WEEK 2
Chapter 3
Chapter 3
Questions
8)
Disinflation tends to lower reported earnings as inflation-induced income is squeezed out
of the firm's income statement resulting in decreased net income. This is particularly true for
firms in highly cyclical industries, such as oil based products, where prices tend to rise and fall
quickly.
10)
There are many different methods of financial reporting accepted by the accounting
profession as promulgated by the Canadian Institute of Chartered Accountants. The
implementation of IFRS (public firms) and ASPE (private firms) should result in better
comparison of statements among companies using the same rules of accounting.Though the
industry has continually tried to provide uniform guidelines and procedures, many options
remain open to the reporting firm. Every item on the income statement and balance sheet must be
given careful attention. Two apparently similar firms may show different values for sales,
research and development, extraordinary losses, and many other items.
Problems
42.
Wizard Industries
2012
2011
2010
Industry
0.1% 5.1%
0.1% 10.2%
0.4% 29.6%
0.4%
0.7%
1.8%
5.8%
8.1%
20.3%
3.9×
93
4.9×
6.3×
74
8.6×
42
5.2×
70
4.1×
5.3×
90
5.6×
65
6.3×
58
4.3×
5.7×
85
8.1×
45
Profitability Ratios
Profit margin
Return on assets
Return on equity
Asset Utilization Ratios
Receivable turnover
Avg. Collection period
Inventory turnover
Inventory turnover (sales)
Inventory holding period
Accounts payable turnover
Accounts payable period
5.1×
72
4.2×
5.6×
86
7.1×
51
Capital asset turnover
Total asset turnover
9.9×
1.8×
10.6×
2.0×
8.4×
1.9×
8.0×
1.7×
1.72
1.08
1.71
.93
1.55
0.82
1.6
1.1
71.4% 65.3% 64.7%
1.02× 3.42× 1.15×
1.02× 3.42× 1.15×
60%
4.3×
Liquidity Ratios
Current ratio
Quick ratio
Debt Utilization Ratios
Debt to total assets
Times interest earned
Fixed charge coverage
The profitability ratios do not appear healthy. Even in 2011 the profit margin did
not reach the industry average. The relatively good performance in year 2011
seems to be dependent on strong sales. Good return on assets results from high
asset turnover and the high return on equity is due to high debt levels. When sales
The asset utilization ratios reveal problems. The slowdown in the collection of
accounts receivable is of considerable concern. The working capital position has
become more dependent on A/R and we must question the quality of these
receivables. Turnover is far below the industry average. The accounts payable
period is now below the industry average which suggests Wizard is not taking
advantage of supplier credit to the full extent possible or suppliers are starting to
cut back on credit to Wizard. Capital asset turnover is above the industry average
and probably reveals that Wizard is overtrading and may not be reinvesting in
assets. The increased inventory turns may also indicate overtrading.
The liquidity ratios appear to be good. We should ask why. We have already
identified the increasing A/R position. This would increase the liquidity ratios but
it is hardly a healthy position. Furthermore, the long-term debt position has been
increasing, perhaps as a substitute for short-term borrowings.
The debt utilization ratios suggest an increasingly precarious position. The profit
failure has severely impacted on the debt load. Interestingly, dividends have been
maintained, Creditors are increasingly holding the bag.
Do not grant credit! Debt loads are increasing and shareholders are not showing a
full commitment to the firm. An equity contribution and reduction of dividends is
required. Furthermore sales are weak and this is impacting on profitability
measures. Those sales that are made are being collected in a longer time. Are they
less creditworthy? There is also evidence of a reluctance to reinvest in equipment
(capital assets).