Financial Analysis For Short Term and Long-Term Debt Paying Ability

Financial Analysis for Short-term and Long-term
Debt Paying Ability
June 6, 2023 Dr. Babandi Ibrahim Gumel

PURPOSE OF THE PRESENTATION
The purpose of this presentation is to look at financial

statements and find out their users and why they need
them.
The presentation will look at the Basics of financial
analysis with a view to understanding the various
reasons for conducting financial analysis.
The presentation will investigate the analysis made to
determine the short-term and long-term debt-paying
ability of a firm, with particular emphasis on financial ratio
analysis. www.ligsuniversity.com 2
AT THE END OF THE PRESENTATION
Learners are expected to understand:

 Financial Reporting
 Financial Statements
 Users of Financial Statements
 Accounting Cycle and Auditor’s opinions
 Responsibility of Management as it relates to financial
statement analysis
 Basics of Analysis
 Types of Analysis
 Financial Analysis for Short term and Long-term debt-paying
ability.
www.ligsuniversity.com 3
INTRODUCTION TO FINANCIAL REPORTING
 The users of financial statements will highlight the importance

of financial reporting in the corporate environment.
 The users of financial statements include Managers,
stockholders, bondholders, security analysts, regulatory
authorities, suppliers, employees, lending institutions, labor
unions, and the general public.
 Looking at the list, they are internal and external stakeholders
of corporations.
 They all require the reports to enable make decisions that will
maximize the wealth of the stakeholders.
USERS OF FINANCIAL STATEMENTS
 Potential investors require financial statements to enable them understand the

wellness of a corporation and make decision of whether to buy the stocks of a
firm.
 Suppliers investigate the financial statements to find out the short-term paying
ability of a firm and decide whether to sell merchandize to a firm on credit.
 Labor unions analyze the statements to understand the nature of free cash
flow coming into the firm and help them press for demands and negotiate on
behalf of employees.
 Management use the statements to understand the profitability of the company.
 Creditors Look at the debt paying ability of firm.
 Government – are interested to determine whether a firm can settle its tax
obligations.
THE FINANCIAL STATEMENTS
 The principal financial statements of corporations are

the balance sheet, income statement, and the
statement of cash flows. There are notes that
accompany these financial statements .
 For a user to understand the financial condition,
profitability, and cash flows of an entity, it is necessary
to understand how to evaluate the financial statements
and the accompanying notes.
BALANCE SHEET
 Balance Sheet (Statement of Financial Position) – it shows the financial
condition of an accounting entity as of a particular date.
 It has three sections:
 The assets, resources of the firm;
 The liabilities, the debts of the firm; and
 The stockholder’s equity, the owner’s interest in the firm.
At any point in time, the total assets amounts must be equal to the total amount
of contributions of the creditors and owners: thus,
Assets = liabilities + stockholders' equity.
The stockholder’s equity of a corporation is the summation of common stock
and retained earnings.
STATEMENT OF STOCKHOLDERS’ EQUITY
 Statement of Stockholders’ Equity (Reconciliation of Stockholders’ Equity
Accounts) – presentation of the beginning and ending period balances of
their stockholders’ equity accounts is a requirement by firms and is
accomplished by presenting the statement of stockholders’ equity.
Retained earnings is one of the accounts of stockholders’ equity.
 Retained Earnings – links income statement with the balance sheet: it is
increased by net income and reduced by dividend paid to stockholders’
and net losses. We describe retained earnings as prior earnings less
prior dividends. While some firms present reconciliation of retained
earnings within statement of stockholders’ equity, others present it at the
bottom of the income statement (combined income statement and
retained earnings).
INCOME STATEMENT (STATEMENT OF EARNINGS)
 Income Statement (Statement of Earnings) – it is the

summary of revenues and expenses; and losses and
gains, ending with net income. Income statement
summarizes the operations results for a particular
period.
 Net income is necessary to be included in retained
earnings in the stockholders’ equity section for balance
sheet to balance.
INCOME STATEMENT (STATEMENT OF EARNINGS)
 Statement of Cash Flows (Statement of Inflows

and Outflows of Cash) – details the inflows and
outflows of cash during a specified period of time
– same period used for income statement. It has
three sections:
 cash flows from operating activities
 cash flows from investing activities, and
 cash flows from financing activities.
NOTES TO FINANCIAL STATEMENTS
 Notes – notes to financial statements present

