Revenue Investment Cost)/Investment Cost = Investment Revenue/Investment Cost

1.

To truly understand the return of an investment presented to you, you must understand what revenues
and costs are being used in the calculation.

A manager might use net sales and cost of goods sold as the revenues and expenses in the equation,
whereas an investor might look more globally at the equation and use gross sales and all expenses
incurred to produce or sell the product including operating and non-operating costs.
d)We consider again the following situation:

Cost of goods sold 600,000

Operating Expenses 40,000
Sales 820,000
Sales returns 20,000
From a managers perspective what would be the ROI?

From an investors perspective what would be the ROI?

Answers:

ROI = Net_sales/COGS = 800,000/600,000=1.33(manager)

ROI = Net_sales/(COGS + Operating Expenses)=800,000/(600,000+400,000)=1.2(investor).

Exercise 15

a)Define the following: Price earnings ratio,Sharpe and Treynor ratio,Loan to Value,Margin of Safety,Net
Income,Net working capital.

Answers:

a)Price earnings ratio = market value price per share / earnings per share.

Can be calculated at the end of each quarter when quarterly financial statements are issued.

Sharpe ratio = (), where =the average rate of return of investment (taken by historic
investments), = the best available rate of return of a risk-free security, StdDev = standard deviation
of a return.

Treynor ratio = ( )/

Loan to Value Ratio (LTV) = Mortgage Amount / Appraised Value of Property.

Margin of Safety = financial ratio that measures the amount of sales that exceeds the break-even point.

In other words,this is the revenue earned after the company or department pays all of its fixed and
variable costs associated with production of goods and services.

Net Income = Total Revenues Total Expenses.

Net working capital = is a liquidity calculation that measures a companys ability to pay off its current
liabilities with current assets.

It shows the firms short-term liquidity as well as managements ability to use its assets efficiently.

Net Working Capital = Current Assets - Current Liabilities.

-----------------------------------------------------------------------------------

b)Suppose we have the following situation:

 Cash: $10,000
Accounts Receivable: $5,000
Inventory: $15,000
Accounts Payable: $7,500
Accrued Expenses: $2,500
Other Trade Debt: $5,000
What is the net working capital ?

Answer: Net working capital = Cash + Accounts Receivable + Inventory Accounts Payable Accrued
Expenses Other Trade Debt = 10,000+5,000+ 15,000-7,500 2,500-5,000=30,000-15,000=15,000.

In this situation, the firms manager can pay all its current liabilities using current assets.

Test no.2

1.Explain the Price to Book Value and Market to Book Ratio concepts briefly. Describe its usage by
investors.

Answer:

Price to Book Ratio =Market price per Share / Book Value per share.

The market price per share is simply the current stock price that the company is being traded on the
open market. To compute the book value per share, we first substract the total liabilities from the total
assets and divide the difference by the total number of shares outstanding on that date.

Many investors use the book-to-market ratio formula by dividing the total book value of the firm by the
total market value of the company.

MB compares values on a company-wide basis.

It doesnt look at individual shares.

It is a financial valuation tool used to evaluate whether the stock of a company is over or undervalued by
comparing the price of all outstanding shares with the net assets of the company.

2.Suppose we have:

Total Assets Value : 1,000,000 $

Total Liab Value : 500,000 $

No.of shares outstanding: 1,000 at 439$ par value

a)What is the book value /share?

b)What is the price to book ratio?

Answer:Book Value=1,000,000-500,000=500,000 and the book value per share is 500,000/1,000=500.

The Price to Book Ratio = 439/500.

3.DuPont Analysis.Describe it briefly.

Answer:

Return on Equity is decomposed in three financial ratios,financial components(Profit Margin,Total Asset

Turnover,Financial Leverage).

ROE = Profit Margin x Total Asset Turnover x Financial Leverage

Profit margin = Net Income/Net Sales; Total Asset Turnover = Net Sales / (Average) Total Assets;

Financial Leverage = Total Assets/Total Equity.

