Juan Isaza

MBA 520 Module Two Financial Statement Analysis

1. Calculate XYZ’s 2013 current and quick ratios based on the projected balance sheet and income
statement data.

Current Ratio = Total current assets / Total Current Liabilities

= $2,680,112 / $1,144,800
= 2.34

Current ratio based on the projected balance sheet and income statement data is 2.34

The company’s ability to pay short-term liabilities (debt and payables) with its short-term assets (cash,
inventory, receivables) is very healthy. Investors and analysists consider a current ratio of 2.05 to be
financially healthy and capable of paying off obligations. Therefore, a current ratio of 2.34 is considered
healthy (Myaccountingcourse, 2017).

Quick Ratio = (Current Assets – Inventories) / Current Liabilities

= ($2,680,112 – $1,716,480) / $1,144,800
= .842

Quick Ratio based on the projected balance sheet and income statement data is .842

The quick ratio excludes inventory because it’s a slower source of immediate cash; hence inventory
takes a while to sell and may even be negotiated at a lower price than book value. A quick ratio of .842
informs investors that the company’s current assets are dependent on inventory. Thus, the company
has $.842 of liquid assets available to cover each $1.00 of current liabilities.

2. (12.5 points) Calculate the 2013 inventory turnover, days sales outstanding (DSO), fixed assets
turnover, and total assets turnover.

Inventory Turnover = Sales / Inventory

=$7,035,600 / $1,716,480
= 4.10

Inventory Turnover based on the projected balance sheet and income statement data is 4.10

The inventory turnover ratio informs investors of the company’s efficiency on managing inventory and
generating sales from it. It is important to use average inventory instead of ending inventory hence
merchandise may fluctuate throughout the year. This means that the company XYZ sold its inventory a

Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.
total of 4.10 times during the year. A low inventory turnover may lead to other costs like storage costs
and holding costs (Myaccountingcourse, 2017).

Days Sales Outstanding = Accounts Receivable / Sales (365 days)

= $878,000 / $7,035,600 (365 days)
= 45.5 days

Days Sales Outstanding based on the projected balance sheet and income statement data is 45.5 days

The days sales outstanding (DSO) calculation informs inventors how many days it takes the company to
collect payment from its credit sales. In addition, this calculation shows how efficient the company’s
collection department is. Therefore, it takes XYZ 45.5 days to convert its sales to cash. Generally, a low
DSO is desired. Companies collecting cash earlier may use this cash for different operations
(Myaccountingcourse, 2017).

Fixed Asset Turnover = Sales / Fixed Assets

= $7,035,600 / $817,040
= 8.6

Fixed Asset Turnover based on the projected balance sheet and income statement data is 8.6

The fixed asset turnover ratio measures the return of a company’s investment in equipment, plant, and
property. The calculations allows investors to understand how well the company utilizes its equipment
to generate sales. Therefore, the company XYZ generates 8.6 times more sales than the net book value
of its assets (Myaccountingcourse, 2017).

Total Asset Turnover = Sales / Total Assets

= $7,035,600 / $3,497,152
= 2.01

Total Asset Turnover based on the projected balance sheet and income statement data is 2.01

By dividing net sales with the average total assets, investors are able to see how efficient a company
may be at using its assets to generate sales. Higher turnover ratios are signs of efficient utilization of
assets. Thus, the company generates a total of $2.01 for every one dollar in assets
(Myaccountingcourse, 2017).

3. (12.5 points) Calculate the 2013 debt-to-assets and times-interest-earned ratios.

Debt-to-assets = Total Debt / Total Assets

= $1,544,800 / $3,497,152
= 44%

Debt-to-assets based on the projected balance sheet and income statement data is 44%

Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.
Dividing the total debt by the total assets gives investors hindsight on the company’s leverage. This
figure shows if the company has enough cash to meet all of its obligations, if it is able to pay a return on
investment, and how much debt the company has accrued. A lower figure is always desired; companies
with higher figures are considered riskier to invest in hence they are more leveraged. Therefore, the
company XYZ has a DTA of .44, meaning it currently has more assets than liabilities. To get a better
understanding of this figure, it is important to take a look at the rest of the industry to analyze
performance (Myaccountingcourse, 2017).

Times-interest-earned Ratio = Earnings Before Interest And Taxes or EBIT / Interest Expense
= $492,648 / $70,008
= 7.04

Times-interest-earned Ratio based on the projected balance sheet and income statement data is 7.04

The times-interest-earned ratio is a measurement of the income which could be used to cover interest
expenses in the foreseeable future. This ratio informs investors of the company’s ability to make
interest and debt service payments. Therefore, the company XYZ could pay the interest with its income
before tax a total of 7.04 times. Moreover, the company’s income is greater than its interest expense
(Myaccountingcourse, 2017).

4. (12.5 points) Calculate the 2013 operating margin, profit margin, basic earning power (BEP), return on
assets (ROA), and return on equity (ROE).

Operating Margin = Operating Income / Net Sales

= $609,608 / $7,035,600
= 9%

Operating Margin based on the projected balance sheet and income statement data is 9%

Also known as the operating profit margin, the operating margin informs investors of how much
revenue is generated from operating income. Thus, it shows the leftover revenue after all variable or
operating costs have been paid. This measurement allows one to see the proportion of revenue
available to pay off other non-operating costs, like interest expense. Therefore, a 9% operating margin
is not a very desirable figure; for, every dollar of income, the company XYZ is retaining 9 cents for every
dollar of income, and this figure does not cover non-operating expenses. However, the operating
margin costs of the previous year is -2.2% and the industry average is 7.3%. In other words, the
company is performing better than last year and is performing better than industry average.

