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					    Chapter 16
Financial Statement
     Analysis

       Learning Objectives
1.   Basic Analytical Procedures
2.   Solvency Analysis
3.   Profitability Analysis
4.   Summary of Analytical Measures
5.   Corporate Annual Reports




                                      C16- 1
                 Lincoln Company
             Comparative Balance Sheet
             December 31, 2003 and 2002
                                                    Increase (Decrease)
       Assets                   2003       2002       Amount Percent
Current assets               $ 550,000 $ 533,000       $ 17,000    3.2%
Long-term investments           95,000    177,500       (82,500) (46.5%)
Fixed assets (net)             444,500    470,000       (25,500) (5.4%)
Intangible assets               50,000     50,000             —
                            $1,139,500 $1,230,500     $ (91,000) (7.4%)
     Liabilities
Current liabilities         $ 210,000   $ 243,000   $ (33,000) (13.6%)
Long-term liabilities         100,000     200,000    (100,000) (50.0%)
                            $ 310,000   $ 443,000   $(133,000) (30.0%)
 Stockholders’ Equity
Preferred stock, $100 par    $ 150,000 $ 150,000             —
Common stock, $10 par          500,000   500,000             —
Retained earnings              179,500   137,500       $42,000    30.5%
                             $ 829,500 $ 787,500       $42,000     5.3%
                            $1,139,500 $1230,500      $(91,000)   (7.4%)
                                                                   C16- 2
                 Lincoln Company
             Comparative Balance Sheet
             December 31, 2003 and 2002
                                                   Increase (Decrease)
       Assets                   2003        2002    Amount Percent
Current assets               $ 550,000 $ 533,000     $ 17,000    3.2%
Long-term investments           95,000     177,500    (82,500) (46.5%)
Fixed assets (net)          Horizontal Analysis:
                               444,500     470,000    (25,500) (5.4%)
Intangible assets           Current year (2003) $550,000 —
                                50,000      50,000
                            $1,139,500 (2002)              = 103.2%
                            Base year $1,230,500 $ (91,000) (7.4%)
                                                 $533,000
     Liabilities
Current liabilities         Increase amount      $17,000
                             $ 210,000 $ 243,000 $ (33,000) (13.6%)
                                                          = 3.2%
Long-term liabilities       Base year (2002)
                               100,000          $533,000
                                          200,000   (100,000) (50.0%)
                             $ 310,000 $ 443,000 $(133,000) (30.0%)
 Stockholders’ Equity
Preferred stock, $100 par    $ 150,000 $ 150,000           —
Common stock, $10 par          500,000   500,000           —
Retained earnings              179,500   137,500     $42,000    30.5%
                             $ 829,500 $ 787,500     $42,000     5.3%
                            $1,139,500 $1230,500    $(91,000)   (7.4%)
                                                                 C16- 3
               Lincoln Company
          Comparative Income Statement
           December 31, 2003 and 2002
                                                 Increase (Decrease)
                             2003       2002       Amount Percent
Sales                    $1,530,500 $1,234,000      $296,500 24.0%
Sales returns                32,500     34,000         (1,500) (4.4%)
Net sales                $1,498,000 $1,200,000     $298,000) 24.8%
Cost of goods sold        1,043,000    820,000       223,000 27.2%
Gross profit              $ 455,000 $ 380,000       $ 75,000 19.7%
Selling expenses          $ 191,000 $ 147,000       $ 44,000 29.9%
Administrative expenses     104,000     97,400           6,600   6.8%
Total operating expenses $ 295,000 $ 244,400        $ 50,600 20.7%
Operating income          $ 160,000 $ 135,600       $ 24,400 18.0%
Other income                  8,500     11,000         (2,500) (22.7%)
                          $ 168,500 $ 146,600        $ 21,900 14.9%
Other expense                 6,000     12,000         (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600         $ 27,900 20.7%
Income tax                   71,500     58,100         13,400 23.1%
Net income                $ 91,000 $ 76,500          $ 14,500 19.0%
                                                                C16- 4
                Lincoln Company
           Comparative Income Statement
            December 31, 2003 and 2002
                                                Increase (Decrease)
                             2003        2002     Amount Percent
Sales                    $1,530,500 $1,234,000     $296,500 24.0%
Sales returns                32,500      34,000       (1,500) (4.4%)
Net sales                $1,498,000 $1,200,000 $298,000) 24.8%
Cost of goods sold        1,043,000     820,000     223,000 27.2%
Gross profit             Horizontal Analysis:
                          $ 455,000 $ 380,000      $ 75,000 19.7%
Selling expenses          $ 191,000 (2003) $1,498,000
                         Current year $ 147,000    $ 44,000 29.9%
