Financial Statement Analysis (FSA)

Overview of FSA, Creditors’ Perspective and Analytical

Techniques – Assigned Cases
Case 8-5 (Financial Statement Analysis – Theory, Application, and Interpretation –
Leopold A. Bernstein & John J. wild – Sixth Edition)

Ian Manufacturing Company was organized five years ago and manufactures toys. Its most
recent three years balance sheets and income statements are reproduced below.

Ian Manufacturing Company

Balance Sheets
As of June 30, Year 5, Year 4, and Year 3

Year 5 Year 4 Year 3

Assets
Cash $12,000 $15,000 $16,000
Accounts receivable, net 183,000 80,000 60,000
Inventory 142,000 97,000 52,000
Other current assets 5,000 6,000 4,000
Plant and equipment (net) 160,000 110,000 70,000
Total assets $502,000 $308,000 $202,000

Liabilities and Equity

Accounts payable $147,800 $50,400 $22,000
Federal income tax payable 30,000 14,400 28,000
Long-term liabilities 120,000 73,000 22,400
Common stock, $5 par value 110,000 110,000 80,000
Retained earnings 94,200 60,200 49,600
Total liabilities and equity $502,000 $308,000 $202,000

Ian Manufacturing Company

Condensed Income Statements
For Years Ended June 30, Year 5, Year 4, and Year 3

Year 5 Year 4 Year 3

Net sales $1,684,00 $1,250,000 $1,050,000

0
Cost of goods sold 927,000 810,000 512,000
Gross margin $757,000 $440,000 $538,000
Marketing and administrative costs 670,000 396,700 467,760
Operating Income $87,000 $43,300 $70,240
Interest cost 12,000 7,300 2,240
Income before federal income tax $75,000 $36,000 $68,000
Income tax 30,000 14,400 28,000
Net income $45,000 $21,600 $40,000

The statement of retained earnings for the years ended June 30, Year 4 and Year 5 is shown
below:

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 Financial Statement Analysis (FSA)
Overview of FSA, Creditor’s Perspective and Analytical
Techniques – Assigned Cases

Ian Manufacturing Company

Statement of Retained Earnings
For Years Ended June 30, Year 5 and Year 4

Year 5 Year 4

Balance, beginning $60,200 $49,600

Add: net income 45,000 21,600
Sub-total $105,200 $71,200
Deduct: Dividends paid 11,000 11,000
Balance, ending $94,200 $60,200

Additional Information:
1. All sales are on account.
2. Long-term liabilities are owed to the company’s bank.
3. Terms of sale are net 30 days.

Required:
1. Compute the following measures for both Years 4 and 5. (For turnover ratios, use
average account balances for the 2 years)
a. Working capital (year 5)
= current assets-current liabilities
= 342,000-177,800
= 164,200

a. Working capital (year 4)

= current assets-current liabilities
= 198,000-64,800
= 133,200

Working capital = 148,700

b. Current ratio (year 5)

= current assets/current liabilities
= 342,000/177,800
Current ratio = 1.9235 or 1.92

b. Current ratio (year 4)

= current assets/current liabilities
= 198,000/64,800
Current ratio = 3.0556 or 3.06

c. Acid-test ratio (year 5)

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 Financial Statement Analysis (FSA)
Overview of FSA, Creditor’s Perspective and Analytical
Techniques – Assigned Cases
= Cash+AR+Inventory/Current Liabilities
= 12,000/+183,000+142,000/177,800
Acid Test Ratio = 1.1248 or 1.12
c. Acid-test ratio (year 4)
= Cash+AR+Inventory/Current Liabilities
= 15,000/+80,000+97,000/64,800
Acid Test Ratio = 1.5586 or 1.56

d. Accounts receivable turnover (year 5)

= net sales/average accounts receivable
= 183,000/1,684,000
Accounts receivable turnover = 9.20
d. Accounts receivable turnover (year 4)
= net sales/average accounts receivable
= 1,250,000/80,000
Accounts receivable turnover = 15.63 or 16

e. Average collection period (year 5)

