Chapter 14

Copyright © 2015 by McGraw-Hill Education (Asia).

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 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 it 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 t ify P r e s e n t e d a s if
in s ta n d a r d iz e d , s i g n if i c 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.

14-2
 Matrix, Inc.
Asset Section: Classified Statements of Financial Position
31 December 2013
Noncurrent assets:
Property, 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
Patents 170,000
Total noncurrent assets 450,000
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
Total assets $ 630,000
14-3
 Dollar &
Trend
Percentage
Percentages
Changes

Component
Percentages
Ratios

14-4
 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.

14-5
 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

14-6
 A r a tio is a s im p le m a t h e m a t ic a l e x p r e s s io 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 co m p an y.

14-7
(1) Liquidity Ratio
Use this information to calculate the liquidity ratios for Babson Builders.

Babson Builders Limited

2013
Cash $ 30,000
Accounts receivable, net
Beginning of year 17,000
End of year 20,000
Inventory
Beginning of year 10,000
End of year 15,000
Total current assets 65,000
Total current liabilities 42,000
Total liabilities 103,917
Total assets
Beginning of year 300,000
End of year 346,390
Revenues 494,000 14-8
Working capital is the excess of current
assets over current liabilities.

31/12/13
Current assets $ 65,000
Current liabilities (42,000)
Working capital $ 23,000

14-9
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

14-10
 Quick Quick Assets
=
Ratio Current Liabilities

Quick assets are cash, marketable

securities, and receivables.
This ratio is like the current
ratio but excludes current assets
such as inventories that may be
difficult to quickly convert into cash.

14-11
 Quick Quick Assets
=
Ratio Current Liabilities

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

14-12
 Babson Builders Limited

Use this 2013

information to Cash $ 30,000

Accounts receivable, net
calculate the Beginning of year 17,000
following End of year 20,000
ratios for Inventory
Babson Beginning of year 10,000

Builders End of year 12,000

Limited Total current assets 65,000

Total current liabilities 42,000
Sales on account 500,000
Cost of goods sold 140,000
14-13
 Accounts
Net CREDIT 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.
14-14
 Inventory Cost of Goods Sold
=
Turnover Average Inventory

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

This ratio measures the

number of times merchandise
inventory is sold and replaced
during the year.
14-15
Use this information to calculate ratios to measure the
well-being of the long-term creditors for Babson
Builders.

Babson Builders Limited

2013
Earnings before interest
expense and income taxes $ 84,000
This is also Interest expense 7,300
referred to as Total assets 346,390
net operating Total shareholders' equity 234,390
profit. Total liabilities 112,000
14-16
 Times Operating Profit 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.
14-17
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.
Debt Total
= ÷ Total Assets
Ratio Liabilities
= $112,000 ÷ $346,390
= 32.33%

14-18
An income statement can be prepared in either a
multiple-step or single-step format.

The single-step format

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

14-19
 Proper Heading

Gross Margin

Operating Expenses

Non-operating Items

Remember
to compute
EPS. 14-20
 Babson Builders Limited
Proper Heading Income Statement
For the Year Ended 31/12/13
Revenues and gains:
Revenues Sales $ 785,250
Interest income 62,187
& Gains
Gain on sale of plant assets 24,600
Total revenues and gains $ 872,037

Expenses and losses:

Cost of goods sold $ 351,800
Selling Expenses 197,350
General and Admin. Exp. 78,500
Expenses Depreciation 17,500
& Losses Interest 27,000
Income taxes 62,500
Loss: sale of investment 9,000
Remember Total expenses & losses 743,650
to compute Operating profit $ 128,387

EPS. 14-21
Use this information to calculate the profitability
ratios for Babson Builders Limited
Babson Builders Limited
2013
Ending market price per share $ 15.25
Number of common shares
outstanding all of 2007 27,400
Operating profit $ 64,580
Profit $ 53,690
Total shareholders' equity
Beginning of year 180,000
End of year 234,390
Revenues 494,000
Cost of sales 140,000
Total assets
Beginning of year 300,000
14-22
End of year 346,390
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.

14-23
This measure indicates how well the
company employed the owners’
investments to earn income.

14-24
Profit for the year (Profit AFTER Tax)-Preference Dividends
Average No. of Ordinary Shares Outstanding = EPS

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

$53,690
= $1.96
27,400

14-25
Measures for evaluating the current market price
of ordinary share.

Price-Earnings ratio
&
Dividend Yield

14-26
 Current Market Price of one Share
= P/E
Earnings Per Share

$15.25
= 7.78
$1.96

•• The measure shows us the relationship between

earning of the company and
and the
the market
market price
price of
of its
share.

14-27
 Dividend = Dividends Per Share
Yield Ratio Market Price Per Share

Babson Builders pays an annual dividend of

$1.50Dividend
per share. The $1.50
market price of the
= = 9.84%
company’s share was$15.25
Yield Ratio $15.25 at the end of
2013.
This ratio identifies the return of
investors, in terms of cash
dividends, on the current market
price of the share.
14-28
 Uses and Limitations
of Financial Ratios
U ses
R a tio s h e lp u s e rs
u n d e r s ta n d
fin a n c ia l r e la tio n s h ip s .
R a tio s p ro v id e fo r
q u ic k c o m p a r is o n
o f c o m p a n ie s .
L im ita tio n s
M a n a g e m e n t m a y e n te r
in t o t r a n s a c t io n s m e r e ly
to im p ro v e th e r a tio s .
R a t io s d o n o t h e lp w ith
a n a l y s i s o f t h e c o m p a n y '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 .
14-29
14-30