Ch 18 - Financial statement analysis (ratios)

Question 1

If your income tax rate is 20% and your profit is $124,600 - how would you calculate your profit before income taxes?
Then your income tax expense would be?

Answer 1

Profit / .8

= 124,600/.8 = 155,750

155,750 x 20% = 124,600

Question 2

How would you calculate net sales is your gross profit margin is 40% and your gross profit is $500,000?

Answer 2

$500,000 / 40% =

1,250,000

Question 3

Horizontal Analysis

Answer 3

Horizontal % of base year:
Analysis period amount/base period amount x 100

Horizontal percentage change for period:
Analysis-period amount - prior period amount / prior period amount

compares data such as line items in a company’s financial statements, by expressing them as dollar or percentage increase and decreases over two or more years
Identifies changes and trends over time. Mainly used within a company.
AKA trend analysis

Question 4

Vertical analysis

Answer 4

compares data by expressing each item in a financial statement as a percentage of a base amount within the same financial statement and year

Focuses on the relationship between items on the same financial statement.

Question 5

Ratio analysis

Answer 5

expresses the relationship between selected items of financial statement data within the same year

Helps us understand the relationship among selected items presented in one or more financial statements.

Question 6

Using horizontal analysis, calculate the horizontal percentage of change for 2014 - 2015, assuming 2015 is the base year
2016 2015
Net sales $9,468 6294
Cost of goods S 7322 5217
Gross profit 2146 1077
Profit 546 110

B) calculate the horizontal percentage of base year

Answer 6

Period amount - prior period / prior period
% of base year: period amount / (base period am) x 100
2016 B)
Net sales 50.4% 150.4%
COGS 40.3% 140.3%
Gross prof 99.3% 199.3%
Profit 396.4% 496.4%

Question 7

For horizontal analysis, if current assets decrease, what will current liabilities usually do?

Answer 7

Decrease. Typically changes between asset and liabilities move in the same direction

Question 8

For horizontal analysis, if either a base or analysis period have a negative number, how does that effect percentage change?

Answer 8

It cannot be calculated

Question 9

Vertical analysis formula

Answer 9

Analysis amount / base amount x 100%

Question 10

What is the base amount commonly used to calculate vertical analysis for the balance sheet?
B) Income statement?

Answer 10

A) Total assets

B) Revenues/Net sales

Question 11

How does total liabilities and shareholders equity fit in with calculating vertical analysis?

Answer 11

L and SE equals total assets so the same base amount (total assets) can be used

Question 12

Ratio analysis:
What do these measure?
A) Liquidity ratio
B) Solvency ratio
C) Profitability ratio

Answer 12

A) companies short-term ability to pay its maturing obligations and to meet unexpected needs for cash
B) companies ability to survive over long period of time
C) Companies operating success for a specific period of time

Question 13

Current ratio calculation and what does it mean

Answer 13

Current assets / current liabilities ie 1.6:1

Means for every $1 of liabilities, company has 1.60 in assets.

Question 14

Acid test ratio formula

How does the acid-test ratio differ from current ratio?

Answer 14

Cash + short term investments + receivables
/ current liabilities
Excludes assets that are less liquid, like inventory, prepaid expenses

Question 15

How do you calculate the gross balance for different ratios?

Answer 15

Add together balance and beginning of year (same as last year) and balance at end of year and divide the sum by 2

Question 16

A) Receivables Turnover ratio
B) What does it tell us?
C) What does it measure
D) Is a higher number for receivables turnover better or worse? How does it effect current ratio?
E) Variant on receivables turnover?

Answer 16

a) Net credit sales
/ average gross accounts receivable = times/year
B) How liquid accounts receivables are
C) the # of times, on average, receivables are collected during the period
D) In general, faster the receivables turnover the better and more reliable the current ratio is for assessing liquidity.
E) convert it into days. days in year/ rec turnover = ___ times

Question 17

A) Inventory Turnover formula
B) Measure what and the purpose?
C) What does a high number mean?
D) Variant of Inventory formula?

Answer 17

Cost of Goods sold = ___ times
/ Average inventory
B)Average number of times inventory is sold during the period. Measures the liquidity of the inventory
C) The high the number the faster inventory is sold. Means less cash is tied up in inventory and less chance inventory will become obsolete
D) Days sales in inventory. Days in year / inventory turnover = ___ days

Question 18

Formula for operating cycle and what it measures

Answer 18

Days sales in inventory + collection period = operating cycle.

Average time it takes to purchase inventory, sell it on account, and collect the cash from customers

Question 19

Formula for Debt to total assets
What does it measure
Is a higher number better or worse?

Answer 19

Total liabilities
/ total assets = ___%
Percentage of the total assets that is provided by creditors
Worse. higher number means a company may not be able to meet maturing obligations

Question 20

What should the debt to total asset ratio never be interpreted without Also looking at?

