Financial & Managerial

Accounting
The Basis for Business Decisions
FOURTEENTH EDITION

Williams Haka Bettner Carcello

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

14
FINANCIAL STATEMENT
ANALYSIS

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

 Purpose
Purpose of
of Analysis
Analysis

Financial statement analysis helps users

make better decisions.

Internal Users External Users

Managers Shareholders
Officers Lenders
Internal Auditors Customers
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Purpose
Purpose of
of Analysis
Analysis
F in a n c ia l m e a s u r e s a r e o fte n u s e d
to ra n k c o r p o r a te p e r fo r m a n c e .
E x a m p le s o f m e a s u r e s in c lu d e :

G ro w th R e tu r n to P r o fit R e tu r n o n
in s a le s s to c k h o ld e rs m a r g in s e q u ity

D e te r m in e d b y
a n a ly z in g th e
fin a n c ia l
s ta te m e n ts .

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 Financial
Financial Statements
Statements Are
Are Designed
Designed
for
for Analysis
Analysis
C la s s ifie d C o m p a ra tiv e C o n s o lid a te d
F in a n c ia l F in a n c ia l F in a n c ia l
S ta te m e n ts S ta te m e n ts S ta te m e n ts

I t e m s w i t h c e r t a in A m o u n ts fr o m In fo r m a tio n fo r th e
c h a r a c te r is tic s a r e s e v e ra l y e a rs p a r e n t a n d s u b s id ia ry
g ro u p e d to g e th e r. a p p e a r s id e b y s id e . a re p re s e n te d .

R e s u lts H e lp s id e n tify P r e s e n t e d a s if
in s ta n d a r d iz e d , s ig n if ic a n t th e tw o c o m p a n ie s
m e a n in g fu l changes and a r e a s in g le
s u b to ta ls . tre n d s . b u s in e s s u n it.

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

 Learning
Learning Objective
Objective

To explain the uses of

dollar and percentage
changes, trend
percentages,
component percentages
and ratios.

LO1
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 Tools
Tools of
of Analysis
Analysis

Dollar &
Trend
Percentage
Percentages
Changes

Component
Ratios
Percentages

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 Dollar
Dollar and
and Percentage
Percentage Changes
Changes

Dollar Change:
Dollar Analysis Period Base Period
Change = Amount – Amount

Percentage Change:

% Percent
Change = Dollar Change
÷
Base Period
Amount

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

 Dollar
Dollar and
and Percentage
Percentage Changes
Changes

Evaluating Percentage Changes

in Sales and Earnings

Sales and earnings In measuring quarterly

should increase at changes, compare to
more than the rate the same quarter in
of inflation. the previous year.

Percentages may be
misleading when the
base amount is small.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Dollar
Dollar and
and Percentage
Percentage Changes
Changes

Let’s
Let’s look
look atat the
the asset
asset
section
section ofof Clover,
Clover, Inc.
Inc.
comparative
comparative balance
balance sheet
sheet
and
and income
income statement
statement for
for
2007
2007 and
and 2006.
2006.
Compute
Compute thethe dollar
dollar change
change
and
and the
the percentage
percentage change
change
for
for cash.
cash.

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

 Clover, Inc.
Comparative Balance Sheets
December 31,
Dollar Percent
2007 2006 Change Change*
Assets
Current 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
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
* Percent rounded to one decimal point.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Clover, Inc.
Comparative Balance Sheets
December 31,
Dollar Percent
2007 2006 Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) ?
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000–
$12,000
$12,000 $ 164,700 =
– $23,500
$23,500 = $(11,500)
$(11,500)
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
* Percent rounded to one decimal point.

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

 Clover, Inc.
Comparative Balance Sheets
December 31,
Dollar Percent
2007 2006 Change Change*
Assets
Current 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 ($11,500
($11,500 ÷÷ $23,500)
$ 155,000$23,500) ×× 100%
$ 164,700 100% == 48.94%
48.94%
Property and equipment:
Land 40,000 40,000 Complete
Complete thethe
Buildings and equipment, net 120,000 85,000 analysis
analysis for
for
Total property and equipment $ 160,000 $ 125,000 the
the other
other
Total assets $ 315,000 $ 289,700
assets.
assets.
* Percent rounded to one decimal point.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Clover, Inc.
Comparative Balance Sheets
December 31,
Dollar Percent
2007 2006 Change Change*
Assets
Current 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%
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%
* Percent rounded to one decimal point.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Trend
Trend Percentages
Percentages

