Chapter Two

Financial Statement And Analysis

I have drawn liberally on chapter Two of Lawrence

“Gitman “ “Principles of Managerial Finance”

Twelfth Edition, Harper Collins Publishers,

2009

Professor: Medhat Hassanein

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(Part One)

Introduction

to Chapter Two

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Financial Statements account identification. Mark each of the accounts listed in the following table as follows:

a) In Column (1), indicate in which statement – income statement (IS) or balance sheet (BS) – the account belongs.

b) In column (2), indicate whether the account is a current asset (CA), current liability (CL), expense (E), fixed asset (FA), long-term debt (LTD), revenue (R), or stockholders’ equity (SE).

(1) (2) Account name Statement Type of account Accounts payable Accounts receivable Accruals Accumulated depreciation Administrative expense Buildings Cash Common stock (at par) Cost of goods sold Depreciation Equipment General expense Interest expense Inventories Land Long-term debts Machinery Marketable securities

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(1) (2)

Account name Statement Type of account Notes payable Operating expense Paid-in capital in excess of par Preferred stock Preferred stock dividends Retained earnings Sales revenue Selling expense Taxes Vehicles

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((SSoolluuttiioonn)) Financial Statements account identification. Mark each of the accounts listed in the following table as follows:

c) In Column (1), indicate in which statement – income statement (IS) or balance sheet (BS) – the account belongs.

d) In column (2), indicate whether the account is a current asset (CA), current liability (CL), expense (E), fixed asset (FA), long-term debt (LTD), revenue (R), or stockholders’ equity (SE).

(1) (2) Account name Statement Type of account Accounts payable BS CL Accounts receivable BS CA Accruals BS CL Accumulated depreciation BS EA Administrative expense IS E Buildings BS FA Cash BS CA Common stock (at par) BS SE Cost of goods sold IS E Depreciation IS E Equipment BS FA General expense IS E Interest expense IS E Inventories BS CA Land BS FA Long-term debts BS LTD Machinery BS FA Marketable securities BS CA

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(1) (2) Account name Statement Type of account Notes payable BS CL Operating expense IS E Paid-in capital in excess of par BS SE Preferred stock BS SE Preferred stock dividends I/S E Retained earnings BS SE Sales revenue IS R Selling expense IS E Taxes IS E Vehicles BS FA

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Balance Sheet Preparation Use the appropriate items from the following list to prepare in good form Owen Davis Company’s balance sheet at December 31, 2011.

Value ($000) at Item December 31, 2011 Account payable $ 220 Account receivable 450 Accruals 55 Accumulated depreciation 265 Buildings 225 Cash 215 Common stock (at par) 90 Cost of goods sold 2,500 Depreciation expense 45 Equipment 140 Furniture and fixure 170 General expense 320 Inventories 375 Land 100 Long-term debts 420 Machinery 420 Marketable securities 75 Notes payable 475

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Value ($000) at Item December 31, 2011 Paid-in capital in excess of par 360 Preferred stock 100 Retained earnings 210 Sales revenue 3,600 Vehicles 25

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22.. BBaallaannccee SShheeeett PPrreeppaarraattiioonn (Solution)

Owen Davis Company

Balance Sheet December 31, 2011

Assets Current assets: Cash $ 215,000 Marketable securities 75,000 Accounts receivable 450,000

Inventories 375,000 Total current assets $ 1,115,000 Gross fixed assets Land and buildings $ 325,000 Machinery and equipment 560,000 Furniture and fixtures 170,000 Vehicles 25,000 Total gross fixed assets $ 1,080,000 Less: accumulated depreciation 265,000 Net fixed assets $ 815,000 Total assets $ 1,930,000

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Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 220,000 Notes payable 475,000 Accruals 55,000 Total Current liabilities $ 750,000 Long-term debt 420,000 Total liabilities $ 1,170,000 Stockholders’ equity Preferred stock $ 100,000 Common stock (at par) 90,000 Paid-in capital in excess of par 360,000 Retained earnings 210,000 Total stockholders’ equity $ 760,000 Total liabilities and stockholders’ equity $ 1,930,000