additional information included in the financial
statements.
 They are integral part of the financial statements.
 Accounting policies are disclosed as the first note or in
a separate summary of significant accounting policies
preceding the first notes.
 Accounting policies includes; inventory valuation
method, depreciation policies, and contingent liabilities.
CONTINGENT LIABILITIES
 Contingent Liabilities – are requiring disclosure in notes. They are dependent on
occurrence and nonoccurrence of one or more future events to confirm liability. An
example of confirmation of contingent liability include settlement of litigation, a ruling of
a tax court, or signing as guarantor of a loan.
 An estimated contingent liability should be charged to income and be established as
liability only if the cost is reasonably determinable and loss is considered probable: such
contingent liability that is recorded is also described as a note.
 A loss contingency that is reasonably estimable and not probable is not charged to
income or established as liability. A loss contingency that is less than reasonably
possible does not need to be disclosed, but where there is unusually large potential
loss, disclosure is desirable.
 There are two varieties of events that occur after the balance sheet date, but before the
statements are issued as follows: first are events that existed at the balance sheet date,
and affect the estimates in the statements, they require adjustments before the
statements are issued.
THE ACCOUNTING CYCLE
 The accounting cycle is the sequence of accounting procedures completed within an accounting period.
There are three broad summary steps of the accounting cycle:
 Recording transactions - as events of transactions happens, they change the firm’s assets,
liabilities, or stockholders’ equity; thus, changing the firm’s financial position. There are basically
two types of transactions, internal and external transactions. While internal transactions are
confined within the company, external transactions happens outside the company.
 Recording adjusting entries - Accrual basis accounting requires that revenue be recognized
when realized (Realization concept) and expenses recognized when incurred (matching
concept). The accrual basis requires numerous adjustments to account balances at the end of
the accounting period. Adjusting entries are recorded in the general journal and then posted to
the general ledger. Once accounts are adjusted to the accrual basis, the financial basis can be
prepared.
 Preparing the financial statements - the accountants uses the accounts after adjustments have
been affected to prepare the financial statements. These statements represent the output of the
accounting system. The balance sheet and the income statement can be prepared directly from
the adjusted accounts, but the preparation of statement of cash flows requires further analysis of
the adjusted accounts.
AUDITOR’S OPINION
 An auditor is a certified public accountant who conducts an independent examination and evaluations of the
accounting information presented by the business (management) and issues a report thereon. The report of
the auditor is a formal report of his opinion of the financial statements after conducting an audit. The following
are the classifications of audit opinions:
 Unqualified opinion – it states that the financial statements present fairly: in all material respects, the
financial position, results of operations, and cash flows of the entity, is in conformity with generally accepted
accounting principles.
 Qualified opinion – states that, except for the effects of the matter(s) to which the qualification relates, the
financial statements present fairly, in all material respects, the financial position, results of operations, and
cash flows of the entity, in conformity with the generally accepted accounting principles.
 Adverse opinion – states that the financial statements do not present fairly the financial position, results of
operations, and cash flows of the entity, in conformity with the generally accepted accounting principles.
 Disclaimer of opinion – states that the auditor does not express an opinion on the financial statements. A
disclaimer of opinion is rendered when the auditor has not performed an audit sufficient in scope to form an
opinion.
 Financial analysts must review the independent auditor’s report during the examination of financial
statements. The audit opinion will be used by financial analysts to advise the users of financial statement
based on whether the financial statements conformed with GAAP or there are explanations of concerns that
will help them make a decision.
MANAGEMENT’S RESPONSIBILITY
FOR FINANCIAL STATEMENTS
 The management are responsible for preparing the financial statements
and ensuring the integrity of the financial statements.
 It is the responsibility of the auditor who are qualified public accountants
to conduct independent examination of the financial statements and
expressing an opinion on the statements based on the audit they
conducted.
 Some companies presented the management statement to shareholders
as part of the annual report to ensure that users of financial statements
are aware of the responsibilities of management.
BASICS OF ANALYSIS
 There are various techniques used in analyzing financial data; the techniques used the data for
comparative analysis to determine the importance of the data presented and evaluate the position of
the firm.
 The followings are the techniques used in financial analysis: ratio analysis, common-size analysis,
study of differences in components of financial statements among industries, review of
descriptive material, and comparisons of results with other types of data.
 The information obtained from the analysis are used to determine the financial position of a firm.
Each of the analysis techniques can be used for a different purpose and by different user of financial
information.
 Being a judgmental process, one of the primary objectives of financial statement analysis is the
identification of major changes in trends, amounts, and relationships. The analyst investigates
the major reasons that caused the major changes to occur.
 A turning point is identified which is the major changes and is a signal of early warning of a
significant shift in the future success or failure of a business.
 The process of analysis is improved with experience and by use of analytical tools
RATIO ANALYSIS
Financial ratios are expressed as a percentage or as times per period. The following are the different
categories of ratios:
- Liquidity Ratios – measures the ability of a firm to meet its current obligation.
- Borrowing Capacity Ratio – otherwise called leverage ratios, it measures the degree of protection of
suppliers of long-term funds.
- Profitability Ratios – measures the earning ability of a firm.
- Investors’ special group of ratios – apart of liquidity, debt, and profitability ratios, investors are
interested in a certain group of ratios to help them determine the viability of a firm.
- Cash Flow Ratios – they indicate liquidity, borrowing capacity, or profitability.
- Ratios are interpretable by making a comparison with 1). Prior ratios, 2). Ratios of competitors, 3).
Industry ratios, and 4). Experts predetermined standards.
- There are two important considerations when making the interpretations: a trend of a ratio and
variability. It should also be noted that ratio analysis must be understood based on the accounting
principles used, business practices, and the country’s culture.
COMMON-SIZE ANALYSIS (VERTICAL AND HORIZONTAL)
 A common size financial statement “displays all items as percentages of a common base
figure rather than as absolute numerical figures. This type of financial statement allows for
easy analysis between companies or between time periods for the same company” (Hayes,
R., p. 1, 2019). It is an expression of comparisons in percentages. Comparisons of firms of
different sizes is much more meaningful with common-size analysis.
 Vertical analysis compares each amount in a financial statement with a base amount
selected from the same year. Assuming an advertising expenses were $1,000 in 2011 and
sales were $100,000, thus, advertising expenses were 1% of sales.
 Horizontal Analysis compares amount with the base amount for a selected base year. For
example, if in 2010, sales were $400,000 and $600,000 in 2011, then sales increased by
50% in 2011.
YEAR-TO-YEAR CHANGE ANALYSIS
 Sometimes it is meaningful to compare financial statements over two time periods
using absolute amounts and percentages. The approach aids in keeping absolute
and percentages changes in perspective. For example, a substantial percentage
change may not be relevant due to an immaterial absolute change.
 The following are some of the rules to used when performing a year-to-year change
analysis;
 When an item has a value in the base year and none in the next period, the
decrease is 100%
 A meaningful percent change is not realizable when one number is positive,
and the other number is negative.
 No percentage change is computable when there is no figure for the base year.
FINANCIAL STATEMENT VARIATION BY
TYPE OF INDUSTRY
 Financial statements components especially income statement and balance sheet
vary by type of industry of firms.
 In merchandize industry, major asset is inventory, with large cash sales and low
receivables or opposite. Because of competition, profit ratios are low on income
statement with large cost of sales and operating expenses.
 In service industry, due to the fact service cannot be stored, inventory is low. Where
service is people extensive such as advertising, there is less investment in property
and equipment compared with manufacturing.
 In manufacturing industry, due to raw materials, work in progress, and finished
goods, inventory is large. There is large investment in property and equipment.
Depending on the terms of sales of a company, notes and accounts receivable may
also be material. Cost of sales is the major expense in the manufacturing firm’s
financial statement.
COMPARISONS
 Financial Analyst compares the data of a company with industry average which are
produced by certain regulatory organizations.
 The following are the financial services that provided the industry averages in the united
states:
 The department of commerce financial report.
 Annual Statement Studies.
 The standards & Poor’s Industry Surveys.
 Almanac of Business and Industrial Financial Ratios. and
 Value Line Investment Survey.
 The data provided by these organizations are used by firms to analyze financial statements.
 Note that countries have many sources of industry average data, thus, analysts in different
countries must refer to the sources of the industry data to make meaningful analysis.
ANALYSIS
 Liquidity of Short-Term Assets; Related Debt-Paying Ability - All users of financial statement attached
importance to the abilities of an entity to maintain its short-term debt paying ability. It is only when an entity can be
able to maintain its short-term debt paying ability the entity can be able to maintain its long-term debt paying ability.
Also, it is only when an entity can maintain both short-term and long-term debt paying ability it can satisfy its
stockholders. A profitable business can turn to be bankrupt if it fails to meet its short-term obligations. The ability of
a firm to pay its current obligations is related to the ability of a firm to generate cash.
 Long-Term Debt-Paying Ability - the long-term debt paying ability of an entity will be viewed from two approaches:
from the view of firm’s ability to carry debt as indicated by the income statement, secondly from the view of the
firm’s ability to carry the debt as indicated by the balance sheet. In the long-run, a relationship exist between
income reported from the use of accrual accounting and the firm’s ability to meets its long-term obligations, which
makes the entity’s profitability an important factor when determining long-term debt paying ability of a firm.
 Analysis for the Investor - There are analysis that are meant to serve the interest of investors. Nevertheless, an
investor is also interested in liquidity, debt, and profitability analysis earlier covered in this course.
 Profitability - Analysts investigates profits because it is vital to stockholders as it generate revenues in the form of
dividends; without profits there will be no dividends to stockholders. Further generation of profits will result in an
increase in the price of the stock of a firm, which will result in capital gains. Creditors are also concern with profits
because profits are one source of debt coverage. Profit is been used by management to measure performance.
THIS PRESENTATION IS ON THE SHORT-TERM AND LONG-TERM DEBT-PAYING ABILITY OF A FIRM.

