In-Class Exercises
Financial Statement Analysis 1
Hint: Group industries into more general classes:
• Financial services
• Capital intensive
• Technology oriented
• Service Firms (basketball franchise is a partnership)
• Consumer Foods
• Retail
Financial Services
• Finance companies lend money, therefore carry
large receivables
– Firm 13 (General Motors Acceptance Company)
• Life Insurance companies must keep large
reserves they pay to customers
– Firm 11 (U.S. Life Corporation)
Capital Intensive
Have large amounts of Property Plant & Equipt.
• Firms 9 and 12
• Steel companies sell a commodity that has
experienced intense global competition – low
profit margins, #9 is Inland Steel
• #12 is Consolidated Edison
Consumer Foods
Heavy advertisers (remember the Superbowl?)
– Firms 4 and 7
– Distilled spirits tend to be aged longer than beer,
resulting in a lower inventory turn
Firm 4: inventory turn = 62/5.6 = 11.1 times/yr
Firm 7: inventory turn = 46.5/21.7 = 2.1 times/yr
– Firm 4 is the brewer (Anheuser Busch) and firm 7 is the
distiller (Brown-Forman)
Technology- Oriented
• R&D expenses are higher
– Firms 3, 5, and 8
– Pharmaceutical companies have typically had high
margins – 8 (Merck)
– Aerospace often receives advances on contracts, R&D
cost is embedded in particular contracts (CGS).
Firm 3 is Aerospace (Rockwell International) and firm
5 is Computer (Data General)
Service Firms
Have few depreciable assets
– Firms 2 and 10
– Firm 2 pays no income taxes as a partnership (Boston
Celtics), firm 10 is the advertising agency (Ogilvy)
Retailers
Department stores carry receivables and have a
lower inventory turnover than grocery stores, so
firm 6 is a department store (May Dept. Stores)
and firm 1 is a grocery (Supermarkets General).
S-T Debt Paying Ability
Working Capital
This Year Last Year
Current assets
$2,060,000 $1,470,000
Current liabilities 1,100,000
600,000
Working capital $ 960,000
$ 870,000
S-T Debt Paying Ability
Current Ratio
Current assets
Current liabilities
Current ratio
This Year Last Year
$2,060,000 $1,470,000
$1,100,000 $600,000
1.87 to 1
2.45 to 1
S-T Debt Paying Ability
Acid-test Ratio (Quick Ratio)
Quick assets
Current liabilities
Acid-test ratio
This Year
$740,000
$1,100,000
0.67 to 1
Last Year
$650,000
$600,000
1.08 to 1
Liquidity Activity Ratio
Average Age of Receivables
This Year
Sales on account
$7,000,000
Average receivables
$525,000
Turnover of receivables 13.3 times
Last Year
$6,000,000
$375,000
16.0 times
Avg age of receivables: 365 ÷ turnover
27.4 days 22.8 days
Liquidity Activity Ratio
Inventory Turnover
This Year Last Year
Cost of goods sold
$5,400,000 $4,800,000
Average inventory
$1,050,000 $760,000
Inventory turnover
5.1 times 6.3 times
Turnover in days: 365 ÷ turnover
71.6 days 57.9 days
Ability to Meet L-T Obligations
Debt-to-Equity Ratio
Total liabilities
Stockholders’ equity
Debt-to-equity ratio
This Year
$1,850,000
$2,150,000
0.86 to 1
Last Year
$1,350,000
$1,950,000
0.69 to 1
Ability to Meet L-T Obligations
Times Interest Earned
Net income before
interest and taxes
Interest expense
Times interest earned
This Year
Last Year
$630,000
$90,000
7.0 times
$490,000
$90,000
5.4 times
Analysis of Liquidity
Working capital has increased, however, its current
position actually has deteriorated significantly
since last year.
• Both the current ratio and the acid-test ratio are
well below the industry average, and both are
trending downward.
Analysis of Profitability
The company has improved its profit margin from
last year.
• This is attributable to an increase in gross margin,
which is offset somewhat by an increase in
operating expenses.
• In both years the company’s net income as a
percentage of sales equals or exceeds the industry
average of 4%.
• The inventory turned only 5 times this year as
compared to over 6 times last year.
• It takes three weeks longer for the company to
turn its inventory than the average for the industry
(71 days as compared to 50 days for the industry).
• This suggests that inventory stocks are higher than
they need to be.
• The drain on the cash account seems to be a result
mostly of a large buildup in accounts receivable
and inventory.
• This is evident both from the common-size
balance sheet and from the financial ratios.
• Notice that the average age of the receivables has
increased by 5 days since last year, and that it is
now 9 days over the industry average.
• Many of the company’s customers are not taking
their discounts, since the average collection period
is 27 days and collection terms are 2/10, n/30.
• This suggests financial weakness on the part of
these customers, or sales to customers who are
poor credit risks. Perhaps the company has been
too aggressive in expanding its sales.
Loan Approval Option
• The loan may be approved on the condition that the
company take immediate steps to get its accounts
receivable and inventory back under control.
• This would mean more rigorous checks of creditworthiness
before sales are made and perhaps paring out of slow
paying customers.
• It would also mean a sharp reduction of inventory levels to
a more manageable size.
• If these steps are taken, it appears that sufficient funds
could be generated to repay the loan in a reasonable period
of time.