4.a) Suppose we have the following situation:

Sales = 20,000$,Expenses=2,000$

Return on sales = 1,500 $

Inventories ----- 3,000$, Cash ---5,000$,Fixed Assets --- 10,000$,Total Equity ----- 14,000$.

Find ROE,Financial Leverage.

Solution:

Net_Sales=20,000-1,500=18,500$ and Net Income=Net_Sales- Expenses=16,500$

Total Assets=3,000+5,000+10,000=18,000$.
16,500 18,500 18,000 16,500
ROE= = = 1.17.
18,500 18,000 14,000 14,000

b)If the Fixed Assets = 300,000$ , Non-Fixed Asset=500,000$, Common Equity = 300,000$,Preferred
Stock=250,000$ the Equity Multiplier=

Total Assets/Total Equity = 800,000/(300,000+250,000)=8/5.5=1.45

c)Equity Ratio =?

Inverse of Equity Multiplier = Total Equity / Total Assets.

The Analysis of Financial Statements

1)Inventory turnover formula : Cost of goods sold/Inventory (it measures, how many times, on average,
inventory is sold during the year.

Same for Accounts Receivable Turnover,Accounts Payable Turnover: measures how many times during a
year the cash and payables respectively are paid during a year.

a)Suppose the net sales are 215,600 $ and net accounts receivable are 8,960 $ . What is the accounts
receivable turnover?

Suppose we have in 2015, 2016 and 2017 the following situation :

 Accounts payable
turnover Cost of goods sold Accounts payable
2015 129,341 13,400
2016 131,210 14,500
2017 125,345 12,100
Find the accounts payable turnover.

Answer:215,600/8,960 = 24.06 times

The formula is COGS/Accounts payable which are 9.65 in 2015,9.04 in 2016,10.35 in 2017.

b)Operating efficiency.What describes it?

c)Short-term liquidity is important for who?

d)What are the liquidity ratios? Leverage measurements, Operating Efficiency,Profitabiity and Market
Measures.

b)Turnover ratios measure the operating efficiency of the firm.

c)ST Liquidity is especially important to creditors, suppliers, management and others who are concerned
with the ability of a firm to meet near-term demands for cash.

d)Liquidity ratios: short-term solvency ratios and Liquidity of Current Assets.

Short-Run Solvency: Current Ratio,Quick Ratio, Cash Flow Liquidity Ratio.

Liquidity of Current Assets: Average Collection Period, Days Inventory Hold, Days Payable Outstanding,
Cash Conversion Cycle.

LEVERAGE: Amount of debt, Coverage of debt.

Amount of debt: Debt Ratio, Debt/equity,LT Debt / Total Cap;

Coverage of Debt: Times Interest Earned, Cash Interest Coverage, Fixed Charge Coverage,Cash Flow
Adequacy.

OPERATING EFFICIENCY: (asset management): Accounts Receivable Turnover, Inventory Turnover,

Accounts Payable Turnover, Fixed Asset Turnover, TOTAL ASSET Turnover, Return on Total Assets.

Profitability:explained by margins and returns:

MARGINS: Gross Profit Margin, Operating Profit Margin, Net Profit Margin, Cash Flow Margin.

Returns: Return on Total Assets,ROE, Cash Return on Assets.

Market Measures: EPS,Price/Earnings,Dividend Payout,Dividend Yield.

EXERCISE 6

a)Define the quick or acid-test ratio. Compare with current ratio.

b)Cash-flow liquidity Ratio.

c)Average Collection Period. Days Inventory Held.Days Payable Outstanding.

a)Quick or acid-test ratio is a rigorous test of short-run solvency and is more rigorous than current ratio
because the numerator eliminates inventory, considered the least liquid current asset and the most
likely source of losses.

Some analysts eliminate prepaid expenses and supplies (if carried as a separate item) from the
numerator.

Liquidity ratios measure a firms ability to meet cash needs as they arise.

Quick Ratio = (Current Assets - Inventory )/(Current Liabilities)

Current Ratio = Current Assets/Current Liabilities.

b)Cash flow liquidity ratio considers cash flow from operating activities (from the statement of cash-
flow).