Answer 20

Interest coverage ratio. Even if there is a high debt position, it is more important to know if a company can afford this level of debt.

Question 21

A) Formula for interest coverage ratio?

B) What does interest coverage ratio indicate?

Answer 21

Profit + interest expense + income tax expense
/ interest expense = ________ times
B) Companies ability to make its interest payments

Question 22

Formula for Free cash flow?

What does it indicate

Answer 22

Cash used by operating activities - cash used by investing activities
B) Amount of money available for company to expand operations, repay debt, or pay dividends

Question 23

A)Formula for Gross profit margin?
B) What happens if gross profit margin is too high?
C) too low?

Answer 23

Gross profit
/ net sales = ___ %.
B) May lose sales if pricing is not competitive
C) May not have enough margin to cover expenses

Question 24

Profit margin formula

What is it?

Answer 24

Profit / net sales = ____ %

Percentage of each dollar of sales that results in profit

Question 25

Asset Turnover formula

What does it measure

Answer 25

Net sales / average total assets = ____ times

How efficiently a company uses its assets to generate sales

Question 26

Return on assets formula

Measures?

Answer 26

Profit / average total assets = _____%

Overall measure of profitability

Question 27

Return on equity formula
Measures?
Alternate name?

Answer 27

Profit / Average shareholder’s equity = ____%
Popular measure of profitability. Shows how many dollars of profit were earned for each dollar invested by shareholder
C) Return on investment

Question 28

Why might a companies return on equity be higher than its return on assets?

Answer 28

Company may have made effective use of financial leverage (borrows at one rate and invests at a higher rate)

Question 29

Earnings per share formula

What is it

Answer 29

Profit - preferred dividends
/ weighted average # of common shares = $____

B) Reduces profit from common shares to a per-share basis

Question 30

A) What does the Price-Earnings (PE) Ratio show?
B) Formula
C) what does a higher number indicate

Answer 30

A) Ratio of market price of each common share to earnings per share
B) Market price per share
/ earnings per share = ___ times its earnings
C) Investors favour the company. Willing to pay more because they believe company has good prospects

Question 31

Payout ratio formula

what does it measure

Answer 31

Cash dividends
/ profit = _____%

Percentage of profit distributed as cash dividends

Question 32

Papat Corp Bearton Limited
Total assets, beg $388,000 $372,000
Total assets, end 434,000 536,000
Total Sh. Eq beg 269,000 296,000
Total sh. eq end 294,000 344,000
Net sales 660,000 780,000
Gross profit 175,000 248,000
Profit 68,000 105,000

Calculate gross profit margin, profit margin, asset turnover, return on assets, and return on equity for each

Answer 32

Gross profit margin 175/660= 26.5% 248/780 = 31.8
Profit margin 68/660 = 10.3 % 105/780 = 13.5%
Asset turnover 660/ 388+434/2 = 1.6x 780/372+536=1.7
Return on assets 68/388+434/2 = 16.5x 105/av ass = 23.1
Return on equity 68/269+294/2 = 24.2x 105/av eq=32.8

Question 33

Rankin Corp reported net sales of $300,000, 330,000 and 360000 in the years 2015, 2016 and 2017. If 2015 is the base year, what is the horizontal percent of base year for 2017?
A) 83% B) 92% C) 110% D) 120%
What is the horizontal percentage change from 2016-2017?
A) 109% B) 120% C) 9% D) 20%

Answer 33

D 120%

C) 9%

Question 34

In a vertical analysis, the base amount for depreciation is expense is generally:
A)Net sales
B) depreciation expense in previous year
C) total assets
D) total property plant and equipment

Answer 34

Net sales A

Question 35

2017 2016
Acc rec 45,000 41,000
Inv 34,000 28,000
Total sh. equity 572,000 438,000
Net credit sales 684,000 597,000
Cost of g. sold 450,000 398,000
Interest expense 14,000 12,000
Income tax exp 22,000 18,000
Profit 134,000 90,000

A) What is the total days sale in inventory for 2017?
B) what is the interest coverage for 2017
C) What is the return on equity for 2017?

Answer 35

A)1st inv turnover= 450,000/ 34+28/2 = 14.51%
365/14.5 =25 days.
B) 134+14+22 / 14 = 12.1 times
C) 134,000 / 572+438/2 = 26.5%

Question 36

Which of the following changes in ratios are both indicative of an improvement in a company’s financial situation?
A) Increasing debt to total assets and interest coverage ratios
B) Increasing current ratio and increasing days sales in inventory
C) Decreasing asset turnover and return on equity
D) Decreasing collection period and increasing gross profit margin

Answer 36

D