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

Trend Analysis Period Amount

Percentages
=
Base Period Amount × 100%

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 Trend
Trend Percentages
Percentages
Berry Products
Income 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 285,000 250,000 225,000 198,000 190,000
Gross profit 115,000 105,000 95,000 92,000 85,000

Item 2007 2006 2005 2004 2003

Revenues 2003
145%is
2003 is the base
base period
the129% 116% so
period its
so 105%
its 100%
Cost of sales 150%
amounts132%
amounts will 118%
will equal
equal 100%.104%
100%. 100%
Gross profit 135% 124% 112% 108% 100%

(290,000  275,000)  100% = 105%

(198,000  190,000)  100% = 104%
(92,000  85,000)
McGraw-Hill/Irwin
 100% = 108% © The McGraw-Hill Companies, Inc., 2008
 Component
Component Percentages
Percentages
Examine the relative size of each item in the
financial statements by computing component
(or common-sized) percentages.

Component Analysis Amount

Percentage
=
Base Amount
× 100%

Financial
Financial Statement
Statement Base
Base Amount
Amount
Balance
Balance Sheet
Sheet Total
Total Assets
Assets
Income
Income Statement
Statement Revenues
Revenues

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 Clover, inc.
Comparative Balance Sheets
December 31,
Complete the common-size analysis for the other Common-size
assets. Percents*
2007 2006 2007 2006
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1%
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
($12,000
($12,000 ÷÷ $315,000)
Total current assets $ 155,000×
$315,000) × 100%
$100% == 3.8%
164,700 3.8%
Property and equipment:
Land ($23,500 ÷÷ $289,700)
($23,50040,000
$289,700) ×× 100%
40,000 100% == 8.1% 8.1%
Buildings and equipment, net 120,000 85,000
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700 100.0% 100.0%
*McGraw-Hill/Irwin
Percent rounded to first decimal point. © The McGraw-Hill Companies, Inc., 2008
 Clover, Inc.
Comparative Balance Sheets
December 31,
Common-size
Percents*
2007 2006 2007 2006
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1%
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%
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%
*McGraw-Hill/Irwin
Percent rounded to first decimal point. © The McGraw-Hill Companies, Inc., 2008
 Clover, Inc.
Comparative Balance Sheets
December 31,
Common-size
Percents*
2007 2006 2007 2006
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 67,000 $ 44,000 21.3% 15.2%
Notes payable 3,000 6,000 1.0% 2.1%
Total current liabilities $ 70,000 $ 50,000 22.3% 17.3%
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:
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%
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 liabilities and shareholders' equity $ 315,000 $ 289,700 100.0% 100.0%
* Percent rounded to first decimal point. © The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
 Clover, Inc.
Comparative Income Statements
For the Years Ended December 31,
Common-size
Percents*
2007 2006 2007 2006
Revenues $ 520,000 $ 480,000 100.0% 100.0%
Costs and expenses:
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%
Income 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. © The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
 Learning
Learning Objective
Objective

To discuss the quality of

a company’s earnings,
assets, and working
capital.

LO2
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 Quality
Quality of
of Earnings
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
company in the same industry.

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

 Quality
Quality of
of Earnings
Earnings

While satisfactory earnings may be a

good indicator of a company’s ability to
pay its debts and dividends, we must also
consider the composition of assets, their
condition and liquidity, the timing of
repayment of liabilities, and the total
amount of debt outstanding

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

 Learning
Learning Objective
Objective

To explain the nature

and purpose of
classifications in
financial statements.

LO3
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 A
A Classified
Classified Balance
Balance Sheet
Sheet
Asset Section of the Balance Sheet
Matrix, Inc.
Balance Sheet
December 31, 2007
Current assets:
Cash $ 30,000
Notes receivable 16,000
Accounts receivable 60,000
Inventory 70,000
Prepaid expenses 4,000
Total current assets 180,000
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:
Patents 170,000
Total assets $ 630,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 A
A Classified
Classified Balance
Balance Sheet
Sheet
Liability and Stockholders’ Equity Section of the Balance Sheet
Matrix, Inc.
Balance Sheet
December 31, 2007
Current 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
Bonds payable (due in 15 years) 100,000
Total long-term liabilities 165,000
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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To prepare a classified
balance sheet and
compute widely used
measures of liquidity
and credit risk.

LO4
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 Ratios
Ratios

A r a ti o i s a s im p l e m a t h e m a t i c a l e x p r e s s i o n
o f th e r e la tio n s h ip b e tw e e n o n e ite m a n d a n o th e r.

