C213 Study Guide - Solution.docx

Chapter 3 introduction to financial statement

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Chapter 3: Introduction to Financial Statement Analysis Recognize the purpose of financial statement analysis and financial ratios. Financial statement analysis can be used to diagnose existing problems and to forecast how a company might do in the future. The financial statement analysis process starts with the financial statements and reviews the ratios and common-sizing results to spot “red flags.” Those red flags are researched with additional data, including details of significant transactions, market share information, competitors' plans, and customer demand forecasts. Once the results are reviewed, you make a decision based on the work and monitor the results. Compute widely used financial ratios. Interpret widely used financial ratios. Calculate cash flow ratios for a given situation. The following covers all ratios discussed in the text but I have separated the ones on the Formula Listing from others since the ones on the Formula Listing the highest probability of being on the OA. Use the following information to solve for the ratios listed below. For each ratio, show your calculations and explain what the ratio measures. Classification 1 Cash 150,000 CA Inventory 250,000 CA Property, plant & equipment 1,900,000 LTA Accounts payable 375,000 CL Accounts receivable 100,000 CA Short-term investments 500,000 CA Accrued liabilities 155,000 CL Long-term debt, less current portion 750,000 LTL Current portion of long-term debt 70,000 CL Long-term investments 650,000 LTA Sales 1,300,000 IS Net income 115,000 IS Interest expense 49,000 IS Cash paid for interest 45,000 CF Income tax expense 40,000 IS Income taxes paid 42,000 CF 1 CA = current asset, CL = current liabilities, LTA = Long-term asset, LTL = long-term liability, IS = Income statement, CF = Cash flow statement, and None = not on any financial statement. 8

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Cost of Goods Sold 780,000 IS Cash from Operations 450,000 CF Cash paid for PPE 578,000 CF Market value of shares 1,713,000 None Calculate the following ratios, show all your work, and explain what they measure. 1 Current Ratio: Current assets / current liabilities Calculations: current assets / current liabilities 1,000,000 / 600,000 = 1.67 current assets = 150,000 + 250,000 + 100,000 + 500,000 = 1,000,000 current liabilities = 375,000 + 155,000 + 70,000 = 600,000 Explanation of what it measures – The current ratio is a firm-level liquidity ratio that measures a firm’s ability to pay liabilities that must be paid in the next year (current liabilities) with assets that should be converted to cash within the next year (current assets). Normally the current ratio should be above 1.0 because firms know for certain they will have to pay their current liabilities, but are less sure that they will be able to convert all their current assets to cash due to things like unsold inventory and uncollected accounts receivable. 2 Debt Ratio: Total liabilities / Total Assets Calculations: total liabilities / total assets = 1,350,000 / 3,550,000 = 0.38 or 38% total liabilities = 600,000 + 750,000 = 1,350,000 total assets = 1,000,000 + 1,900,000 + 650,000 = 3,550,000 Explanation of what it measures – It measures the level of debt burden and leverage the firm is employing. If this ratio exceeds 0.5 or 0.6, then the firm may be using too much leverage and getting itself to heavily in debt.
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• Spring '16
• Kenneth Cassell
• Balance Sheet, Generally Accepted Accounting Principles

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