FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
Module 10: Financial Statement Analysis and Cash Flow
Part 2:
Assignment 21-5 (Chapter 21, pages 1327-1328)
Requirement 1
Forest Products Ltd.
Income Statement for the years ended 31 December
Net sales
Cost of products sold
Depreciation, depletion and amortization
Selling and administrative
Operating earnings (loss)
Interest expense
Other income (expense)
Earnings(loss before income taxes
and non-controlling interest
Income taxes (recovery)
Earnings (loss) before non-controlling interest
Non-controlling interest
Earnings (loss) from discontinued operations
Net earnings (loss)
20x8
100.0%
130.0%
13.5%
16.3%
-59.8%
-0.6%
11.5%
20x7
20x6
20x5
100.0% 100.0% 100.0%
83.6% 75.3% 76.6%
10.0%
6.4%
6.8%
5.1%
3.8%
3.8%
1.3% 14.5% 12.8%
-1.5% -1.2%
-1.9%
-0.1% -0.4%
1.6%
-48.9%
-16.5%
-32.4%
-0.3%
-0.3%
0%
12.9%
5.7%
7.2%
137.5%
105.1%
12.6%
12.6%
3.9%
11.1%
12.5%
5.4%
7.1%
1.5%
5.6%
Forest Products Ltd.
Condensed Balance Sheets as at 31 December
Assets
20x8
20x7
20x6
20x5
Working capital
41.0%
17.1%
4.6%
7.9%
Investments and other
3.9%
1.5%
2.4%
3.9%
Fixed assets
55.1%
54.2% 47.5% 88.2%
Assets of discontinued operations
27.2% 45.5%
Net assets
100.0% 100.0% 100.0% 100.0%
Liabilities and shareholders’ equity
Long-term debt
Deferred income taxes
Liabilities of discontinued operations
Preferred shares issued by subsidiaries
Non-controlling interest
Shareholders’ equity
Total capitalization
6.9%
93.1%
100.0%
8.5%
7.3%
2.7%
4.9%
15.8%
9.1%
7.6%
1.4%
6.4%
7.0%
84.2% 70.2% 74.9%
100.0% 100.0% 100.0%
1
FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
A21-5 con’t
Requirement 2
Forest Products Ltd.
Income Statement for the years ended 31 December
Net sales
Cost of products sold
Depreciation, depletion and amortization
Selling and administrative
Operating earnings (loss)
Interest expense
Other income (expense)
Earnings(loss) before income taxes
and non-controlling interest
Income taxes (recovery)
Earnings (loss) before non-controlling interest
Non-controlling interest
Earnings (loss)from discontinued operations
Net earnings (loss)
Balance Sheet
Assets
Working capital
Investments and other
Fixed assets
Assets of discontinued operations
Net assets
Liabilities and shareholders’ equity
Long-term debt
Deferred income taxes
Liabilities of discontinued operations
Preferred shares issued by subsidiaries
Non-controlling interest
Shareholders’ equity
Total capitalization
20x8
13.2%
22.4%
26.1%
56.1%
-61.7%
4.2%
93.7%
20x7
20x6
44.1% 64.5%
48.1% 63.4%
64.5% 60.4%
59.3% 64.6%
4.5% 72.9%
36.5% 40.0%
-1.4% -15.2%
20x5
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
-51.6%
-40.6%
-59.7%
-713.0%
248.6%
-1.1% 66.4% 100.0%
-2.3% 69.1% 100.0%
-0.3% 64.6% 100.0%
--- 100.0%
218.8% 100.0%
99.5% 128.6% 100.0%
20x8
484.4%
92.6%
58.6%
0.0%
93.7%
20x7
20x6
20x5
206.2% 63.8% 100.0%
37.1% 70.3% 100.0%
58.5% 59.9% 100.0%
51.3% 100.0%
95.3% 111.1% 100.0%
85.2%
0.0%
116.4%
93.7%
33.0% 100.0%
106.7% 71.9% 100.0%
39.8% 100.0%
100.0%
101.0% 100.0%
107.0% 104.1% 100.0%
95.3% 111.1% 100.0%
2
FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
Part 3:
Question 18 (Page 1318). Explain and illustrate the effect of financial leverage.