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3. Template Income Statement

Technica, Inc

Income statement For the Year Ended December 31, 2011

Sales revenue $ 600000 Less: Cost of goods sold 460000 Gross profits 140000 Less: Operating expenses General and administrative 30000 Selling expenses 0 Lease (rent) expense 0 Total operating expenses 30000 Earnings before interest, taxes, depreciation and amortization (EBITDA) 110000 Less: Depreciation allowance 30000 Earnings before interest and taxes = EBIT = operating profits 80000 Less: Interest 10000 Earnings before tax = EBT = Profits before taxes 70000 Less: Taxes 27100 Earnings after tax = EAT = NI 42900 Less: Preferred stock dividends 0 Earnings available to shareholders 42900

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4. Statement of Retained Earnings

Bartlett Company Statement of Retained Earnings ($000) for the Year Ended December 31, 2011 Retained earnings balance (January 1, 2011) $ 1,012 Plus: Net profits after taxes (for 2011) 231 Less: Cash dividends (paid during 2011) Preferred stock ($10) Common stock ( 98) Total dividends paid ( 108) Retained earnings balance (December 31, 2011) $ 1,135

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Chapter Two

(Part Two)

Financial Ratio Analysis

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Fox Manufacturing

Financial Ratio Analysis (Case Study)

Revisited

by Professor: Medhat Hassanein

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Cross-sectional ratio analysis Use the following financial statements for Fox Manufacturing Company for the year ended December 31, 2011, along with the industry average ratios also given in what follows, to: a- Prepare and interpret a complete ratio analysis of the firm’s 2011 operations. b- Summarize your findings and make recommendations.

Fox Manufacturing Company Income Statement

for the year Ended December 31, 2011

Sales revenue $600,000 Less: Cost of goods sold 460,000 Gross profits $140,000 Less: Operating expenses General and administrative expense $30,000 Depreciation expenses $30,000 Total operating expense 60,000 Operating Profits $ 80,000 Less: Interest expense 10,000 Net profits before taxes $ 70,000 Less: Taxes 27,100 Net profits after taxes (earnings available for common stockholders) $ 42,900 Earnings per share (EPS) $2.15

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Fox Manufacturing Company Balance Sheet

December 31, 2011

Assets Cash $ 15,000 Marketable Securities 7,200 Accounts receivable 34,100 Inventories 82,000 Total current assets $138,300 Net fixed assets $270,000 Total assets $408,300

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Liabilities and stockholders’ Equity:

Accounts payable $ 57,000 Notes payable 13,000 Accruals 5,000 Total current liabilities $ 75,000 Long – term debt $150,000 Stockholders’ equity Common stock equity (20,000 shares outstanding) $110,200 Retained earnings 73,100 Total stockholders’ equity $183,300 Total liabilities and stockholders’equity $408,300

* Note: Industry averages appear at the top of the following page.

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Ratio Industry average, 2011 Current ratio 2.35 Quick ratio 0.87 Inventory turnover ª 4.55 Average collection Period ª 35.3days Total asset turnover 1.09 Debt ratio 0.300 Times interest earned ratio 12.3 Gross profit margin 0.202 Operating profit margin 0.135 Net profit margin 0.091 Return on total assets (ROA) 0.099 Return on common equity (ROE) 0.167 Earnings per share (EPS) $ 3.10 ªBased on a 360-day year and on end-of-year figures.

