FINANCIAL STATEMENT Financial statement analysis helps users...

7-1

Chapter

7FINANCIAL STATEMENT ANALYSIS

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

7-2

Purpose of AnalysisPurpose of Analysis

Financial statement analysis helps users make better decisions.make better decisions.

Internal Users External UsersManagersOfficers

ShareholdersLenders


OfficersInternal Auditors

LendersCustomers

7-3

Purpose of AnalysisPurpose of Analysis

Financial measures are often usedto rank corporate performance.Examples of measures include:Examples of measures include:

Growthin sales

Return tostockholders

Profitmargins

Return onequity

Determined byanalyzing the

financialstatements.


statements.

7-4

Financial Statements Are Designed Financial Statements Are Designed for Analysisfor Analysis

ClassifiedFinancial

Statements

ComparativeFinancial

Statements

ConsolidatedFinancial

StatementsStatements Statements Statements

Items with certaincharacteristics aregrouped together.

Amounts fromseveral years

appear side by side.

Information for theparent and subsidiary

are presented.

Results

g p g

Helps identify

pp y

Presented as if

p

Resultsin standardized,

meaningfulbt t l

Helps identifysignificant

changes andt d

Presented as ifthe two companies

are a singleb i it


subtotals. trends. business unit.

7-5

Learning ObjectiveLearning Objective

To explain the uses of dollar and percentagedollar and percentage

changes, trend tpercentages,

component percentages and ratios.

LO1© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

LO1

7-6

Tools of AnalysisTools of Analysis

Dollar & Percentage Trend

PercentagesChanges Percentages

C tComponent Percentages Ratios


7-7

Dollar and Percentage ChangesDollar and Percentage Changes

Dollar Change:

Analysis Period Amount

Base PeriodAmount

DollarChange = –

Percentage Change:Percentage Change:

Dollar Change Base PeriodPercent ÷%%%% Dollar Change Base PeriodAmount

PercentChange = ÷%%%%


7-8


Evaluating Percentage Changesin Sales and Earnings

Sales and earnings In measuring quarterlygshould increase atmore than the rate

of inflation

g q ychanges, compare tothe same quarter inthe previous yearof inflation. the previous year.

Percentages may bemisleading when the


base amount is small.

7-9


Let’s look at the asset Let’s look at the asset section of Clover, Inc.section of Clover, Inc.section of Clover, Inc. section of Clover, Inc.

comparative balance sheet comparative balance sheet and income statement forand income statement forand income statement for and income statement for

2007 2007 and and 20062006..Compute the dollar changeCompute the dollar changeCompute the dollar change Compute the dollar change and the percentage change and the percentage change

for cashfor cashfor cash.for cash.


7-10

Clover, Inc.Comparative Balance Sheets

December 31, Dollar Percent

2007 2006Dollar

ChangePercent Change*

AssetsC t tCurrent assets: Cash and equivalents 12,000$ 23,500$ ? ? Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200

Total current assets 155 000$ 164 700$ Total current assets 155,000$ 164,700$ Property and equipment: Land 40,000 40,000 Buildings and equipment, net 120,000 85,000 Total property and equipment 160,000$ 125,000$ Total assets 315,000$ 289,700$


Total assets 315,000$ 289,700$ * Percent rounded to one decimal point.

7-11



2007 2006Dollar


AssetsCurrent assets:Current assets: Cash and equivalents 12,000$ 23,500$ (11,500)$ ? Accounts receivable, net 60,000 40,000 I t 80 000 100 000 Inventory 80,000 100,000

Prepaid expenses 3,000 1,200 Total current assets 155,000$ 164,700$ $12,000 – $23,500 = $(11,500)Property and equipment: Land 40,000 40,000 Buildings and equipment, net 120,000 85,000

$ , $ , $( , )

Buildings and equipment, net 120,000 85,000 Total property and equipment 160,000$ 125,000$ Total assets 315,000$ 289,700$ * P t d d t d i l i t


* Percent rounded to one decimal point.