Profit Margin = Net Income / Net sales

= $253,584 / $7,035,600
= 4%

Profit Margin based on the projected balance sheet and income statement data is 4%

In continuation of the previous ratio, this ratio shows the total revenue after all expenses have been paid
off. It is also important to be aware of the industry average for a better understanding of this figure.

Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.
Thus, XYZ was able to convert 4% of its sales into actual profits. However, this figure is higher than
industry average and is higher than last year. But, not higher than the year prior to last year.

Basic Earning Power = Earnings Before Taxes or EBIT / Total Assets

= $492,648 / $3,497,152
= 14%

Basic Earning Power based on the projected balance sheet and income statement data is 14%

The higher the ratio, the more effectiveness in generating income for assets. This ratio utilizes EBIT
instead of operating income for it considers all income earned by the company and not only income
from operating activity. This allows a bigger picture of how the company generates cash
(Myaccountingcourse, 2017).

Return On Assets or ROA = Net Income / Average Total Assets

= $253,584 / $3,497,152
= 7.25%

Return On Assets based on the projected balance sheet and income statement data is 7.25%

Return on assets, or ROA, is a ratio that is utilized to measure the net income generated by total assets.
By utilizing this ratio, one is able to measure the company’s efficiency in managing its assets to produce
profits during a certain period. Thus, the company was able to generate $.07 of net income for every
$1.00 invested in assets (Myaccountingcourse, 2017).

Return On Equity or ROE = Net Income / Equity

= $253,584 / $1,952,352
= 12.9%

Return On Equity or ROE based on the projected balance sheet and income statement data is %13

The ROE ratio exposes the ability of a form to create profits from shareholder investments. Therefore,
for every dollar of common shareholder’s equity, XYZ was able to yield $0.13 out of that one dollar. The
average industry ROE is 18.2%. Thus, XYZ is below the industry average, but performed better than the
previous year (-32.5%) (Myaccountingcourse, 2017).

5. (12.5 points) Calculate the 2013 price/earnings ratio, and market/book ratio.

Price/Earnings Ratio = Price Per Share / Earnings Per Share

= $12.7 / $1.014
= 12 times

Price/earnings ratio based on the projected balance sheet and income statement data is 12 times.

This ratio lets investors know how much they ought to pay for a stock based on the company’s current
earnings. Therefore, investors are willing to pay $12 for every dollar of earnings (Myaccountingcourse,
2017).

Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.
Market/Book Ratio = Market Price Per Share / Book Value Per Share
= $12.17 / 7.809
= 1.55 times
Market/book ratio based on the projected balance sheet and income statement data is 1.55 times.

This is the price the market thinks the company is worth. A P/B ratio of 1 or more generally indicates a
bright future; for investors are willing to pay more than the worth of a company’s net assets
(Myaccountingcourse, 2017).

6. (12.5 points) Use the extended DuPont equation to provide a summary and overview of XYZ’s
financial condition as projected for 2013.

DuPont Equation = Profit Margin × Total Assets Turnover × Financial Leverage

= Net Income × Net Sales × Total Assets

Net sales Total Assets Total Equity

= ($253,584 / $7,035,600) × ($7,035,600 / $3,497,152) × ( $3,497,152 / $1,952,352)

= (0.036) × (2.01) × (1.79)
= 13%

The DuPont equation is more useful for some industry than it is for others. At a quick glance, the
company XYZ may seem like it is not performing all that well. However, it is imperative to compare its
performance with the industry average. And, XYZ is in par with the rest of the industry
(Myaccountingcourse, 2017).

7. (12.5 points) Use the following simplified 2013 balance sheet to show, in general terms, how an
improvement in the DSO would tend to affect the stock price. For example, if the company could
improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry
average without affecting sales, how would that change “ripple through” the financial statements
(shown in thousands below) and influence the stock price?

Reducing the DSO from 45.6 days to 32 days would have an immediate effect on all other processes.
Even if sales are not affected, a reduced DSO is always desired. For the faster a company can convert its
sales into cash, the faster it can purchase stock, expand business, and reduce debt. All these processes
have an influence on stock price (Myaccountingcourse, 2017).

Accounts receivable $878 Debt $1,545

Other current assets 1,802
Net fixed assets 817 Equity 1,952
Total assets $3,497 Liabilities plus equity $3,497

First, we need to calculate XYZ’s daily sales.

Daily sales = Sales / 365

Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.
 Daily sales = $7,035,600 / 365
Daily sales = $19,275.62

Target A/R = Daily sales × Target DSO

Target A/R = $19,276 × 32
Target A/R = $616,820

Freed-up cash =old A/R – new A/R

Freed-up cash =$878,000 – $616,820
Freed-up cash =$261,180

8. (12.5 points) Provide a brief summary or rationale of how these ratios are used, and why they are
important.

I provided a brief summary or rationale for each and every question. All the ratios previously mentioned
are all important for a financial statement analysis as they give hindsight on all important factors of the
company. After performing this analysis, I have found the importance in checking the industry average
before making an opinion on performance (Myaccountingcourse, 2017).

Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.
Worksheet adapted from Brigham, E., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.).
Boston, MA: Cengage Learning.