Financial leverage is the extent to which a company uses fixed-term debt obligations
to finance its assets. It may have an effect on the return on equity, if the after-tax
interest rate is different than the rate of return earned on assets; it may be either
positive or negative. There is a financial leverage effect only when there is debt.
Leverage is present when there is a difference between ROA and ROE. To illustrate
favorable financial leverage, assume the rate of return on total assets is 10 percent
and the rate of return on owners’ equity is 15 percent. The differential is favorable
because the rate on total assets must exceed the rate of interest paid on debt. The
residual accrues to equity holders.
Part 4:
Assignment 21-19 (Chapter 21, pages 1338-1339)
Requirement 1
Measurement and evaluation of liquidity:
20x4
20x5
20x6
a)
Current ratio
$468,000
$330,000
= 1.42
$550,000
$250,000
= 2.2
$580,000
$250,000
= 2.32
b)
Quick ratio
$165,000
$330,000
= .5
$110,000
$250,000
=.44
$105,000
$250,000
= .42
Evaluation:
In this situation, the current ratio increased significantly, which usually is viewed as
favourable, although the ratio should not climb too high. At the same time, the quick
ratio is declining, which indicates that the increase is due to non-monetary current assets,
likely inventory. This may be a serious negative factor if inventory may become
obsolete. The inventory investment policy should be investigated further.
Requirement 2
Measurement and evaluation of solvency:
20x4
20x5
20x6
a)
Debt:equity
$1,490,000
$910,000
= 1.64
$1,510,000
$930,000
= 1.62
$1,300,000 = 1.25
$1,040,000
b)
Debt:total
assets
$1,490,000
$2,400,000
= 62%
$1,510,000 = 61.9%
$2,440,000
$1,300,000 =55.6%
$2,340,000
c)
Times interest
earned
$70,000 + $38,000
+ $23,000
$38,000
$40,000 + $12,000
+ $30,000 =2.7
$30,000
$50,000 + $16,000 = 2.9
+ $34,000
$34,000
= 3.4
3
FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
A21-19 con’t
Evaluation:
The debt:equity ratio and debt:total assets reflect the same relationship, but in different
ways. Both reflect a shift of the proportion of total assets provided by creditors versus
owners - in short, total debt decreased as a percentage and total owners’ equity increased.
This change means that leverage (trading on the equity) declined. To assess the
advisability of reducing leverage, the returns on total assets and owners’ equity must be
evaluated (this is done in Requirement 3).
Times interest earned declined over the period, as income is much lower in 20x6. This is
a thin margin for lenders.
Requirement 3
Measurement and evaluation of profitability.
Calculations:
20x4
a) Operating
margin
$50,000 + $34,000
+ $16,000
$6,600,000
20x5
= 1.5
b) Return on
assets (after tax)
($50,000 + = 3.2%
($34,000 (.8)))
$2,400,000*
c) Return on common
equity
$50,000
$910,000*
= 5.5%
20x6
$70,000 + $38,000 =1.9% $40,000 + $30,000 = 1.2%
+ $23,000
+ $12,000 .
$7,000,000
$7,100,000
($70,000 +
= 4.1%
($38,000 (.8))
$2,420,000
$70,000
$920,000
= 7.6%
($40,000 +
($30,000 (.8)))
$2,390,000
$40,000
$985,000
=2.7%
=4.1
*Data not available to compute average.
Evaluation:
The operating margin has decreased which is unfavourable because a lower percentage of
each dollar of sales is reflected in income. As a measure of profitability, however, profit
margin is deficient because it does not consider the amount of assets employed to
generate earnings.
Both return on assets and on equity have decreased significantly in 20x6, which is very
unfavorable. The reason for the variability in these two ratios—low in 20x4, higher
20x5, but even lower in 20x6, strongly suggests the need for further investigation and
action.
Leverage is positive in all years, as ROE is higher than ROA. Like other indicators,
though, leverage is lower in 20x6, likely because ROA has significantly declined.
4
FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
Part 6:
Assignment 21-26 (Chapter 21, pages 1343-1345)
Requirement 1
Crane Inc.
Cash Flow Statement
For the Year ended 31 December 20x3
Cash for operations:
Cash from customers ($1,684,000 - $40,000).................... $1,644,000
Cash paid for materials and labour*.................................. (1,633,000)
Cash paid for interest (115,000 + $5,000) .........................