7-12



2007 2006Dollar


AssetsC t tCurrent assets: Cash and equivalents 12,000$ 23,500$ (11,500)$ -48.9% Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200

Total current assets 155 000$ 164 700$($11,500 ÷ $23,500) × 100% = 48.94% Total current assets 155,000$ 164,700$ Property and equipment: Land 40,000 40,000

($11,500 $23,500) 100% 48.94%

Complete the Buildings and equipment, net 120,000 85,000 Total property and equipment 160,000$ 125,000$ Total assets 315,000$ 289,700$

analysis for the other assets


Total assets 315,000$ 289,700$ * Percent rounded to one decimal point.

assets.

7-13



2007 2006Dollar


AssetsC t tCurrent assets: Cash and equivalents 12,000$ 23,500$ (11,500)$ -48.9% Accounts receivable, net 60,000 40,000 20,000 50.0% Inventory 80,000 100,000 (20,000) -20.0% Prepaid expenses 3,000 1,200 1,800 150.0%

Total current assets 155 000$ 164 700$ (9 700) -5 9% Total current assets 155,000$ 164,700$ (9,700) -5.9%Property and equipment: Land 40,000 40,000 - 0.0% Buildings and equipment, net 120,000 85,000 35,000 41.2% Total property and equipment 160,000$ 125,000$ 35,000 28.0%Total assets 315,000$ 289,700$ 25,300$ 8.7%


Total assets 315,000$ 289,700$ 25,300$ 8.7%* Percent rounded to one decimal point.

7-14

Trend PercentagesTrend Percentages

Trend analysis is used to reveal patterns in data y pcovering successive periods.

TrendPercentages

Analysis Period Amount Base Period Amount 100%= ×


Percentages

7-15

Trend Percentages

Berry Products

Trend Percentages

Berry ProductsIncome Information

For the Years Ended December 31, Item 2007 2006 2005 2004 2003

Revenues 400,000$ 355,000$ 320,000$ 290,000$ 275,000$ Cost of sales 285 000 250 000 225 000 198 000 190 000Cost of sales 285,000 250,000 225,000 198,000 190,000 Gross profit 115,000 105,000 95,000 92,000 85,000

Item 2007 2006 2005 2004 20032003 is the base period so its

amounts will equal 100%.

Item 2007 2006 2005 2004 2003Revenues 145% 129% 116% 105% 100%Cost of sales 150% 132% 118% 104% 100%G fit 135% 124% 112% 108% 100%

qGross profit 135% 124% 112% 108% 100%

(290,000 275,000) 100% = 105%


(198,000 190,000) 100% = 104%(92,000 85,000) 100% = 108%

7-16

Component Percentages

Examine the relative size of each item in the

Component Percentages

Examine the relative size of each item in the financial statements by computing component

(or common sized) percentages(or common-sized) percentages.

Component Analysis AmountComponent Percentage 100%Analysis Amount

Base Amount= ×

Financial Statement Base AmountBalance Sheet Total AssetsIncome Statement Revenues


Income Statement Revenues

7-17Clover, inc.Comparative Balance Sheets

December 31, Common-size

Percents*Complete the common-size analysis for the other

assets. Percents2007 2006 2007 2006

Assets

assets.

Current assets: Cash and equivalents 12,000$ 23,500$ 3.8% 8.1%Accounts receivable net 60 000 40 000 Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000 Prepaid expenses 3,000 1,200

($12 000 ÷ $315 000) × 100% = 3 8% Total current assets 155,000$ 164,700$ Property and equipment:Land 40 000 40 000

($12,000 ÷ $315,000) × 100% = 3.8%

($23,500 ÷ $289,700) × 100% = 8.1% Land 40,000 40,000 Buildings and equipment, net 120,000 85,000 Total property and equipment 160,000$ 125,000$

($23,500 ÷ $289,700) × 100% 8.1%


Total assets 315,000$ 289,700$ 100.0% 100.0%* Percent rounded to first decimal point.