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Ratio Analysis (Solution)

Fox Manufacturing Company Year Ended December 31, 2011

I. Liquidity Ratios:

F. Co. Industry

1. Current Ratio = Current Assets = 138,300 = 1.84 2.35 Current Liabilities 75,000

2. Quick Ratio = Current Assets – Inventory = 138,300 – 82,000= .75 .87

Current Liabilities 75,000

II. Activity Ratios: 3. Inventory Turnover = Cost of Goods Sold = 460,000 = 5.61 4.55 Inventory 82,000 4. Average Collection Period = A / R = 34,100 = 20.46 35.3 Sales per Day 600,000/360 5. Fixed Assets Turnover = Sales = 600,000 = 2.2 N. Fixed Assets 270,000 6. Total Assets Turnover = Sales = 600,000 = 1.47 1.09

Total Assets 408,300

III. Debt Ratios / Coverage Ratios:

7. Debt Ratio = Total Liabilities Total Assets = Total Debt = 225,000 = .55 .30 Total Assets 408,300 8. Debt / Equity = Total Debt = 225,000 = 1.23 Stockholders Equity 183,300

= T. Debt /T. Assets = .55 1- T. Debt/T. Assets 1 - .55 = .55 = 1.22 .45 9. Times Interest Earned = EBIT = 80,000 = 8.00 12.3 Interest 10,000

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F.Co Industry

10. Fixed Payment Coverage = EBIT + Lease Payment Interest + Lease Payment = 80,000 + 0 = 8.00 10,000 + 0

IV. Profitability Ratios:

11. Gross Profit Margin = Gross Profit = 140,000 = .233 .202 Sales 600,000 12. Operating Profit Margin = Operating Profit = EBIT Sales Sales = 80,000 = .133 .135 600,000 13. Net Profit Margin = Net Profit Available to Shareholders Sales = 42,900 = .072 .091 600,000 14. Return on Total Assets = Net Profit = 42,900 = .105 .099 Total Assets 408,300 15. Return on Equity = Net Profit = 42,900 = .234 .167 Shareholders’ Equity 183,300 16. Earnings per Share = Net Income =42,900 = $ 2.145 $3.10 No. of Common Shares 20,000 17. Market = PxS = $ 15x 20,000 = 1.64 times B.V BV 183,300

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Du Pont Equation

ROE = ROA * EM = NPM * ATO * EM = NPM * ATO * 1 1 – Leverage ROE (FOX Manufacturing) = .105 * 408,300 183,300

= .105 * 2.23 = .234

ROE Industry = .099 * 1.69 = .167

.072*1.47*2.23FoxROE = = .236

.091*1.09 *1.69IndustryROE = = .168

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Footnote:

Current Ratio And

Quick Ratio

Fox Manufacturing Company Current Assets Current Liabilities Cash $15,000 A/P $57,000 M/S 7,200 N/P 13,000 A/R 34,100 Accruals 5,000 Inventories 82,000 Total C/L $75,000 Total Current Assets $138,300 Current Ratio = 138,300 = 1.84 75,000 Quick Ratio = 138,300 – 82,000 = 56,300 = .75 75,000 75,000

Assume a different C/A Structure Current Assets Current Liabilities Cash $20,000 M/S 11,150 A/R 34,100 Inventories 73,050 Total C/L $75,000 $138,300 Current Ratio = 138,300 = 1.84 75,000 Quick Ratio = 138,300 – 73,050 = 65,250 = .87 75,000 75,000

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Average Age of Inventories for Fox Manufacturing Company

= 360 Inventory Turnover = 360 5.61 = 64.17 days

Average Age of Inventories for the Industry = 360 Inventory Turnover = 360 4.55 = 79.12 days

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Debt Ratio: = Total Debt Total Assets = Total Liabilities Total Assets = 225,000 = .55 408,300 Find the Debt / Equity Ratio: Debt = 225,000 Equity 183,300 = 1.23 Or Debt / Equity = Debt / Total Assets – Debt = Debt / Total Assets

1 - Debt / Total Assets = Debt Ratio 1- Debt Ratio = .55 1 - .55 = .55 = 1.22 .45

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Equity Multiplier: EM = TA Equity = TA TA – debt = 1 1 - Debt

TA = 1 1 - Leverage