Administrative expenses Base year (2002)
                            104,000      97,400
                                              $1,200,000
                                                            =
                                                        6,600 124.8%
                                                                6.8%
Total operating expenses $ 295,000 $ 244,400       $ 50,600 20.7%
Operating income         Increase amount
                          $ 160,000 $ 135,600 $298,000
                                                   $ 24,400 18.0%
                                                          = 24.8%
Other income                   year
                         Base8,500 (2002) $1,200,000
                                         11,000       (2,500) (22.7%)
                          $ 168,500 $ 146,600       $ 21,900 14.9%
Other expense                 6,000      12,000       (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600        $ 27,900 20.7%
Income tax                   71,500      58,100       13,400 23.1%
Net income                $ 91,000 $ 76,500         $ 14,500 19.0%
                                                               C16- 5
                        Lincoln Company
                    Comparative Balance Sheets
                              December 31, 2003    December 31, 2002
       Assets                 Amount Percent       Amount Percent
Current assets               $ 550,000    48.3%    $ 533,000    43.3%
Long-term investments           95,000     8.3       177,500    14.4
Fixed assets (net)             444,500    39.0       470,000    38.2
Intangible assets               50,000     4.4        50,000     4.1
                            $1,139,500   100.0%   $1,230,500   100.0%
     Liabilities
Current liabilities         $ 210,000    18.4%     $ 243,000   19.7%
Long-term liabilities         100,000     8.8        200,000   16.3
                            $ 310,000    27.2%     $ 443,000   36.0%
 Stockholders’ Equity
Preferred stock, $100 par    $ 150,000    13.2%   $ 150,000     12.2%
Common stock, $10 par          500,000    43.9      500,000     40.6
Retained earnings              179,500    15.7      137,500     11.2
                             $ 829,500    72.8%   $ 787,500     64.0%
                            $1,139,500   100.0%   $1230,500    100.0%
                                                                 C16- 6
                      Lincoln Company
                  Comparative Balance Sheets
                            December 31, 2003    December 31, 2002
       Assets               Amount Percent       Amount Percent
Current assets            $ 550,000    48.3%     $ 533,000    43.3%
Long-term investments        95,000     8.3        177,500    14.4
Fixed assets (net)          444,500    39.0        470,000    38.2
Intangible assets            50,000     4.4         50,000     4.1
                         $1,139,500   100.0%    $1,230,500   100.0%
     Liabilities
Current liabilities         $ 210,000   18.4%    $ 243,000   19.7%
Long-term liabilities         100,000    8.8       200,000   16.3
   Vertical Analysis:        $310,000   27.2%    $ 443,000   36.0%
 Stockholders’ Equity
   Current liabilities $210,000
Preferred stock, $100 par $ 150,000     13.2%   $ 150,000     12.2%
                                 = 18.4%
   Total stock,
Common assets $10 par $1,139,500
                              500,000   43.9      500,000     40.6
Retained earnings             179,500   15.7      137,500     11.2
                             $829,500   72.8%    $787,500     64.0%
                           $1,139,500 100.0%    $1230,500    100.0%
                                                               C16- 7
                        Lincoln Company
                    Comparative Balance Sheets
                              December 31, 2003 December 31, 2002
       Assets                 Amount Percent    Amount Percent
                                       Common-Size Statements
Current assets               $ 550,000    48.3%    $ 533,000    43.3%
Long-term investments           95,000     8.3       177,500    14.4
Fixed assets (net)             444,500    39.0       470,000    38.2
Intangible assets               50,000     4.4        50,000     4.1
                            $1,139,500   100.0%   $1,230,500   100.0%
     Liabilities
Current liabilities         $ 210,000    18.4%     $ 243,000   19.7%
Long-term liabilities         100,000     8.8        200,000   16.3
                             $310,000    27.2%     $ 443,000   36.0%
 Stockholders’ Equity
Preferred stock, $100 par    $ 150,000    13.2%   $ 150,000     12.2%
Common stock, $10 par          500,000    43.9      500,000     40.6
Retained earnings              179,500    15.7      137,500     11.2
                              $829,500    72.8%    $787,500     64.0%
                            $1,139,500   100.0%   $1230,500    100.0%
                                                                 C16- 8
           Solvency Analysis


Solvency is the ability of a business to meet its
financial obligations (debts) as they are due.
Solvency analysis focuses on the ability of a
business to pay or otherwise satisfy its current
and noncurrent liabilities.
This ability is normally assessed by examining
balance sheet relationships.