7-18Clover, Inc.Comparative Balance Sheets

December 31, Common-size

Percents* Percents2007 2006 2007 2006

AssetsCurrent assets: Cash and equivalents 12,000$ 23,500$ 3.8% 8.1%Accounts receivable net 60 000 40 000 19 0% 13 8% Accounts receivable, net 60,000 40,000 19.0% 13.8%

Inventory 80,000 100,000 25.4% 34.6% Prepaid expenses 3,000 1,200 1.0% 0.4% Total current assets 155,000$ 164,700$ 49.2% 56.9%Property and equipment:Land 40 000 40 000 12 7% 13 8% Land 40,000 40,000 12.7% 13.8%

Buildings and equipment, net 120,000 85,000 38.1% 29.3% Total property and equipment 160,000$ 125,000$ 50.8% 43.1%


Total assets 315,000$ 289,700$ 100.0% 100.0%* Percent rounded to first decimal point.

7-19Clover, Inc.Comparative Balance Sheets

December 31,December 31,

Common-size

Percents*2007 2006 2007 20062007 2006 2007 2006

Liabilities and Shareholders' EquityCurrent liabilities: Accounts payable 67,000$ 44,000$ 21.3% 15.2%p y ,$ ,$ Notes payable 3,000 6,000 1.0% 2.1% Total current liabilities 70,000$ 50,000$ 22.3% 17.3%Long-termliabilities:Long term liabilities: Bonds payable, 8% 75,000 80,000 23.8% 27.6% Total liabilities 145,000$ 130,000$ 46.1% 44.9%Shareholders' equity:Shareholders equity: Preferred stock 20,000 20,000 6.3% 6.9% Common stock 60,000 60,000 19.0% 20.7%Additional paid-in capital 10,000 10,000 3.2% 3.5% Additional paid in capital 10,000 10,000 3.2% 3.5%

Total paid-in capital 90,000$ 90,000$ 28.5% 31.1%Retained earnings 80,000 69,700 25.4% 24.0%

Total shareholders' equity 170 000$ 159 700$ 53 9% 55 1%


Total shareholders equity 170,000$ 159,700$ 53.9% 55.1%Total liabilities and shareholders' equity 315,000$ 289,700$ 100.0% 100.0%* Percent rounded to first decimal point.

7-20Clover, Inc.

Comparative Income StatementspFor the Years Ended December 31,

Common-size Percents*

2007 2006 2007 2006Revenues 520 000$ 480 000$ 100 0% 100 0%Revenues 520,000$ 480,000$ 100.0% 100.0%Costs and expenses:Cost of sales 360 000 315 000 69 2% 65 6% Cost of sales 360,000 315,000 69.2% 65.6%

Selling and admin. 128,600 126,000 24.7% 26.3% Interest expense 6,400 7,000 1.2% 1.5%pIncome before taxes 25,000$ 32,000$ 4.8% 6.7%Income taxes (30%) 7,500 9,600 1.4% 2.0%Net income 17,500$ 22,400$ 3.4% 4.7%Net income per share 0.79$ 1.01$


Avg. # common shares 22,200 22,200 * Rounded to first decimal point.

7-21


To discuss the quality of a company’s earningsa company’s earnings,

assets, and working it lcapital.


LO2

7-22

Quality of EarningsQuality of Earnings

Investors are interest in companies that demonstrate an ability to earn income at a

growing rate each year. Stability of earnings growth helps investors predict future prospects

for the company.

Financial analyst often speak of the “quality of earnings” at one company being higher than another

i th i d tcompany in the same industry.