= 183,000/1,684,000*365
= 183,000/4,613.70
= 39.66 or 40 days
e. Average collection period (year 4)
= 80,000/1,250,000*365
= 80,000/3,424.66
= 23.36 or 23 days

f. Inventory turnover (year 5)

=cost of goods sold/average inventory
= 927,000(/142,000+97,000/2)
927,000/119,500
=7.76
f. Inventory turnover (year 4)
=cost of goods sold/average inventory
= 810,000(/52,000+97,000/2)
810,000/74,500
=10.87

g. Average age of inventory (AAI) (year 5)

= 365 days/inventory turnover
= 365/7.76
= 47.04 or 47 days
g. Average age of inventory (AAI) (year 4)
= 365 days/inventory turnover
= 365/10.87
= 33.58 or 34 days

h. Debt-to-equity ratio (Year 5)

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 Financial Statement Analysis (FSA)
Overview of FSA, Creditor’s Perspective and Analytical
Techniques – Assigned Cases
=total liabilities/shareholders equity
= (147,800+ 30,000+120,000)/(110,000+94,200)
=297,800/204,200
= 1.46

h. Debt-to-equity ratio (Year 4)

=total liabilities/shareholders equity
= (50,400+ 14,400+73,000)/(110,000+60,200)
=137,800/204,200
= 0.8096 or 0.81

i. Times interest earned (year 5)

= net operating income/interest expense
= 87,000/12,000
= 7.25

i. Times interest earned (Year 4)

= net operating income/interest expense
= 43,300/7,300
= 5.93

2. Using Year 3 as the base year, compute an index number trend series for
a. Sales
b. Cost of goods sold
c. Gross margin
d. Marketing and administrative costs.
e. Net income.
3. Based on your analysis in (1) and (2), prepare a report regarding a recommendation on
whether to grant a loan to Ian Manufacturing. Support your recommendation with
relevant analysis.

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 Financial Statement Analysis (FSA)
Overview of FSA, Creditor’s Perspective and Analytical
Techniques – Assigned Cases
Problem 26 – Foundations of Financial Management – Ninth Edition –
Stanley B. Block and Geoffrey A. Hirt

Given the financial statements for Turner Corporation shown here:

1. Would you as credit manager for a supplier; approve the extension of (short-term) trade
credit to Turner Corporation? Why? Compute the following ratios before answering.
a. Profit margin h. Total asset turnover
b. Return on assets (investment) i. Current ratio
c. Return on equity j. Quick ratio
d. Receivable turnover k. Debt to total assets
e. Average collection period l. Time interest earned.
f. Inventory turnover j.. Fixed charge coverage
g. Fixed asset turnover

Turner Corporation
Balance Sheet
As of December 31, 2004

Current Assets
Cash $5,000
Accounts receivable 90,000
Inventory 55,000
Tota Current Assets 150,000

Long-term Assets
Fixed Assets $600,000
Less: Accumulated depreciation (150,000)
Net Fied Assets 450,000

Total Assets $600,000

Liabilities
Accounts payable $110,000
Bonds payable (long-term) 80,000
Total Liabilities 190,000

Stockholders' Equity
Common stock $140,000
Paid-in capital 70,000
Retained earnings 200,000
410,000
Total Liabilities and Stockholders' Equity $600,000

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 Financial Statement Analysis (FSA)
Overview of FSA, Creditor’s Perspective and Analytical
Techniques – Assigned Cases
Turner Corporation
Condensed Income Statements
For the Year Ended December 31, 2004

Year 3

Net sales (on credit) $1,500,000

Cost of goods sold 1,000,000
Gross margin $500,000
Selling and administrative expense 244,500
Less: Depreciation expense 50,000
Operating Profit 205,500
Interest expense 8,000
Earnings before taxes $197,500
Tax expense $79,000
Net income $118,500