                                                    C16- 9
  Solvency Measures — The Short-Term Creditor

Working Capital and Current Ratio

                      2003         2002
Current assets      $550,000     $533,000
Current liabilities 210,000       243,000   Divide
Working capital     $340,000     $290,000 current
Current ratio             2.6         2.2 assets by
                                           current
 Use: To indicate the ability to meet     liabilities
      currently maturing obligations.




                                                   C16- 10
  Solvency Measures — The Short-Term Creditor

Acid-Test Ratio
                                2003      2002
Quick assets:
  Cash                       $ 90,500 $ 64,700
  Marketable securities        75,000   60,000
  Accounts receivable (net) 115,000 120,000
    Total                   $280,500 $244,700
Current liabilities         $210,000 $243,000
Acid-test ratio                    1.3     1.0

Use: To indicate instant debt-paying ability.



                                                 C16- 11
  Solvency Measures — The Short-Term Creditor

Accounts Receivable Turnover
                                 2003     2002
Net sales on account         $1,498,000 $1,200,000
Accounts receivable (net):
  Beginning of year           $ 120,000 $ 140,000
  End of year                   115,500   120,000
  Total                       $ 235,000 $ 260,000
  Average                     $ 117,500 $ 130,000
Accts. receivable turnover         12.7       9.2

Use: To assess the efficiency in collecting
     receivables and in the management of credit.

                                                 C16- 12
  Solvency Measures — The Short-Term Creditor

Number of Days’ Sales in Receivables

                                2003      2002
Accounts receivable (net)
  end of year              $ 115,000 $ 120,000
Net sales on account       $1,498,000 $1,200,000
Average daily sales on
  on account (sales  365) $    4,104 $    3,288
Number of days’ sales in
  receivables                      28        36.5

Use: To assess the efficiency in collecting
     receivables and in the management of credit.

                                                 C16- 13
  Solvency Measures — The Short-Term Creditor

Inventory Turnover
                            2003      2002
Cost of goods sold      $1,043,000 $ 820,000
Inventories:
  Beginning of year      $ 283,000 $ 311,000
  End of year              264,000   283,000
  Total                  $ 547,000 $ 594,000
  Average                $ 273,500 $ 297,000
Inventory turnover              3.8      2.8


Use: To assess the efficiency in the
     management of inventory.

                                                C16- 14
  Solvency Measures — The Short-Term Creditor

Number of Days’ Sales in Inventory

                             2003          2002
Inventories, end of year $ 264,000       $283,000
Cost of goods sold       $1,043,000      $820,000
Average daily cost of
  goods sold
  (COGS  365)            $   2,858      $   2,247
Number of days’ sales
  in inventory                 92.4          125.9

  Use: To assess the efficiency in the
       management of inventory.

                                                     C16- 15
  Solvency Measures — The Long-Term Creditor

Ratio of Fixed Assets to Long-Term Liabilities

                             2003          2002
Fixed assets (net)         $444,500      $470,000
Long-term liabilities      $100,000      $200,000
Ratio of fixed assets to
  long-term liabilities          4.4          2.4

 Use: To indicate the margin of safety
      to long-term creditors.




                                                    C16- 16
  Solvency Measures — The Long-Term Creditor

Ratio of Liabilities to Stockholders’ Equity

                             2003        2002
Total liabilities          $310,000    $443,000
Total stockholders’ equity $829,500    $787,500
Ratio of liabilities to
  stockholders’ equity         0.37            0.56

Use: To indicate the margin of safety to creditors.




                                                      C16- 17
  Solvency Measures — The Long-Term Creditor

Number of Times Interest Charges Earned

                                  2003       2002
Income before income tax      $ 900,000 $ 800,000
Add interest expense             300,000    250,000
Amount available for interest $1,200,000 $1,050,000
Number of times earned               4.0        4.2

 Use: To assess the risk to debtholders in terms
      of number of times interest charges were
      earned.