7-23

Quality of EarningsQuality of Earnings

While satisfactory earnings may be a good indicator of a company’s ability togood indicator of a company s ability to

pay its debts and dividends, we must also consider the composition of assets theirconsider the composition of assets, their

condition and liquidity, the timing of t f li biliti d th t t lrepayment of liabilities, and the total

amount of debt outstanding


7-24


To explain the nature and purpose ofand purpose of classifications in

fi i l t t tfinancial statements.


LO3

7-25

A Classified Balance SheetA Classified Balance Sheet

Matrix IncAsset Section of the Balance SheetAsset Section of the Balance Sheet

Current assets:

Matrix, Inc.Balance Sheet

December 31, 2007

Cash 30,000$ Notes receivable 16,000 Accounts receivable 60,000

I t 70 000 Inventory 70,000 Prepaid expenses 4,000 Total current assets 180,000 Plant and equipment:Plant and equipment: Land 150,000$ Building 121,000$ Less: Accumulated depreciation (10,000) 111,000 Equipment and Fixtures 46,000 Less: Accumulated depreciation (27,000) 19,000 Total plant and equipment 280,000 Other assets:


Other assets: Patents 170,000 Total assets 630,000$

7-26

A Classified Balance SheetA Classified Balance Sheet

Matrix IncLiability and Stockholders’ Equity Section of the Balance SheetLiability and Stockholders’ Equity Section of the Balance Sheet

Current liabilities

Matrix, Inc.Balance Sheet

December 31, 2007Current liabilities Notes payable 10,000$ Accounts payable 62,000 Income taxes payable 16,000 Accrued expenses payable 8,000 Total current liabilities 4,000 Long-term liabilities: 100,000

Mortgage payable (due in 25 years) 65 000$ Mortgage payable (due in 25 years) 65,000$ Bonds payable (due in 15 years) 100,000 Total long-term liabilities 165,000

Total liabilities 265,000 Total liabilities 265,000 Stockholders' equity Capital stock (15,000 shares) 15,000$ Retained earnings 350,000


Total stockholders' equity 365,000 Total liabilities and stockholders' equity 630,000$

7-27


To prepare a classified balance sheet andbalance sheet and

compute widely used f li iditmeasures of liquidity

and credit risk.


LO4

7-28

RatiosRatios

A ratio is a simple mathematical expressionof the relationship between one item and another.

Along ith dollar and percentage changesAlong with dollar and percentage changes,trend percentages, and component percentages,

ratios can be used to compare:ratios can be used to compare:

Past performance topresent performance.

Other companies toyour company.


y y

7-29

Babson Builders, Inc.2007

Cash 30,000$ Accounts receivable netAccounts receivable, net Beginning of year 17,000

End of year 20,000Use this Use this

i f ti ti f ti t End of year 20,000 Inventory Beginning of year 10,000

information to information to calculate the calculate the

End of year 15,000 Total current assets 65,000 T t l t li biliti 42 000

liquidity ratios liquidity ratios for Babsonfor Babson Total current liabilities 42,000

Total liabilities 103,917 Total assets

for Babson for Babson Builders, Inc.Builders, Inc.

Total assets Beginning of year 300,000 End of year 346,390


y ,Revenues 494,000

7-30

Working CapitalWorking Capital

Working capital is the excess of current assets over current liabilities.assets over current liabilities.

12/31/07C t t 65 000$Current assets 65,000$ Current liabilities (42,000)Current liabilities (42,000) Working capital 23,000$


7-31

Current RatioCurrent Ratio

This ratio measures the short-term debt-paying ability of the company.

CurrentRatio

Current AssetsCurrent Liabilities=Ratio Current Liabilities

Current $65,000 = 11..55 55 : : 11CurrentRatio

$65,000$42,000=


7-32

Quick RatioQuick Ratio

Quick AssetsCurrent Liabilities=Quick

Ratio

Quick assetsQuick assets are cash, marketableare cash, marketable

Current LiabilitiesRatio

Quick assetsQuick assets are cash, marketable are cash, marketable securities, and receivables.securities, and receivables.