LIQUIDITY OF SHORT-TERM ASSETS; RELATED DEBT-PAYING
ABILITY
 All users of financial statements attached importance to the abilities of an

entity to maintain its short-term debt-paying ability.
 It is only when an entity can be able to maintain its short-term debt-paying
ability that entity can be able to maintain its long-term debt-paying ability.
 Also, it is only when an entity can maintain both short-term and long-term
debt-paying ability that it can satisfy its stockholders.
 A profitable business can turn out to be bankrupt if it fails to meet its short-
term obligations. The ability of a firm to pay its current obligations is related
to the ability of a firm to generate cash.
LIQUIDITY OF SHORT-TERM ASSETS; RELATED DEBT-PAYING
ABILITY - CONTINUED
 The short-term debt-paying ability of a firm is found by determining the

relationship between current assets and current liabilities because, in most
cases, the current liabilities are paid with assets.
 In accrual accounting, a firm may report large profits but may not have the
cash flow to pay its bills due to a lack of available funds.
 There are certain instances where a firm may report a loss and can pay its
short-term obligations.
 The procedure for determining the short-term debt-paying ability suggests
an understanding of current assets, current liabilities, and notes to financial
statements.
 During the analysis of this chapter to chapter ten of this course, the
financial statements for 2011 of Nike, Inc. will be used.
CURRENT ASSETS, CURRENT LIABILITIES, AND THE
OPERATING CYCLE
Current assets are in the form of

 1). Cash,
 2). Will be realized cash, or
 3). Assets that will conserve the use of cash within the operating cycle of a business or one year,
whichever is longer.
There are five categories usually found in current assets:
- cash,
- marketable securities,
- receivables,
- inventories, and
- prepayments.
Non-commonly found forms of current assets are assets held for sale.
The operating cycle for a firm is the time period between the acquisition of goods and the final
realization resulting from sales and subsequent collections. Most companies have an operating cycle of
one year.
OPERATING CYCLE - CONTINUED
Cash – is a medium of exchange that banks accept as deposits and creditors

except for payment.
 For cash to be classified as a current asset, it has to be free from any
restrictions preventing it from being accepted by banks as a deposit and by
creditors as means of making payment.
 Many firms classify cash with restrictions as a current asset, but the
restrictions have to be disclosed.
 When determining the short-term paying ability of a firm, the cash restricted
for short-term creditors should be eliminated along with related short-term
debt.
 Therefore, cash must be available to make payments for general short-term
creditors to be considered as part of a company’s short-term debt-paying
ability. www.ligsuniversity.com 26
Marketable Security – because there is the cost of keeping cash,

management does not keep all the cash needed in the form of
cash throughout the year; they utilize the keeping of short-term
investments, otherwise called marketable securities, which can be
converted into cash as the needs arise.
For a short-term investment to qualify as marketable security, it
has to be readily marketable, and management must have the
intent of converting it into cash within the operating cycle or one
year, whichever is longer. The managerial intent is the key agent
in this case.
 Banks require a portion of a loan (compensating balances) to remain on deposit for the duration of
the loan.
 The compensating balances reduce the amount of cash available to borrowers to meet obligations
and increase the borrower’s effective interest rate.
 Compensating balances against short-term loans are stated in the current assets or notes.
Compensating balances against long-term borrowing are stated as noncurrent assets under either
investment or other assets.
 The cash account on the balance sheet is usually titled cash, cash equivalents, or cash and
certificates of deposits.
 Cash classification includes currency and unrestricted funds on deposit in a bank.
 There are two major problems with analyzing current assets; the determination of fair value and its
liquidity. With cash, the problem applies when it has been restricted.
 Marketable securities should be temporary. Example of marketable securities include treasury bills,
short-term notes of corporations, government bonds, corporate bonds, preferred stock, and common
stock. Investment in common stock and preferred stock are called marketable equity securities.
The liquidity of a security must be determined to classify it as a marketable security, they must be
readily marketable. www.ligsuniversity.com 28
Receivables – there are a number of claims by entities to future inflows of cash.

 The claims are classified as accounts receivable and notes receivable on the financial statements.
 Two fundamental claims are that of selling merchandise or services to customers, referred to as
trade receivables, with a promise by customers to pay within a specified time, usually one month.
Other claims include loans to employees or federal tax refunds.
 The common feature is that a firm expects to collect cash sometime in the future, which causes two
valuation problems: firstly, because time passes before collection, there is a cost involved; secondly,
the collection might not be made.
 The cost that arose as a result of waiting to collect problem is ignored in the valuation of receivables
and notes classified as current assets because of the short waiting period, and even if considered,
the difference is immaterial.
 In a situation where the waiting period is long-term and is classified as long-term, the waiting period
is not ignored. Use of a stipulated interest rate is termed as fair, except if: no interest is stated; the
stated interest rate is clearly unreasonable; and the face value of the note is different from cash
sales price of the product or service, or the market value of the note at the date of the transaction.
 The second problem in valuing receivables or notes is that collection may

not be made.
 An allowance called uncollected accounts is estimated. Estimated losses
are accrued against income, and impairment of the asset is recognized
under the following conditions:
1. Available information prior to issuance of the financial statement shows
that there is a probability the asset has been impaired or liability has been
incurred at the date of the financial statements.
2. The amount of the loss can be estimated.
CURRENT ASSETS, CURRENT LIABILITIES, AND THE OPERATING
CYCLE - CONTINUED.
Days’ Sales in Receivables – is used to determine the liquidity of the trade receivables for a company. It
relates to the amount of the accounts receivable to the average daily sales on account. The accounts
receivable should include trade notes receivable, receivables not related to sales on account should not
be included in computations. The formula for computing Days’ Sales in Receivables = Gross
Receivables / (Net Sales / 365). 56.19 approx. 57 days is the length of time receivables are outstanding
at the end of the year.
Table 1: Days Sales in Receivables of Nike Inc.