(Cash and cash equivalents + Marketable securities +CFO)/Current Liabilities.

The cash flow liquidity ratio uses in the numerator, as an approximation of cash resources, cash and
marketable securities which are truly liquid current assets, and cash flow from operating activities,
which represents the amount of cash generated from the firms operations, such as the ability to sell
inventory and collect cash.

c)Average Collection Period = Net accounts receivable / Average daily sales

Represents the average number of days required to convert receivables into cash.(sales/365 days).

Days inventory held = Inventory /Average Daily cost of sales.

The days inventory held is the average number of days it takes to sell inventory to customers. This ratio
measures the efficiency of the firm in managing its inventory.Generally, a low number of days inventory
held is a sign of efficient management.

It depends on the industry also: the florists and produce retailers are expected to have a relatively low
days inventory held because they deal in perishable products, whereas retailers of jewelry or farm
equipments would have higher days inventory held, but higher profit margins.

Days payable Outstandind = is the average number of days it takes to pay payables in cash. This ratio
offers insight into a firms pattern of payments to suppliers.

QUIZ(Part 2)

1. What does the balance sheet summarize for a business enterprise?

a)Operating results for a period; b)Financial position at a point in time; c) Financing and investment
activities for a period;d)Profit or loss at a point in time.

2. Balancing equation for balance sheet:

a)Assets=Liabilities+ Stockholders equity;b)Assets+ Stockholders equity =

Liabilities;c)Assets+Liabilities=Equity;d)Revenues-Expenses=Net income.

3.What is a common-size balance sheet?

4.Which of the following assets would be classified as current assets on the balance sheet?

a)Cash,accounts payable, deffered income taxes;b)Cash equivalents.inventory,prepaid

expenses;c)Accounts receivable;prepaid expenses;property,plant and equipment;

d)Inventory,goodwill,unearned revenue.

5.What items should be calculated when analyzing the accounts receivable and allowance for doubtful
accounts?a)The growth rates of sales and inventories;b)The growth rates of sales, accounts
receivable,and the alllowance for doubtful accounts,as well as the percentage of the allowance account
relative to the total or gross accounts receivables;d) The growth rates of all assets and liabilities.

We have the following situation:

Unit Cost per Unit

#1 $5

#2 $10

#3 $12

#4 $15

#5 $17

#6 $19

6.If the company uses the cost flow assumption of FIFO, what would be the total cost of goods sold if
three units are sold, and the corresponding ending invetory cost to be reported in the balance sheet?

7.What would be COGS and Ending Inventory if LIFO is used instead?

8.What if the average cost method was used instead?

Solutions:

1.b)Financial position at a point in time

2.Assets = Liabilities + Stockholders equity (balance sheet)

3.A statement that expresses each account on the balance sheet as a percentage of total assets.

4.cash equivalents, inventory, prepaid expenses

5.b) Growth rates of sales, accounts receivables, and the allowance for doubtful accounts,etc.

6.COGS=5+10+12=27 $, Ending inventory = 15+17+19=51.

7.LIFO gives COGS=15+17+19=51 and Ending Inventory =27$

8.Average cost method = Average of all purchases / Average of all purchases (Cost of goods
sold/Inventory Valuation).

For that we consider: Total cost of all units/6 x 3 units (for units sold )= (5 +10 + 12+ 15 + 17)/6 *3 = 39

The same for Units Remaining in Inventory(End inventory) =39$.

TEST NO.3 (Financial analysis)(Long Test and sometimes difficult to solve).

1.What are the form 10-K components?

2.What are the financial statements presented usually in a corporate annual report?

Answers:

1.

Form 10-K components are several items as follows(See SEC website for examples).