                                                   C16- 18
             Profitability Analysis

Profitability is the ability of an entity to earn profits.
This ability to earn profits depends on the
effectiveness and efficiency of operations as well
as resources available.
Profitability analysis focuses primarily on the
relationship between operating results reported in
the income statement and resources reported in
the balance sheet.




                                                         C16- 19
Profitability Measures — The Common Stockholder

Ratio of Net Sales to Assets
                               2003         2002
Net sales                  $1,498,000   $1,200,000
Total assets:
  Beginning of year        $1,053,000 $1,010,000
  End of year               1,044,500  1,053,000
  Total                    $2,097,500 $2,063,000
  Average                  $1,048,750 $1,031,500
            Excludes long-term investments




                                                 C16- 20
Profitability Measures — The Common Stockholder

Ratio of Net Sales to Assets
                                2003           2002
Net sales on account        $1,498,000     $1,200,000
Total assets:
  Beginning of year          $1,053,000    $1,010,000
  End of year                 1,044,500     1,053,000
  Total                      $2,097,500    $2,063,000
  Average                    $1,048,750    $1,031,500
Ratio of net sales to assets         1.4          1.2

 Use: To assess the effectiveness
      of the use of assets.


                                                    C16- 21
Profitability Measures — The Common Stockholder

Rate Earned on Total Assets
                              2003          2002
Net income                  $ 91,000      $ 76,500
Plus interest expense          6,000        12,000
  Total                     $ 97,000      $ 88,500
Total assets:
  Beginning of year        $1,230,500 $1,187,500
  End of year               1,139,500  1,230,500
  Total                    $2,370,000 $2,418,000
  Average                  $1,185,000 $1,209,000
Rate earned on total assets     8.2%       7.3%

 Use: To assess the profitability of the assets.

                                                   C16- 22
Profitability Measures — The Common Stockholder

Rate Earned on Stockholders’ Equity

                              2003          2002
Net income                  $ 91,000      $ 76,500
Stockholders’ equity:
  Beginning of year         $ 787,500  $ 750,000
  End of year                 829,500    787,500
  Total                    $1,617,000 $1,537,500
  Average                   $ 808,500  $ 768,750
Rate earned on equity           11.3%     10.0%

Use: To assess the profitability of the
     investment by stockholders.


                                                 C16- 23
Profitability Measures — The Common Stockholder

Rate Earned on Common Stockholders’ Equity
                              2003        2002
Net income                  $ 91,000   $ 76,500
Less preferred dividends       9,000      9,000
Remainder—common stock $ 82,000        $ 67,500
Common stockholders’ equity:
  Beginning of year        $ 637,500 $ 600,000
  End of year                679,500    637,500
  Total                   $1,317,000 $1,237,500
  Average                  $ 658,500 $ 618,750
Rate earned on common equity 12.5%       10.9%
 Use: To assess the profitability of the
      investment by common stockholders.
                                             C16- 24
Profitability Measures — The Common Stockholder

Earnings Per Share on Common Stock

                             2003        2002
Net income                 $ 91,000   $ 76,500
Less preferred dividends      9,000      9,000
Remainder—common stock $ 82,000       $ 67,500
Shares of common stock       50,000     50,000
Earnings per share on common $1.64       $1.35

 Use: To assess the profitability of the
      investment by common stockholders.




                                             C16- 25
Profitability Measures — The Common Stockholder

Price-Earnings Ratio

                                   2003         2002
Market price per share of common $41.00       $27.00
Earnings per share on common      $ 1.64       $ 1.35
Price-earnings ratio on common        25           20

Use: To indicate future earnings prospects,
     based on the relationship between
     market value of common stock and
     earnings.




                                                   C16- 26
Profitability Measures — The Common Stockholder

Dividend Yield

                                  2003       2002
Dividends per share of common    $ 0.80     $ 0.60
Market price per share of common $41.00    $27.00
Dividend yield on common stock   1.95%     2.22%

Use: To indicate the rate of return to common
     stockholders in terms of dividends.




                                                C16- 27
     Corporate Annual Reports

In addition to financial statements, the
annual report includes:
1.   Financial Highlights
2.   President’s Letter to the Stockholders
3.   Management Report
4.   Independent Auditors’ Report
5.    Historical Summary




                                              C16- 28
              HOME WORK
READING:
  1. Illustrative problem
  2. Self- examination questions
  3. Multiple choice
Writing:
  1. Exercise:
  2. Problem : 16-4B
Discussion:

                                   C16- 29
This is the end of Chapter 16




                            C16- 30

				
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