Years Ended May 31, 2011 and 2010.
In Millions 2011 2010
Account Receivable, Net $3,138 $2,650
Allowance for uncollectible accounts 74 74
Gross Receivables (net plus allowances) (A) 3,212 2,724
Net Sales 20,862 19,014
Average daily sales on account (net sales on account divided by 57.16 52.09
365) (B)
Days’ Sales in Receivables (A / B) 56.19 days 52.29 days
CYCLE - CONTINUED
Table 2: Account Receivable Turnover of Nike Inc.
Years Ended May 31, 2011 and 2010
(In Millions) 2011 2010
Net sales (A) $20,862 $19,014
End-of-year receivables, net 3,138 2,650
Beginning-of-year receivables, net 2,650 2,884
Allowance for doubtful accounts:
End of 2011 $74.0
End of 2010 $74.0
End of 2009 $73.9
Ending gross receivables (net plus allowance) 3,212 2,724
Beginning gross receivables (net plus allowance) 2,724 2,958
Average gross receivables (B) 2,968 2,841
Account receivables turnover (A / B) 7.03 times 6.69 times
CYCLE – CONTINUED.
Account Receivable Turnover – shows the liquidity of the receivables and is measured in times per
year using the formula Account receivable turnover = Net Sales / Average Gross Receivables. Table 2
shows the computation of the account receivable turnover of Nike Inc. Table 2 shows an increase in
account receivables turnover from 6.69 times per year in 2010 to 7.03 times per year in 2011, indicating
a good trend for Nike Inc.
Account Receivable Turnover in Days – account receivable turnover can be expressed in days as
against times per year. The turnover is expressed in the number of days which gives room for
comparisons with the number of days’ sales in the ending receivables. It also helps answer directly the
credit terms of a firm. It can be computed using the formula: Account receivable turnover in days =
Average Gross Receivables / (Net Sales / 365). Table 3 illustrates the computation of the account
receivable turnover in days of Nike Inc.
In the Nike Inc. illustration of table 3, the computation shows the account receivable turnover in days
decreased from 54.54 days in 2010 to 51.92 days in 2011; thus, a decrease in the number of days to
turnover receivables to the company is a good trend.
CYCLE - CONTINUED
Table 3: Account Receivable Turnover in Days for Nike Inc.

(In Million) 2011 2010
Net Sales $20,861 $19,014
Average gross receivables (A) 2,968 2,841
Sales per day (net sales divided by 365) (B) 57.16 52.09
Account receivable turnover in days (A / B) 51.92 54.54
days days
CYCLE - CONTINUED
Credit Sales Versus Cash Sales – liquidity is the problem of credit sales versus cash sales. A firm’s net
sales include both credit sales and cash sales. When computing receivables, it will only be realistic when the
credit sales are included; if cash sales are included, it will be overstated.
The internal analyst of a firm determines the credit sales figure in order to eliminate the problem of credit
sales versus cash sales. The external analyst should be aware of the problem and avoid being misled by
liquidity figures. It is not also an issue to external analysts because certain firms sell on a cash only, while
others sell on credit only.
Inventories – is often the most significant asset when determining the short-term debt-paying ability of a
company, in some instances, is more than half the value of total current assets. Thus, it is important to know
how to analyze the inventory.
For an asset to be classified as an inventory, an asset must be for sale in the ordinary business course of an
entity or be consumed during the production of goods. Merchandise inventory appears in one account,
whether for retail or wholesale. Inventory for manufacturing is of three types: raw material used for the
production of goods, inventory in production called work-in-progress, and completed inventory or finished
goods inventory.
 Inventory is sensitive to changes in business activities which necessitates the need for management
to balance inventory with business activity, as failure will lead to the excessive cost of storage,
disruption of production, and employee layoffs.
 The costs and quantities of inventory may be accounted for using either a perpetual or periodic
system. The perpetual system maintains a continuous record of quantities of inventory. It may also
maintain a continuous record of cash. When the company updates sales and purchases, the system
continuously maintains a continuous record. A physical count is done once per year.
 The periodic system counts the inventory physically once per year. The cost of the ending inventory
is determined by attaching a cost to the physical quantities on hand based on the cost flow
assumption used. The cost of goods sold is determined by subtracting the ending inventory from the
cost of goods available for sale.
 Inventory Cost – since the cost prices of inventories vary over time, it becomes difficult to determine
the cost to use for inventory. It is impracticable to determine the cost of inventory since goods move
in and out regularly, and cost prices fluctuate over time. The exception to this is expensive items
such as diamonds or cars in the showroom. A specific cost identification method is used for
such expensive goods.
 Because of the difficulty of determining the cost of inventories, companies use a cost flow
assumption. The most common cost flow assumptions are first-in-first-out (FIFO), last-in-last-out
(LIFO), and average computations.
 The FIFO assumes the inventory acquired first is sold first. Thus, the latest items purchased remain
in inventory. With a low turnover or substantial inflation, even FIFO may not produce an inventory
figure that will represent the replacement cost. During high inflation, the resulting profit figure may be
overstated because of an understatement of inventory cost.
 LIFO assumes the cost of the last items bought or produced is matched against the current sales.
The LIFO improves the matching of current costs against the current revenue, which results in a
realistic profit figure. A firm that stays long on this assumption will have an inventory figure dating
many years back. Because of inflation, the current inventory figure will not reflect current
replacement costs.
 The average method of computation lumps the cost and takes a mid-point. Average computation
results in inventory cost lying between FIFO and LIFO.
CYCLE - CONTINUED
Let’s understand the following illustration for the periodic system in table 4 used with the inventory count
at the end of the year.
Table 4: Periodic System of inventory count.
Date Description Number of Cost per Unit Total Cost
Units
January 1 Beginning 200 $6 $ 1,200
inventory
March 1 Purchase 1,200 7 8,400
July 1 Purchase 300 9 2,700
October 1 Purchase 400 11 4,400
2,100 $16,700
On December 31, a physical count reveals 800 units on hand. There were
2,100 available within the year, 800 left at the end of the year, and 1,300 units
sold during the year.
CYCLE - CONTINUED
The four assumptions of FIFO, LIFO, Average, and Specific identifications will be illustrated after the
determination of the inventory in table 4 using the periodic system. The illustration is to determine the
ending inventory and related cost of goods sold using the four cost flow assumptions.
Table 5: FIFO determination of ending inventory and cost of goods sold.