Item 1.(1A).Business;(1B).Unresolved staff comments;2.Properties;3.Legal proceedings;4.Submission of

Matters to a Vote of Security Holders;5.Market for Registrants Common Equity and Related Stockholder
Matters;6.Selected Financial Data;7.Managements discussion and analysis of financial condition and
Results of Operations; 7A.Quantitative and Qualitative Disclosures about Market Risk;

8.Financial Statements and Supplementary Data;9.Changes in and Disagreements with Accountants or

Accounting and Financial Disclosure; 9A.Controls and Procedures;9B.Other information;

10.Directors and Executive Officers of the Registrant

11.Executive Compensation.12.Security Ownership of Certain Beneficial Owners and Management and

Related Stockholder Matters;13.Certain Relationships and Related Transactions;14.Principal Accountant
Fees and Services;15.Exhibits,Financial Statement Schedules, and Reports on form 8-K.

What is form 8-K?Is a report of unscheduled material events or corporate changes at a company that
could be of importance to the shareholders or the Securities and Exchange Comission(SEC).

2.

Financial Statements:

a)The balance sheet or statement of financial position shows the financial position --- assets,liabilities
and stockholders equity --- of the firm on a particular date,such as the end of a quarter or a year.

b)Income/earning statements;
c)Statement of stockholders equity

d)Statement of cash flows.

b)(Presents the results of operations revenues, expenses, net profit or loss, and net profit or loss per
share for the accounting period).

d)Cash inflows and outflows from operating,financing, and investing activities during an accounting
period.

3.a)What among the following can be categorized as current assets?

Inventories, Cash and cash equivalents,Land,Buildings and leasehold improvements,goodwill,prepaid

expenses.

b)Complete the following tables:

2016 2015 2014

Net sales $215,600 $153,000 $140,700
Cost of goods
sold $129,364 $91,879 $81,606
Gross profit

2016 2015 2014

Net
sales $320,000 $240,000 $120,000
Cost of Goods Sold $191,000 $129,000 $87,000
Gross Profit
Selling and admin expenses $15,000 $19,000 $10,000
Advertising $10,000 $21,000 $9,000
Depreciation and
amortization $5,000 $12,000 $4,000
Impairment
charges $3,000 $3,000 $1,000
Operating profit

Answers: a)Current assets: Inventories,cash and cash equivalents,prepaid expenses;

B)Gross Profit = Net sales COGS = :

Gross profit $86,236 $61,121 $59,094

Gross Profit $129,000 $111,000 $33,000

Operating profit $96,000 $59,000 $9,000

Operating profit= Gross profit Selling and admin expenses Advertising Depreciation and
amortization Impairment charges.

Part II of test 3 Balance Sheet

1.Marketable securities. Present them a bit.

2.Accounts receivable.Allowance for doubtful accounts

3.What is included in prepaid expenses?

4.What are liabilities?

5.Accounts payable.

6.Short-term Debt..

7.Current Maturities of Long-Term Debt.

8.Accrued Liabilities.

Answers:

1.Marketable securities, also referred to as short-term investments, are highly liquid investments in debt
and equity securities that can be readily converted into cash or mature in a year or less. Firms with
excess cash that is not needed immediately in the business will often purchase marketable securities to
earn a return.

Types:a)Held to maturity:these securities are reported at amortized cost(applies to debt securities).

Debt securities are securities representing a creditor relationship, including U.S. Treasury securities,
municipal securities, corporate bonds, convertible debt, and commercial paper.

b)Trading securities. Are debt and equity securities that are held for resale in the short term. Equity
securities represent an ownership interest in an entity, including common and preferred stock.

c)Securities available for sales.

2.Accounts receivable are customer balances outstanding on credit sales and are reported on the
balance sheet at their net realizable value,that is, the actual amount of the account less an allowance for
doubtful accounts.

3.Prepaid expenses

Certain expenses, such as insurance, rent, property taxes, and utilities, are sometimes paid in
advance.They are included in current assets if they will expire within one year or one operating cycle,
whichever is longer.

4.Liabilities : represent claims against assets, and current liabilities are those that must be satisfied in
one year or one operating cycle,whichever is longer.

Current liabilities include accounts and notes payable, the current portion of long-term debt, accrued
liabilities, unearned revenue, and deferred taxes.
5.Accounts payable: are short-term obligations that arise from credit extended by supplyiers for the
purchase of goods and services.