A lo n g w ith d o lla r a n d p e r c e n ta g e c h a n g e s ,
tre n d p e rc e n ta g e s , a n d c o m p o n e n t p e rc e n ta g e s ,
r a tio s c a n b e u s e d to c o m p a r e :

P a s t p e r fo r m a n c e to O th e r c o m p a n ie s to
p re s e n t p e rfo rm a n c e . yo u r c o m p an y.

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

 Babson Builders, Inc.
2007
Cash $ 30,000
Accounts receivable, net
Use this Beginning of year 17,000
End of year 20,000
information to Inventory
calculate the Beginning of year 10,000
End of year 15,000
liquidity ratios Total current assets 65,000
for Babson Total current liabilities 42,000
Builders, Inc. Total liabilities 103,917
Total assets
Beginning of year 300,000
End of year 346,390
Revenues 494,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Working
Working Capital
Capital

Working capital is the excess of current

assets over current liabilities.

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

Current Current Assets

=
Ratio Current Liabilities

Current $65,000
= = 1.55 : 1
Ratio
$42,000

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

 Quick
Quick Ratio
Ratio

Quick Quick Assets

=
Ratio Current Liabilities

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

This
This ratio
ratio is
is like
like the
the current
current
ratio
ratio but
but excludes
excludes current
current assets
assets
such
such as
as inventories
inventories thatthat may
may be
be
difficult
difficult to
to quickly
quickly convert
convert into
into cash.
cash.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Quick
Quick Ratio
Ratio

Quick Quick Assets

=
Ratio Current Liabilities

Quick $50,000
= = 1.19 : 1
Ratio $42,000

This
This ratio
ratio is
is like
like the
the current
current
ratio
ratio but
but excludes
excludes current
current assets
assets
such
such asas inventories
inventories that
that may
may be
be
difficult
difficult to
to quickly
quickly convert
convert into
into cash.
cash.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Uses
Uses and
and Limitations
Limitations of
of Financial
Financial
Ratios
Ratios

U ses L im ita tio n s

R a tio s h e lp u s e rs M a n a g e m e n t m a y e n te r
u n d e r s ta n d in t o t r a n s a c t io n s m e r e ly
fin a n c ia l r e la tio n s h ip s . to im p ro v e th e r a tio s .

R a tio s p ro v id e fo r R a t io s d o n o t h e lp w ith
q u ic k c o m p a r is o n a n a l y s i s o f t h e c o m p a n y 's
o f c o m p a n ie s . p ro g re s s to w a rd
n o n f in a n c ia l g o a ls .

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

 Learning
Learning Objective
Objective

To prepare a multiple-
step and a single-step
income statement and
compute widely used
measures of profitability.

LO5
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 Measures
Measures of
of Profitability
Profitability

An income statement can be prepared in either a

multiple-step or single-step format.

The
The single-step
single-step format
format is
is simpler.
simpler.
The
The multiple-step
multiple-step format
format provides
provides
more
more detailed
detailed information.
information.

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

 Income
Income Statement
Statement (Multiple-Step)
(Multiple-Step)
Proper Heading

Gross Margin

Operating Expenses

Non-operating Items

Remember
Remember to
to
compute
compute EPS.
EPS.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Income
Income Statement
Statement (Single-Step)
(Single-Step)
Proper Heading

Remember
Remember to
to
Revenues & Gains compute
compute EPS.
EPS.

Expenses & Losses

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

 Babson Builders, Inc.
2007
Ending market price per share $ 15.25
Use this
Number of common shares
information to
outstanding all of 2007 27,400
calculate the Net income $ 53,690
profitability Total shareholders' equity
ratios for Beginning of year 180,000
Babson End of year 234,390
Builders, Inc. Revenues 494,000
Cost of sales 140,000
Total assets
Beginning of year 300,000
End of year 346,390

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

 Learning
Learning Objective
Objective

To put a company’s net

income into perspective
by relating it to sales,
assets, and
stockholders’ equity.

LO6
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Earning
Earning Per
Per Share
Share

Net Income
Average Shares of Capital Stock Outstanding = EPS

Look back at the information

$53,690 from Babson and get
= $1.96
the values we need27,400
to calculate earning per share.

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

 Price-Earnings
Price-Earnings Ratio
Ratio

Current Market Price of one Share of Stock

Earnings Per Share = P/E

$15.25
= 7.78
$1.96

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

 Learning
Learning Objective
Objective

To compute the ratios

widely used in financial
statement analysis and
explain the significance
of each.