Number of Cost per Inventory Cost of
Units Unit Cost Goods Sold
October 1 Purchase 400 @ $11 $4,400
July 1 Purchase 300 @ 9 2,700
March 1 Purchase 100 @ 7 700
Ending Inventory 800 $7,800
Cost of goods sold $8.900
($16,700 - $7,800)
The ending inventory is found by attaching cost to physical hand count based on FIFO
cost flow assumption. Cost of goods sold is found by subtracting ending inventory from
cost of goods available for sale as determined in table 3.
CYCLE - CONTINUED
Table 6: Using LIFO, determination of ending inventory and cost of goods sold.
Number Cost per Inventory Cost of
of Units Unit Cost Goods Sold
January 1 Beginning Inventory 200 @ $6 $1,200
March 1 Purchase 600 @ 7 4,200
Ending Inventory 800 $5,400
Cost of goods sold $11,300
($16,700 - $5,400)
The ending inventory is found by attaching cost to the physical quantities on hand based on the
LIFO cost flow assumption. The cost of goods sold is calculated by subtracting the ending inventory
cost from the cost of goods available for sale.
CYCLE - CONTINUED
The ending inventory cost and cost of goods sold can also be found using the average cost assumption
and the specific identification of cost methods.
Average Cost – the weighted average divides the total cost by the total units to arrive at the average
cost per unit. The inventory cost is determined by multiplying the cost per unit by the inventory quantity.
Ending inventory is subtracted from the cost of goods available for sale.
Average cost per unit = $16,700 / 2,100 = $7.95
Ending inventory = 800 x $7.95 = $6,360
Cost of goods sold = $16,700 - $6,360 = $10,340
Specific Identification – the items in inventory are identified from specific purchases. Assuming the
items are identified with the March 1 purchase of 800 items which was at $7. The cost of goods sold is
determined by subtracting the cost of ending inventory from the cost of goods available for sale.
Ending inventory = 800 x $7 = $5,600
Cost of goods sold = $16,700 - $5,600 = $11,100.
The difference between inventories with different cash flow assumptions methods may be material or
immaterial. Inflation is the factor that affects inventory costs. The higher the inflation rate, the greater
the difference. Analysts should take note.
CYCLE - CONTINUED
FIFO and LIFO cash flow assumptions inventory costing methods are regarded as the most prominent
and frequently used. They are the most extremes, and the followings are the summary of the two
methods:
1. Use of LIFO generally results in lower profits than does FIFO due to high cost of goods sold. The
difference can be substantial.
2. Profits reported under LIFO is generally realistic than FIFO because cost of goods sold is closer to
replacement cost under LIFO. The case is under both inflationary and deflationary conditions.
3. FIFO reports a higher inventory ending balance which is closer to replacement cost. The figure
usually falls short of true replacement cost.
4. LIFO has higher cash flow than FIFO due to difference in tax liability between the two methods; this
makes firms to select LIFO.
5. Some firms use periodic inventory system because purchases made late in the year becomes part
of the cost of goods sold under LIFO.
6. Firms using LIFO are likely to face a severe tax problem and severe cash problem if sales reduce or
eliminate the amount of inventory normally carried.
7. LIFO may not be used for inventory with high turnover rate because the difference in results
between LIFO and FIFO might be immaterial.
8. LIFO results in lower profits which give rise to higher cost of goods sold.
CYCLE - CONTINUED
If a firm decides to use LIFO, it must disclose a LIFO reserve account, usually in a note to the financial
statement. The amount disclosed is usually added to inventory to approximate the inventory at FIFO,
because an inventory at FIFO is usually an approximation of the current replacement cost of the
inventory.
Lower-of-Cost-or-Market Rule – this is the measurement of the utility of the goods through market
valuation. When the market value falls below the cost, the inventory is written down the lower market
value. The market is defined in terms of current replacement cost, either by purchase or manufacture.
Liquidity of Inventory – the analysis is like that of accounts receivable.
Days Sales in Inventory - days sales in inventory at the end of the accounting period, computation
gives an indication of the length of time that it will take to use up the inventory through sales. It can be
misleading because certain sales are seasonal. The formula: Days’ Sales in Inventory = Ending
Inventory / (Cost of goods sold / 365). See table 7 for an illustration of the computation of days’ sales in
inventory for Nike Inc. The computation shows that the days’ sales in inventory for Nike Inc. have
increased from 72.94 days at the end of 2010 to 87.27 days at the end of 2011, representing a negative
trend for the company. That, the number of days to use up inventory has increased. The lower the days,
the better.
CYCLE - CONTINUED
Table 7: Days’ Sales in Inventory of Nike Inc.
(In millions) 2011 2010
Inventories, end of year (A) $2,715 $2,041
Cost of goods sold 11,354 10,214
Average daily cost of goods sold (cost of goods sold 31.11 27.98
divided by 365) (B)
Number of days’ sales in inventory (A / B) 87.27 72.94 days
days
CYCLE - CONTINUED
Inventory Turnover – indicates the liquidity of an inventory. Inventory turnover = cost of goods sold /
average inventory. Table 8 shows the Nike Inc. inventory turnover, and the results show an increase
from 4.64 in 2010 to 4.77 in 2011.
Inventory Turnover in Days – is used when the analyst feels the inventory turnover is not realistic due
to unrealistic inventory cost. It is expressed in the number of days. Inventory turnover in days = average
inventory / (cost of goods sold /365). Table 9 shows an illustration of the inventory turnover of Nike Inc.
The computation shows that there is a decrease from 2010 to 2011, which represents a favorable
figure.
Operating Cycle – represents the period of time that elapsed between the acquisition of goods and the
final cash realization resulting from sales and subsequent collections. It is determined using the
receivable liquidity figures and inventory liquidity figures. An operating cycle can be calculated as
follows: Operating Cycle = Accounts Receivable Turnover in Days + Inventory Turnover in Days. If the
two components are not realistic, the operating cycle will not be realistic. In the case of Nike Inc. the
operating cycle = 51.92 + 76.44 = 128.36 in 2011, and 54.54 + 78.62 = 133.16 in 2010.
The operating cycle could help companies when comparing a firm from period to period and when
comparing a firm with similar companies.
CYCLE - CONTINUED
Table 8: Illustration of Inventory Turnover for Nike Inc.

Cost of goods sold (A) $11,354 $10,214
Inventories:
Beginning of year 2,041 2,357
End of year 2,715 2,041
Total 4,756 4,398
Average inventory (B) 2,378 2,199
Merchandise inventory turnover (A / B) 4.77 times 4.64 time
per year per year
CYCLE - CONTINUED
Table 9: Illustration of Inventory turnover in days for Nike Inc.

