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Warren SMChap15 - CHAPTER 15 FINANCIAL STATEMENT ANALYSIS...

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767 CHAPTER 15 FINANCIAL STATEMENT ANALYSIS EYE OPENERS 1. Horizontal analysis is the percentage analy- sis of increases and decreases in corre- sponding statements. The percent change in the cash balances at the end of the pre- ceding year from the end of the current year is an example. Vertical analysis is the percentage analysis showing the relation- ship of the component parts to the total in a single statement. The percent of cash as a portion of total assets at the end of the current year is an example. 2. Comparative statements provide information as to changes between dates or periods. Trends indicated by comparisons may be far more significant than the data for a single date or period. 3. Before this question can be answered, the increase in net income should be compared with changes in sales, expenses, and assets devoted to the business for the current year. The return on assets for both periods should also be compared. If these comparisons indicate favorable trends, the operating per- formance has improved; if not, the apparent favorable increase in net income may be off- set by unfavorable trends in other areas. 4. You should first determine if the expense amount in the base year (denominator) is significant. An 80% or more increase of a very small expense item may be of little con- cern. However, if the expense amount in the base year is significant, then over an 80% increase may require further investigation. 5. Generally, the two ratios would be very close, because most service businesses sell services and hold very little inventory. 6. The amount of working capital and the change in working capital are just two indi- cators of the strength of the current position. A comparison of the current ratio and the quick ratio, along with the amount of working capital, gives a better analysis of the current position. Such a comparison shows: Current Preceding Year Year Working capital ....... $100,000 $90,000 Current ratio ........... 2.0 2.5 Quick ratio .............. 0.8 1.4 It is apparent that, although working capital has increased, the current ratio has fallen from 2.5 to 2.0, and the quick ratio has fallen from 1.4 to 0.8. 7. The bulk of Wal-Mart sales are to final cus- tomers that pay with credit cards or cash. In either case, there is no accounts receivable. Procter & Gamble, in contrast, sells almost exclusively to other businesses, such as Wal-Mart. Such sales are “on account,” and thus, create accounts receivable that must be collected. A recent financial statement showed Wal-Mart’s accounts receivable turning 64 times, while Procter & Gamble’s turned only 6 times. 8. No, an accounts receivable turnover of 5 with sales on a n/45 basis is not satisfactory. It indicates that accounts receivable are col- lected, on the average, in one-fifth of a year, or approximately 73 days from the date of sale. Assuming that some customers pay within the 45-day term, it indicates that other accounts are running beyond 73 days. It is also possible that there is a substantial amount of past-due accounts of doubtful collectibility on the books.
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