LO7
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Return
Return On
On Investment
Investment (ROI)
(ROI)

This
This ratio
ratio is
is aa good
good measure
measure of of
the
the efficiency
efficiency of of utilization
utilization of
of
assets
assets by by the
the business.
business.

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

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

This
This ratio
ratio is
is generally
generally considered
considered
the
the best
best overall
overall measure
measure of of aa
company’s
company’s profitability.
profitability.

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

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

This
This measure
measure indicates
indicates how
how well
well the
the
company
company employed
employed the
the owners’
owners’
investments
investments to
to earn
earn income.
income.

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

 Learning
Learning Objective
Objective

To analyze financial
statements from the
viewpoints of common
stockholders, creditors,
and others.

LO8
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Dividend
Dividend Yield
Yield

Dividend Dividends Per Share

=
Yield Ratio Market Price Per Share

Babson Builders pays an annual dividend of

Dividend
$1.50 per share of $1.50stock. The market
capital
= = 9.84%
Yieldof
price Ratio $15.25
the company’s capital stock was
$15.25 at the end of 2007.
This ratio identifies the return, in
terms of cash dividends, on the
current market price of the stock.

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

 Analysis
Analysis by
by Long-Term
Long-Term Creditors
Creditors

Use this information to calculate ratios

to measure the well-being of the long-
term creditors for Babson Builders.
Babson Builders, Inc.
2007
Earnings before interest
expense and income taxes $ 84,000

This is also referred Interest expense 7,300

to as net operating Total assets 346,390

income. Total stockholders' equity 234,390
Total liabilities 112,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Interest
Interest Coverage
Coverage Ratio
Ratio

Times Operating income before Interest

Interest = and Income Taxes
Earned Annual Interest Expense

Times
$84,000
Interest = = 11.5 times
7,300
Earned

This
This is
is the
the most
most common
common
measure
measure ofof the
the ability
ability of
of aa firm’s
firm’s
operations
operations toto provide
provide protection
protection
to
to the
the long-term
long-term creditor.
creditor.

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

 Debt
Debt Ratio
Ratio

A measure of creditor’s long-term risk.

The smaller the percentage of assets that
are financed by debt, the smaller the risk
for creditors.

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

 Analysis
Analysis by
by Short-Term
Short-Term Creditors
Creditors
Babson Builders, Inc.
Use this 2007
information to Cash $ 30,000

calculate ratios Accounts receivable, net

Beginning of year 17,000
to measure the End of year 20,000
well-being of the Inventory
short-term Beginning of year 10,000

creditors for End of year 12,000

Total current assets 65,000
Babson Builders, Total current liabilities 42,000
Inc. Sales on account 500,000
Cost of goods sold 140,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accounts
Accounts Receivable
Receivable Turnover
Turnover Rate
Rate
Accounts
Net Sales
Receivable =
Average Accounts Receivable
Turnover

Accounts
$500,000
Receivable = = 27.03 times
($17,000 + $20,000) ÷ 2
Turnover

This ratio measures how many

times a company converts its
receivables into cash each year.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Number
Number of
of Days
Days to
to Collect
Collect Receivables
Receivables

Average 365 Days

Collection = Accounts Receivable Turnover
Period

Average
365 Days
Collection = = 13.50 days
27.03 Times
Period

This
This ratio
ratio measures,
measures, on on average,
average,
how
how many
many days
days itit takes
takes to
to collect
collect
an
an account
account receivable.
receivable.

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

 Inventory
Inventory Turnover
Turnover Rate
Rate

Inventory Cost of Goods Sold

=
Turnover Average Inventory

Inventory $140,000
= = 12.73 times
Turnover ($10,000 + $12,000) ÷ 2

This
This ratio
ratio measures
measures the
the number
number
of
of times
times merchandise
merchandise inventory
inventory
is
is sold
sold and
and replaced
replaced during
during the
the year.
year.

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

 Average
Average Days
Days Sales
Sales In
In Inventory
Inventory
Average 365 Days
=
Sale Period Inventory Turnover

Average 365 Days

= = 28.67 days
Sale Period 12.73 Times

This
This ratio
ratio measures
measures howhow many
many
days,
days, on
on average,
average, itit takes
takes to
to
sell
sell the
the inventory.
inventory.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Operating
Operating Cycle
Cycle
1.
Pu

e
bl
rc

ce f
iv a
re o
ha
t s on Cash se
un cti
of
co lle

M
er
ac C o

ch
3.

an
dis
e
Accounts
Inventory
Receivable

2. Sale of merchandise on account

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

 End
End of
of Chapter
Chapter 14
14

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