This ratio is like the currentThis ratio is like the currentti b tti b t l dl d t tt tratio but ratio but excludesexcludes current assets current assets

such as inventories that may be such as inventories that may be diffi lt t i kl t i t hdiffi lt t i kl t i t h


difficult to quickly convert into cash. difficult to quickly convert into cash.

7-33

Quick RatioQuick Ratio

Quick AssetsCurrent Liabilities=Quick

Ratio Current LiabilitiesRatio

$50 000Quick $50,000$42,000 = 11..19 19 : : 11=Quick

Ratio

This ratio is like the currentThis ratio is like the currentti b tti b t l dl d t tt tratio but ratio but excludesexcludes current assets current assets

such as inventories that may be such as inventories that may be diffi lt t i kl t i t hdiffi lt t i kl t i t h


difficult to quickly convert into cash. difficult to quickly convert into cash.

7-34

Uses and Limitations of Financial RatiosRatios

Uses Limitations

R ti h l

Uses

M t t

Limitations

Ratios help usersunderstand

financial relationships.

Management may enterinto transactions merely

to improve the ratios.

Ratios provide for Ratios do not help withRatios provide forquick comparison

of companies.

Ratios do not help withanalysis of the company's

progress towardnonfinancial goals


nonfinancial goals.

7-35


To prepare a multiple-step and a single stepstep and a single-step income statement and

t id l dcompute widely used measures of profitability.


LO5

7-36

Measures of ProfitabilityMeasures of Profitability

An income statement can be prepared in either aAn income statement can be prepared in either a multiple-step or single-step format.

The single-step format is simpler.The multiple step format providesThe multiple-step format provides

more detailed information.


7-37

Income Statement (Multiple Step)Babson Builders, Inc.

I SP H diP H di

Income Statement (Multiple-Step)

Income StatementFor the Year Ended 12/31/07

Sales net 785 250$

Proper HeadingProper Heading

Sales, net 785,250$ Cost of goods sold 351,800 Gross margin 433,450$ Operating expenses:

S lli 197 350$

Gross MarginGross Margin

Selling expenses 197,350$ General & Admin. 78,500 Depreciation 17,500 293,350 Income from Operations 140,100$

Operating ExpensesOperating Expensesp ,$

Other revenues & gains: Interest income 62,187$ Gain 24,600 86,787 Other expenses:NonNon--operating Itemsoperating Items Other expenses: Interest 27,000$ Loss 9,000 (36,000) Income before taxes 190,887$

NonNon operating Itemsoperating Items

Remember to Remember to


Income taxes 62,500 Net income 128,387$

compute EPS.compute EPS.

7-38

Income Statement (Single Step)Babson Builders, Inc.

Income Statement (Single-Step)

Income StatementFor the Year Ended 12/31/07

Proper HeadingProper Heading

Revenues and gains: Sales, net 785,250$ Interest income 62,187

Gain on sale of plant assets 24 600Revenues & GainsRevenues & Gains

Remember to compute EPS. Gain on sale of plant assets 24,600

Total revenues and gains 872,037$

Expenses and losses:

p

Cost of goods sold 351,800$ Selling Expenses 197,350 General and Admin. Exp. 78,500

Depreciation 17 500Expenses & LossesExpenses & Losses Depreciation 17,500 Interest 27,000 Income taxes 62,500 Loss: sale of investment 9,000

Expenses & LossesExpenses & Losses


oss sa e o est e t 9,000Total expenses & losses 743,650 Operating income 128,387$

7-39

Babson Builders IncBabson Builders, Inc.2007

E di k t i h 15 25$Use this Use this information to information to

Ending market price per share 15.25$ Number of common shares

t t di ll f 2007 27 400calculate the calculate the profitability profitability

outstanding all of 2007 27,400 Net income 53,690$ Total shareholders' equityp yp y

ratios for ratios for Babson Babson

Total shareholders equity Beginning of year 180,000 End of year 234,390

Builders, Inc.Builders, Inc.y ,

Revenues 494,000 Cost of sales 140,000 Total assets Beginning of year 300,000

End of year 346 390


End of year 346,390

7-40


To put a company’s net income into perspectiveincome into perspective by relating it to sales,

t dassets, and stockholders’ equity.