(120,000)
Cash received for taxes (#6) .............................................
54,000
Cash flow for operations..........................................
$ (55,000)
Cash from investing:
Sale of building (#2).........................................................
Sale of machine (#3).........................................................
Sale of land (80+22gain) ..................................................
Purchase of machine (875-135+120+ ? = 1,080)...............
Cash from investing.................................................
Cash from financing:
Issued preferred shares, for cash (1,048-843)....................
Dividends—preferred (#4)................................................
Dividends—common (311-81-50-2-?=138) ......................
Purchase of common shares (#5) ......................................
Cash from financing .........................................................
Decrease in cash.....................................................................
Opening balance...............................................................
Closing balance ................................................................
60,000
40,000
102,000
(220,000)
( 18,000)
205,000
(50,000)
( 40,000)
(57,000)
58,000
(15,000)
20,000
5,000
*Purchases = $1,103,000 (CGS) + $99,000 (inv.) = 1,202,000 + $70,000(act pay) =
1,272,000 plus other expense 361,000
#2 Accum amort.
20,000*
Cash
60,000
Building
80,000
*(380+110-? = 470)
#3 Cash
40,000
Accum amort
68,000*
Loss on sale
27,000
Machine
135,000
*(212+75-? = 219)
5
FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
A21-26 Con’t
#5 Common shares 55,000
RE
2,000
Cash
57,000
Machine
120,000
Common shares 120,000
Requirement 2
Quick ratio = $5,000 + $220,000 + $190,000/$76,000 = 5.5
Accounts receivable turnover = ($1,684,000 x .8)/(($220,000 + $180,000)/2)) = 6.74
Return on total assets
(after tax)
($81,000) + $115,000 (.6)
= (.4)%
($3,007,000 + $2,985,000)/2
Debt: equity ratio (total debt)
$76,000 + $810,000 + $180,000
= .55
$1,048,000 + $190,000 + $565,000 + $138,000
Return on common equity1
($81,000)
(($565,000 + $138,000 + $1,048,000 +$190,000)
+ ($500,000 + $311,000 + $843,000 + $190,000))/2
Asset turnover
1
$1,684,000
($3,007,000 + $2,985,000)/2
= (4.3)%
= .56
Includes preferred as they are akin to common.
6
FA3 Class notes
Barbara Wyntjes, B.Sc., CGA
Part 7:
Assignment 21-27 (Chapter 21, pages 1345-1346)
Requirement 1 only
Alfa Company
Cash Flow Statement
for the year ended 31 December 20x4
Cash from operating activities
Net income....................................................................
Reconcile:
Amortization (non-cash) ..........................................
Loss on sale of investments (non-cash) ....................
Income tax payable (not paid as payable increased) .
A/R increase ...........................................................
Inventory increase ...................................................
Wages payable increase ..........................................
Cash from operating activities..................................
Cash for investing activities
Sale of short-term investments (#1 = decrease) ..............
Sale of equipment (#2) ..................................................
Sale of long-term investments (#1) ................................
Purchase of equipment (#2) ...........................................
Cash for financing
Repurchased shares (#4) ................................................
Repaid bond (#3)...........................................................
Dividends (#5: 162 + 39 – 7 - ? = 167) – $6 not paid)....
Change in cash ....................................................................
Opening cash (44,000-70,000).............................................
Closing cash (5,200-86,000)................................................
$39,000
28,000
5,000
30,000
(38,400)
(44,400)
2,000
$21,200
8,000
5,000
32,000
(43,000)
2,000
(17,000)
(40,000)
(21,000)
(78,000)
(54,800)
(26,000)
$(80,800)
#1: Cash
32,000
Loss on sale
5,000
Investment
37,000
#3 Convertibles BP
11,000
C/S conv. rights
1,100
Common shares
12,100
7
FA3 Class notes
#4 Common shares
RE
Cash
Barbara Wyntjes, B.Sc., CGA
10,000
7,000
17,000
NOTE: On the online lecture I stated (at ~11 minutes 4 seconds) net increase of $12,100
for common shares, should be $2,100. Under #4 paid out $17,000 to retire $10,000 worth
of shares and #3, issued $12,100 shares. This accounts for the net increase of $2,100
($12,100 increase less $10,000 decrease to common shares)
THE END
8