Cost of goods sold $11,354 $10,210
Average inventory (A) 2,378 2,199
Sales of inventory per day (cost of goods sold divided 31.11 27.97
by 365) (B)
Inventory turnover in days (A / B) 76.44 78.62
Days Days
CYCLE - CONTINUED
Prepayments – are unexpired cost for which payment has been made. Are current assets expected to
be consumed within the operating cycle or one year, whichever is longer. They normally represent an
immaterial portion of the current assets, thus, have little influence over the short-term debt paying ability
of a firm. They relate to the short-term debt paying ability because they conserve cash.
Problem of valuation and liquidity of prepayment is handled in simple manner, where valuation is taken
as the cost that has been paid. Since it is a current asset that has been paid in relatively short period
before balance sheet date, cost paid fairly represents the cash used for the prepayment. In rare cases,
a prepayment will not result in cash receipt, thus, no liquidity computation in required. For example, an
insurance policy cancelled early require no liquidity computations.
Other Current Assets – there are other assets other than cash, marketable securities, receivables,
inventories, and prepayments that may be listed as current assets. Such assets may be material in one
year and may distort liquidity if they are not recurring. Such other assets will in management’s opinion
be realized in cash or conserve the use of cash within the operating cycle or one year whichever is
longer. They are often explained in notes: example include property held for sale and advances or
deposits.
CYCLE - CONTINUED
Current Liabilities – are “obligations whose liquidation is reasonably expected to require the use of
existing resources properly classifiable as current assets or the creation of other current liabilities”
(Gibson, 2013, p. 241). Typical items of current liabilities include account payable, notes payable,
accrued wages, accrued taxes, collection received in advance, and current portion of long-term
liabilities.
The followings are listed as current liabilities of Nike Inc:
Current liabilities (In millions)
Current portion of long-term debt $ 200
Notes payable 187
Accounts payable 1,469
Accrued liabilities 1,985
Income taxes payable 117
Total current liabilities $ 3,958
For current liabilities, liquidity is not a problem and valuation problem is immaterial and should be
disregarded.
CYCLE - CONTINUED
Comparisons of Current Assets with Current Liabilities – the comparisons indicate the short-term
debt-paying ability of the entity. The following are some of the tools to use when determining this
ability: 1. working capital, 2. current ratio, 3. acid-test ratio, and 4. cash ratio.
The working capital – of a business is an indication of the short-term solvency of the business. It
is computed as follows: working capital = current assets – current liabilities. Table 10 is an
illustration of Nike Inc.’s working capital computations. The result shows that Nike Inc. had a
working capital of $7,339,000,000 in 2011 and $7,595,000,000 in 2010. The figures tend to be
understated may be due to some items in the current assets being understated, such as the
inventory. Analysts should adopt the comparisons of figures from year to year to determine if the
working capital is reasonable as a firm’s size may expand or contract. Analysts should consider
analyzing the items in the current assets and current liabilities of a company if the working capital
appears to be out of line.
Current ratio – determine the short-term debt-paying ability of a company; and is computed as
Current Ratio = Current Assets / Current Liabilities. Table 11 is an illustration of the computation of
the current ratio for Nike Inc. The result shows a current ratio of 2.85 for 2011 and 3.26 for 2010.
Though a 2.0 current ratio is termed adequate, the Nike Inc. result indicates a negative trend. A
comparison with the industry average will help.
CYCLE - CONTINUED
Table 10: Illustration of Nike Inc. Working Capital Computations
Current Assets (A) $11,297 $10,959
Current Liabilities (B) 3,958 3,364
Working Capital (A – B) $ 7,339 $ 7,595
CYCLE - CONTINUED
Table 11: Illustration of Nike Inc. Current Ratio Computations
Current Assets (A) $11,297 $10,959
Current Liabilities (B) 3,958 3,364
Current Ratio (A / B) 2.85 3.26
CYCLE - CONTINUED
The current ratio, unlike the working capital, which determines the absolute difference between current
assets and current liabilities, shows the relationship between the size of the current assets and the size
of the current liabilities, which makes it feasible to compare current ratios between firms.
Caution is necessary for firms that use LIFO as their inventory cost determination because it
understates the inventory, which may tend to understate the current ratio.
Analysts are advised to compute accounts receivable turnover and merchandise inventory turnover
before calculating the current ratio to enable making an opinion on whether there is a liquidity problem
with receivables and/or inventory. Such opinion will influence the opinion of the analyst on the current
ratio.
Acid-Test Ratio (Quick Ratio) – there are times when it is more desirable to access a more immediate
position than indicated by the current ratio. Acid-Test Ratio relates the most liquid assets to the current
liabilities. Inventory is removed for current assets when determining of acid-test ratio because it may be
slow-moving, possibly obsolete, or part of the inventory may have been pledged to specific creditors.
Acid-Test Ratio = Current Assets – Inventory / Current Liabilities. Table 12 is an Illustration of Nike Inc.
Acid-test ratio computations. Results show 2.17 for 2011 and 2.65 for 2010, a negative trend for the
firm. Table 13 is an illustration of a more conservative Acid-test ratio for Nike Inc., where other current
assets are removed. Though a 1.00 acid-test ratio is the minimum, there is a negative trend.
CYCLE - CONTINUED
Table 12: Illustration of Nike Inc. Acid-Test Ratio Computations
Current Assets $11,297 $10,959
Less: Ending Inventory 2,715 2,041
Remaining current assets (A) $ 8,582 $ 8,918
Current Liabilities (B) $ 3,958 $ 3,369
Acid-test Ratio (A / B) 2.17 2.65
CYCLE - CONTINUED
Table 13: Illustration of Nike Inc. Acid-Test Ratio (Conservative Approach) computations
Cash, including short-term investments $4,538 $5,146
Net receivables 3,138 2,650
Total quick assets (A) $7,676 $7,796
Current liabilities (B) $3,958 $3,364
Acid-test ratio (A / B) 1.94 times 2.32 times
CYCLE - CONTINUED
Cash Ratio – is used to view the liquidity of a firm from an extremely conservative viewpoint. It is
usually used when analysts suspect severe liquidity problems in receivables and inventory. The formula
is: Cash Ratio = Cash Equivalents + Marketable Securities / Current Liabilities. It is mostly used when
an analyst wants to determine the liquidity of a company. It indicates the immediate liquidity of a firm. A
high cash ratio indicates a firm is not utilizing its cash to its best advantage, while a low cash ratio
indicates a firm has an immediate problem paying its bills. Table 14 is an illustration of Nike Inc.’s cash
ratio computations. The results show a cash ratio of 1.15 for 2011 and 1.53 for 2010, indicating a
decreased ratio.
Other Liquidity Considerations – the first consideration is for sales to working capital and followed by
the considerations, not on the face of financial statements.
Sales to Working Capital (Working Capital Turnover) – gives an indication of the turnover in working
capital per year. Comparison of the ratio is with past competitors and with industry averages to form an
opinion as to the adequacy of the working capital turnover. A low ratio indicates an unprofitable use of
working capital, while a high ratio indicates the firm is undercapitalized and is susceptible to liquidity
problems as a result of changes in business conditions. Table 15 is an illustration of Nike Inc.’s sales to
working capital computations, with a result showing a 2.79 ratio for 2011 and a 2.71 ratio for 2010:
indicating a slightly more profitable use of working capital in 2011.
CYCLE - CONTINUED
Table 14: Illustration of Nike Inc. cash ratio computations
Cash, including short-term investments (A) $4,538 $5,146
Current Liabilities (B) $3,958 $3,364
Cash ratio (A / B) 1.15 1.53
CYCLE - CONTINUED
Table 15: Illustration of Nike Inc. sales to working capital computations
Net Sales (A) $20,862 $19,014
Working capital at beginning of year 7,595 6,457
Working capital at end of year 7,339 7,595
Average working capital (B) 7,467 7,026
Sales to working capital (A / B) 2.79 times per 2.71 times per