LO6

7-41

Earning Per ShareEarning Per Share

Net IncomeAverage Shares of Capital Stock Outstanding = EPSAverage Shares of Capital Stock Outstanding

Look back at the information from Babson and get Look back at the information from Babson and get the values we need to calculate earning per share.the values we need to calculate earning per share.

$$5353,,6906902727,,400400 = $= $11..9696

g pg p


7-42

Price Earnings RatioPrice-Earnings Ratio

Current Market Price of one Share of StockEarnings Per Share = P/EEarnings Per Share

$$1515..2525$$11..9696 = = 77..7878


7-43


To compute the ratios widely used in financialwidely used in financial statement analysis and

l i th i ifiexplain the significance of each.


LO7

7-44

Return On Investment (ROI)Return On Investment (ROI)

This ratio is a good measure of This ratio is a good measure of the efficiency of utilization ofthe efficiency of utilization ofthe efficiency of utilization of the efficiency of utilization of

assets by the business.assets by the business.

A l t ( fit) f d i t tAnnual return (profit) from and investmentAverage amount invested

ROI =


7-45

Return On Assets (ROA)Return On Assets (ROA)

This ratio is generally consideredThis ratio is generally consideredthe best overall measure of athe best overall measure of athe best overall measure of athe best overall measure of a

company’s profitability.company’s profitability.

ROA N t i A t t l tROA N t i A t t l tROA = Net income ÷ Average total assets

= 53 690$ ÷ ($300 000 + $346 390) ÷ 2

ROA = Net income ÷ Average total assets

= 53 690$ ÷ ($300 000 + $346 390) ÷ 2 53,690$ ($300,000 + $346,390) ÷ 2 = 16.61% 53,690$ ($300,000 + $346,390) ÷ 2 = 16.61%


7-46

Return On Equity (ROE)Return On Equity (ROE)

This measure indicates how well the company employed the owners’company employed the owners

investments to earn income.

ROA = Net income ÷ Average total equity

= 53,690$ ÷ ($180,000 + $234,390) ÷ 2= 25.91%


7-47


To analyze financial statements from thestatements from the

viewpoints of common t kh ld ditstockholders, creditors,

and others.


LO8

7-48

Dividend YieldDividend Yield

DividendYield Ratio

Dividends Per ShareMarket Price Per Share=Yield Ratio Market Price Per Share

Di id d $1 50Babson Builders pays an annual dividend of Babson Builders pays an annual dividend of $$11 5050 h f it l t k Th k th f it l t k Th k tDividend

Yield Ratio$1.50$15.25= = 99..8484%%$$11..50 50 per share of capital stock. The market per share of capital stock. The market

price of the company’s capital stock was price of the company’s capital stock was $$1515 2525 t th d ft th d f 20072007

This ratio identifies the return inThis ratio identifies the return in

$$1515..25 25 at the end of at the end of 20072007..

This ratio identifies the return, in This ratio identifies the return, in terms of cash dividends, on the terms of cash dividends, on the

current market price of the stock.current market price of the stock.


pp

7-49

Analysis by Long Term CreditorsAnalysis by Long-Term Creditors

Use this information to calculate ratios Use this information to calculate ratios to measure the wellto measure the well--being of the longbeing of the long--g gg g

term creditors for Babson Builders.term creditors for Babson Builders.Babson Builders, Inc.