6.Short-term Debt: Consists of obligations in the form of promissory notes to suppliers or financial
institutions due in one year or less.

7.When a firm has bonds, mortgages, or other forms of long-term debt outstanding, the portion of the
principal that will be repaid during the upcoming year is classified as a current liability.

8.Accrued Liabilities

Accrued liabilities result from the recognition of an expense in the accounting records prior to the actual
payment of cash.

PART 3 of Test 3

1.What can you say about the revenue for a transaction on credit to a company from the accounting
perspective?

2.What is measuring the statement of a cash flow?

3.How would you segregate the statement of cash flows?

Answers:

1.When a company sells its products or services on credit, the sales revenue for that transaction is
recognized in the accounting period when the sale is made, and an accounts receivable is created to
reflect what the customer owes.

2.Measures the actual cash flowing in and flowing out during an accounting period from all the firms
operations as well as from its other activities,such as borrowings and investing.

3.Operating activities, Investing activities and financing activities.

4.Give examples of inflows and outflows on operating activities.

5.The same for investing activities.

6.The same for financing activities.

Answers:

4.Inflows Outflows

Cash from sales of goods or services Payments for purchase of inventory

Returns on equity securities(dividends) Payments for operating expenses(salaries,rent,etc)

Returns on interest-earning assets Payments for purchases from suppliers other than

(interest) inventory

Payments to lenders(interest)

Payments for taxes

5.Investing Activities

Inflows Outflows

Cash from sales of property,plant,and equipment Purchases of property, plant, and equipment Loan

Cash collections from loans(principal) to others (principal) to others

Cash from sales of debt or equity Purchases of debt or equity securities of other

Securities of other entities(except securities entities.

Traded as cash equivalents)*

6.Financing activities

Inflows Outflows

Proceeds from borrowing Repayments of debt principal

Proceeds from issuing the firms own equity Repurchase of a firms own shares

Securities Payment of dividends

7. Long-term Debt

8.What do current liabilities and common assets have in common?

9.Which of the following items could cause the recognition of accrued liabilities?

a)Sales,net expenses,rent;b)Sales,taxes,interest income;

c)Salaries,rent,insurance; d)Salaries, interest expense,interest income.

Answers:

7.Long term debt: obligations with maturities beyond one year are designated on the balance sheet as
non-current liabilities.Most common forms found are described below:

Long-term notes payable contractual agreement between borrower and lender which
designates the principal and interest repayment schedule and other conditions of the loan.
Mortgageloan agreement secured by real estate.
Debentures unsecured debt backed by the companys general credit standing.
Bonds payable financial instruments used to raise cash which are traded in capital
markets. Bonds are generally issued in denominations of $1,000(face value or maturity
value) and have a stated interest rate. Since bonds are traded on markets, the issue price
investors are willing to pay, may be more or less than the face or maturity value.
Convertible debt debt in the form of bonds or notes that allows the investor or lender the
opportunity to exchange a companys debt for common stock of that company. The terms of
the agreement are specified in a document referred to as the bond indenture. The
conversion price, or dollar value at which the debt may be converted into common stock,
is generally set at an amount higher than the current market price of the firms stock
when the debt is issued.
 Long-term warranties nonmonetary liabilities that promise the delivery of goods or
services during a specified warranty period. Examples would include a two-year warranty
offered for new home construction or three-year warranty offered for new car purchases.

8.Current liabilities and current assets are those items that will be satisfied and converted into
cash, respectively, in one year or one operating cycle, whichever is longer.

9.Salaries,rent,insurance.

10. a)T/F. Deferred taxes arise from the use of the same method of depreciation for tax and
reporting purposes.

b)T/F Deferred taxes are the product of temporary differences in the recognition of revenue
and expense for taxable income relative to reported income

c)T/F.Salaries,interest expense and interest income could cause the recognition of accrued
liabilities.

a)False.

b)True.

c)Salaries,rent, insurance cause the recognition of accrued liabilities.