(Sales to working capital = sales/average working capital) year year
CYCLE - CONTINUED
Liquidity Considerations Not on the Face of the Statements – the following list present some of the
considerations that may add to the liquidity of a company:
1. Unused bank credit lines is an addition to liquidity, usually disclosed in the notes
2. Long-term assets that could be converted quickly to cash, would add to the liquidity of a firm
3. A company may be in a long-term debt position and therefore have the capability to issue debt or
stock which will relieve a firm from a severe liquidity problem in a reasonable amount of time.
The followings are some of the reasons why a firm may not be in a good position of liquidity as
indicated by ratios:
4. When a firm have a notes discounted on which the other party have a full recourse against the firm.
Discounted notes should be disclosed in notes.
5. A firm may have a major contingent liabilities that have not been recorded, such as tax claim.
Unrecorded contingent liabilities that are material are disclosed in note.
6. A firm may have guaranteed a bank note for another company. This would be disclosed in a note.
LONG-TERM DEBT-PAYING ABILITY
The long-term debt-paying ability of an entity will be viewed from two approaches: from the view of the
firm’s ability to carry debt as indicated by the income statement, secondly, from the view of the firm’s
ability to carry the debt as indicated by the balance sheet.
 In the long run, a relationship exists between income reported from the use of accrual accounting
and the firm’s ability to meet its long-term obligations, which makes the entity’s profitability an
important factor when determining the long-term debt-paying ability of a firm. It is also important to
analyze the amount of debt in relation to the size of the firm. The analysis will indicate the
relationship between the number of funds provided by outside providers with those provided by the
owners.
 If the outsiders have provided a higher proportion of resources, risk has been substantially shifted to
outsiders. A large proportion of debt in the capital structure of a firm increases the risk of a firm not
meeting the principal and interest obligations due to the fact that the firm may not meet these
obligations.
LONG-TERM DEBT-PAYING ABILITY - CONTINUED
 The ability of a firm to pay its long-term debt as indicated by the income statement may be viewed
through two types of tools: times interest earned and the fixed charge coverage.
 Times interest earned ratio – indicates the long-term debt-paying ability of a firm from the income
statement viewpoint. An adequate times interest earned ratio indicates that little danger exists that
the firm will not be able to meet its interest obligations. With good coverage of interest, a firm will be
able to pay interest obligations and refinance principal. A relatively stable and high-interest coverage
indicates a good record, while a low and fluctuating coverage indicates poor coverage. Firms with a
good record will finance a relatively high proportion of debt in relation to shareholders’ equity and
also obtain funds at favorable rates. It can be computed as:
Times interest earned = Recurring Earnings, Excluding Interest Expense, Tax Expense, Equity
Earnings, and Noncontrolling Interest / Interest Expense, Including capitalized interest.
For evaluation purposes, times interest earned should be computed for a period of three to five years
and compared to that of competitors and the industry average. It will provide insight into interest
coverage stability as it will cover good and bad years. Refer to table 16 for an illustration of the times
interest earned ratio computation for Nike Inc. The results show a decrease in the ratio from 70.92 in
2010 to 84.65 times in 2011. The use of 3 to five years ratio will be good to evaluate adequacy.
INCOME STATEMENT CONSIDERATION WHEN DETERMINING
LONG-TERM DEBT-PAYING ABILITY
Table 16: Illustration of times interest earned computation for Nike Inc.

Income before income taxes $2,844 $2,517
Plus: Interest Expense (both expensed and capitalized) 34 36
Adjusted income (A) $2,878 $2,553

Interest Expense 34 36
Capitalized interest (was not material in 2011 and 2010) ** **
Total interest expense (B) $ 34 $ 36

Times interest earned (A / B) 84.65 70.92
Fixed Charged Coverage Ratio – an extension of the times interest earned ratio, also indicates the
long-term debt-paying ability of a firm from the view of the income statement. It indicates the firm's
ability to cover fixed charges. It is computed as Fixed Charge Coverage = Recurring Earnings,
excluding interest expense, tax expense, equity earnings, and noncontrolling interest + interest portion
of rentals / Interest expense, including capitalized interest + interest portion of rentals.
There is a difference of opinion on what should be included in the fixed charges. Leased assets are
either capital leases or operating leases. Part of lease payments may be considered interest payments,
and interest payments on income statements include interests related to capital leases. Usually, one-
third of the operating lease charges are included in the fixed charges.
In the Nike Inc. financial statements, there is a disclosure of the interest components of leases of one-
tenth of the rental expense.
Among other components considered in fixed charges are depreciation, depletion and amortization,
debt principal payments, and pension payments.
The substantial preferred dividend should be included, or a separate ratio should be computed.
The more items considered, the more conservative the process. Table 17 is an illustration of the fixed
charge ratio computation for Nike Inc. The result shows a very good figure for Nike.
Table 17: Fixed charge coverage ratio computation for Nike Inc.
(In million) 2011 2010

Income before income taxes $2,844 $2,517
Plus: Interest expense (both expensed and capitalized) 34 36
Interest portion of leases 45 42
Earning adjusted (A) $2,923 $2,595
Interest expense 34 36
Capitalized interest (was not material in 2011 and 2010) see note 3 ** **
Interest potion of leases 45 42
Adjusted interest (B) $ 79.0 $ 78.0
Fixed charge coverage 37 times per 33.27 times
year per year
BALANCE SHEET CONSIDERATION WHEN DETERMINING LONG-
TERM DEBT-PAYING ABILITY
The ability of a firm to carry debt as indicated by the balance sheet, can be considered using the debt
ration and the debt/equity ratio.
Debt ratio – indicates a firm’s long-term debt-paying ability and can be computed as Debt Ratio = Total
Liabilities / Total Assets. Total liabilities include short-term liabilities, reserves, deferred tax liabilities,
noncontrolling interests, redeemable preferred stock, and any other noncurrent liability. Shareholders’
equity is not part of the total liabilities.
The debt ratio indicates the percentage of assets financed by creditors and helps determine how well
creditors are protected in case of insolvency. If existing creditors are not protected, the firm can not
issue additional long-term debt. Table 18 is an illustration of the debt ratio of Nike Inc’s computations.
The result shows that less than one-half of Nike Inc’s assets were financed by outsiders in both 2010
and 2011. Analysis of debt ratio is by comparing with competitors and industry averages.
Some firms exclude short-term liabilities because they are not long-term sources of funds and are not a
valid indication of the firm’s long-term debt position. Other firms include short-term liabilities because
they are part of the total sources of outside funds in the long run.
TERM DEBT-PAYING ABILITY - CONTINUED
Table 18: Illustration of Nike Inc. Debt Ratio Computations