2007Earnings before interestEarnings before interest expense and income taxes 84,000$ Interest expense 7,300 This is also referredThis is also referred p ,Total assets 346,390 Total stockholders' equity 234,390

This is also referred This is also referred to as net operating to as net operating

income.income.


q yTotal liabilities 112,000

co eco e

7-50

Interest Coverage RatioInterest Coverage Ratio

Times Interest Earned

Operating income before Interest and Income Taxes

Annual Interest Expense=

Earned Annual Interest Expense

Times $84 000Interest Earned

$84,0007,300= = 1111..5 5 timestimes

This is the most common This is the most common measure of the ability of a firm’smeasure of the ability of a firm’smeasure of the ability of a firm s measure of the ability of a firm s operations to provide protection operations to provide protection

to the longto the long--term creditor.term creditor.


gg

7-51

Debt RatioDebt Ratio

A measure of creditor’s long-term risk.The smaller the percentage of assets thatThe smaller the percentage of assets that

are financed by debt, the smaller the risk f ditfor creditors.

Debt Ratio = Total

Liabilities ÷ Total AssetsDebt Ratio = Total

Liabilities ÷ Total Assets

= $112,000 ÷ $346,390


= 32.33%

7-52

Analysis by Short Term CreditorsAnalysis by Short-Term Creditors

Babson Builders, Inc.2007

C h 30 000$

Use this Use this information toinformation to Cash 30,000$

Accounts receivable, net Beginning of year 17 000

information to information to calculate ratios calculate ratios t tht th Beginning of year 17,000

End of year 20,000 Inventory

to measure the to measure the wellwell--being of the being of the

Beginning of year 10,000 End of year 12,000

shortshort--term term creditorscreditors for for

Total current assets 65,000

Total current liabilities 42,000 S l t 500 000

Babson Builders, Babson Builders, IncInc


Sales on account 500,000 Cost of goods sold 140,000

Inc.Inc.

7-53

Accounts Receivable Turnover RateAccounts Receivable Turnover Rate

Net SalesAverage Accounts Receivable

Accounts ReceivableTurnover

=Turnover

Accounts= 2727..03 03 timestimes$500,000

($17,000 + $20,000) ÷ 2

Accounts ReceivableTurnover

=

Thi ti hThi ti hThis ratio measures how many This ratio measures how many times a company converts its times a company converts its

receivables into cash each yearreceivables into cash each year© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

receivables into cash each year.receivables into cash each year.

7-54

Number of Days to Collect ReceivablesNumber of Days to Collect Receivables

Average Collection =

365 DaysAccounts Receivable Turnover

Period

= 1313..50 50 daysdaysAverage

Collection Period

= 365 Days27.03 Times

This ratio measures, on average,This ratio measures, on average,

Period

This ratio measures, on average, This ratio measures, on average, how many days it takes to collect how many days it takes to collect

an account receivable. an account receivable.


7-55

Inventory Turnover RateInventory Turnover Rate

Cost of Goods SoldAverage Inventory

InventoryTurnover = g y

$140 000Inventory = 1212..73 73 timestimes$140,000($10,000 + $12,000) ÷ 2

InventoryTurnover =

This ratio measures the numberThis ratio measures the numberof times merchandise inventoryof times merchandise inventory

is sold and replaced during the year.is sold and replaced during the year.


7-56

Average Days Sales In InventoryAverage Days Sales In Inventory

A 365 DAverage Sale Period = 365 Days

Inventory Turnover

A 365 D = 2828..67 67 daysdaysAverage Sale Period = 365 Days

12.73 Times

This ratio measures how manyThis ratio measures how manyThis ratio measures how many This ratio measures how many days, on average, it takes to days, on average, it takes to

sell the inventorysell the inventory


sell the inventory.sell the inventory.

7-57

Operating CycleOperating Cycle

Cash

InventoryAccountsReceivableReceivable

22. Sale of merchandise on account. Sale of merchandise on account


7-58

End of ChapterEnd of Chapter


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