Total liabilities compiled:
Current liabilities $3,958 $3,364
Long-term debt 276 446
Deferred income taxes and other liabilities 921 855
Redeemable preferred stock 0 0
Total liabilities (A) $5,155 $4,665
Total assets (B) $14,998 $14,419
Debt Ratio (A / B) 34.37% 32.35%
TERM DEBT-PAYING ABILITY
The debt/Equity Ratio – is another computation used to determine the long-term debt-paying ability of
an entity. It compares the total debt with the shareholders’ equity. It helps determine how well creditors
are protected in case of insolvency. The lower the ratio, the better the debt position of a company when
determining the long-term debt-paying ability. Analysts should compare the ratio with that of competitors
and the industry average during the analysis of the long-term debt-paying ability of an entity. It is
computed as follows: Debt/Equity Ratio = Total Liabilities / Shareholders’ Equity. Table 19 is an
illustration of the debt/equity ratio for Nike Inc. The computations show a result that at the end of 2011,
the debt/equity ratio was 52.37%, which was down from 47.83% at the end of 2010. Note that the lower
the ratio, the better; thus, the 2010 ratio was better, indicating a slight pressure on the long-term debt-
paying ability of the firm in 2011.
Debt to Tangible Net Worth – also determines the long-term debt-paying ability of an entity. The ratio
also indicates how well creditors are protected in case of insolvency. As in the case of debt ratio and
debt/equity ratio from the perfective of the long-term debt-paying ability of an entity, the lower the ratio,
the better. The debt to tangible net worth ratio is a much more conservative ratio than the debt and
debt/equity ratios because it eliminates intangible assets such as goodwill and trademarks during the
computations, as they do not provide resources to pay creditors. The ratio is computed as:
Debt to Tangible Net Worth Ratio = Total Liabilities / Shareholders’ Equity – Intangible Assets. Table 20
is an illustration of Nike Inc.’s debt to tangible net worth ratio computations. The results show a
substantial increase in the ratio from the year 2010 to 2011.
Table 19: Illustration of Nike Inc. Debt/Equity Ratio Computations
Total liabilities (refers to table 18) (A) $5,155 $4,665
Shareholders’ equity (B) $9,843 $9,754
Debt/Equity ratio (A / B) 52.37% 47.83%
Table 20: Illustration of Nike Inc. Debt to Tangible Net Worth Ratio
Computations
Total liabilities (refer to table 18) (A) $5,155 $4,665
Shareholders’ Equity $9,843 $9,754
Less: Intangible assets (692) (655)
Adjusted shareholders’ equity (B) $9,151 $9,099
Debt to tangible net worth ratio (A / B) 56.33% 51.27%
Other Long-term Debt-Paying Ability Ratios – includes: 1. Current debt/net worth ratio – indicates
a relationship between current liabilities and shareholders’ funds: a higher proportion of funds by current
liabilities, the higher the risk. 2. Total capitalization ratio – compares long-term debt to total
capitalization: the lower the ratio, the lower the risk. 3. Fixed asset/equity ratio – indicates the extent
to which shareholders provided funds in relation to fixed assets: the higher the fixed assets in relation to
equity, the greater the risk.
QUESTION AND
ANSWERS
SESSION
REFERENCES
Alexandra, D. (2011). Private company financial reporting. Journal of Accounting, 34-36.
American Accounting Association's Financial Accounting Standards Committee. (2007).
The FASB's conceptual framework for financial reporting:
A critical analysis. Accounting Horizons, 229-238.
Ge, W. & Sarah, M. (2005). The disclosure of material weaknesses
internal control after the Sarbanes-Oxley act. Accounting Horizons, 137-158.
Geiger, M. A. & Raghunandan, K. (2002). Going-concern opinions in
the new legal environment. Accounting Horizons, 17-26.
Gibson, C. H. (2013). Financial Statement Analysis. Delhi: Cengage Learning India Private Limited.
Glen, C. (2007). If IFRS offers the answer, they sure raise a lot of questions. Financial Executive, 21-
23.
Hayes, A. (2019). Common-size Analysis. Retrieved December 27, 2019,
from Investopedia: https://www.investopedia.com/terms/c/commonsizefinancialstatement.asp
Ray, B. (2008). What is the actual economic role of financial reporting? Accounting Horizons, 427-
432.

Financial Analysis For Short Term and Long-Term Debt Paying Ability

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Analysis For Short Term and Long-Term Debt Paying Ability

Uploaded by

Copyright:

Available Formats

Financial Analysis for Short-term and Long-term

Debt Paying Ability

June 6, 2023 Dr. Babandi Ibrahim Gumel

The purpose of this presentation is to look at financial

Learners are expected to understand:

 The users of financial statements will highlight the importance

 Potential investors require financial statements to enable them understand the

 The principal financial statements of corporations are

 Income Statement (Statement of Earnings) – it is the

 Statement of Cash Flows (Statement of Inflows

 Notes – notes to financial statements present

THIS PRESENTATION IS ON THE SHORT-TERM AND LONG-TERM DEBT-PAYING ABILITY OF A FIRM.

 All users of financial statements attached importance to the abilities of an

 The short-term debt-paying ability of a firm is found by determining the

Current assets are in the form of

Cash – is a medium of exchange that banks accept as deposits and creditors

Marketable Security – because there is the cost of keeping cash,

Receivables – there are a number of claims by entities to future inflows of cash.

 The second problem in valuing receivables or notes is that collection may

Table 1: Days Sales in Receivables of Nike Inc.

Table 3: Account Receivable Turnover in Days for Nike Inc.

Table 5: FIFO determination of ending inventory and cost of goods sold.

Table 8: Illustration of Inventory Turnover for Nike Inc.

Table 9: Illustration of Inventory turnover in days for Nike Inc.

Table 10: Illustration of Nike Inc. Working Capital Computations

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Current Assets (A) $11,297 $10,959

Current Liabilities (B) 3,958 3,364

Working Capital (A – B) $ 7,339 $ 7,595

Table 11: Illustration of Nike Inc. Current Ratio Computations

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Current Assets (A) $11,297 $10,959

Current Liabilities (B) 3,958 3,364

Current Ratio (A / B) 2.85 3.26

Table 12: Illustration of Nike Inc. Acid-Test Ratio Computations

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Current Assets $11,297 $10,959

Less: Ending Inventory 2,715 2,041

Remaining current assets (A) $ 8,582 $ 8,918

Current Liabilities (B) $ 3,958 $ 3,369

Acid-test Ratio (A / B) 2.17 2.65

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Cash, including short-term investments $4,538 $5,146

Net receivables 3,138 2,650

Total quick assets (A) $7,676 $7,796

Current liabilities (B) $3,958 $3,364

Acid-test ratio (A / B) 1.94 times 2.32 times

Table 14: Illustration of Nike Inc. cash ratio computations

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Cash, including short-term investments (A) $4,538 $5,146

Current Liabilities (B) $3,958 $3,364

Cash ratio (A / B) 1.15 1.53

Table 15: Illustration of Nike Inc. sales to working capital computations

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Net Sales (A) $20,862 $19,014

Working capital at beginning of year 7,595 6,457

Working capital at end of year 7,339 7,595