Chapter 13, Problem 13.2CP

Analyzing Comparative Financial Statements Using Selected Ratios

Use the data given in CP13-1 for Golden Corporation.

Required:

1. 1. Compute the gross profit percentage for the current and previous years. Round the percentages to one decimal place. Are the current year results better, or worse, than those for the previous year?
2. 2. Compute the net profit margin for the current and previous years. Round the percentages to one decimal place. Are the current year results better, or worse, than those for the previous year?
3. 3. Compute the earnings per share for the current and previous years. Are the current year results better, or worse, than those for the previous year?

   TIP: To calculate EPS, use the balance in Common Stock to determine the number of shares outstanding. Common Stock equals the par value per share times the number of shares.

4. 4. Stockholders’ equity totaled $30,000 at the beginning of the previous year. Compute the return on equity (ROE) ratios for the current and previous years. Express the ROE as percentages rounded to one decimal place. Are the current year results better, or worse, than those for the previous year?
5. 5. Net property and equipment totaled $35,000 at the beginning of the previous year. Compute the fixed asset turnover ratios for the current and previous years. Round the ratios to two decimal places. Are the current year results better, or worse, than those for the previous year?
6. 6. Compute the debt-to-assets ratios for the current and previous years. Round the ratios to two decimal places. Is debt providing financing for a larger or smaller proportion of the company’s asset growth? Explain.
7. 7. Compute the times interest earned ratios for the current and previous years. Round the ratios to one decimal place. Are the current year results better, or worse, than those for the previous year? Explain.
8. 8. After Golden released its current year’s financial statements, the company’s stock was trading at $30. After the release of its previous year’s financial statements, the company’s stock price was $21 per share. Compute the P/E ratios for both years, rounded to one decimal place. Does it appear that investors have become more (or less) optimistic about Golden’s future success?

To determine

To Compute: The gross profit percentage for current and previous year.

Explanation of Solution

Gross Profit Percentage:

Gross profit is the financial ratio that shows the relationship between the gross profit and net sales. It represents gross profit as a percentage of net sales. Gross Profit is the difference between the net sales revenue, and the cost of goods sold. It can be calculated by dividing gross profit and net sales.

Compute the gross profit percentage for the previous year.

$\begin{array}{c}\text{Gross profit percentage = }\frac{\text{Net Sales Revenue }-\text{Cost of goods sold}}{\text{Net sales revenue}}\times \text{ 100}\\ =\frac{\text{\$165,000}-\text{\$100,000}}{\$165,000}\times \text{ 100}\\ =39.4\%\end{array}$

Compute the gross profit percentage for the current year.

$\begin{array}{c}\text{Gross profit percentage = }\frac{\text{Net Sales Revenue }-\text{Cost of goods sold}}{\text{Net sales revenue}}\times \text{ 100}\\ =\frac{\text{\$180,000}-\text{\$110,000}}{\$180,000}\times \text{ 100}\\ =38.9\%\end{array}$

By comparing the percentage gross profit percentage of Corporation G during previous year (39.4%) with current year (38.9%) there is a decrease in the gross profit percentage by 0.5cents in current year which is slightly lower than previous year this indicates that company is earning lower profit for per dollar of sales.

To determine

To Compute: The net profit margin for current and previous year.

Explanation of Solution

Net Profit margin:

This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.

Compute the net profit margin for previous year.

$\begin{array}{c}\text{Net profit margin =}\frac{\text{Net Income}}{\text{Net Sale Revenue}}\times 100\\ =\frac{\$9,000}{\$165,000}\times 100\\ =5.5\text{\%}\end{array}$

Compute the net profit margin for the current year.

$\begin{array}{c}\text{Net profit margin =}\frac{\text{Net Income}}{\text{Net Sale Revenue}}\times 100\\ =\frac{\$10,000}{\$180,000}\times 100\\ =5.6\text{\%}\end{array}$

The net profit margin for the current year is slightly higher (5.6%) comparing to the previous year net profit margin (5.5%). Thus the Corporation G is functioning better in the current year.

Working Notes:

Corporation G
Particulars	Current (A)	Previous (B)	Increase or Decrease
			Amount $\left(C=A–B\right)$	Percentage $\left(D=C÷B\right)$
Income statement
Sales revenue	$180,000	$165,000	$15,000	9.1%
Less: Cost of goods sold	$110,000	$110,000	$0	0.0%
Gross profit	$70,000	$65,000	$5,000	7.7%
Less: Operating expenses:	$53,300	$50,400	$2,900	5.8%
Interest expenses	$2,700	$2,600	$100	3.8%
Income before income taxes	$14,000	$12,000	$2,000	16.7%
Less: income tax expense	$4,000	$3,000	$1,000	33.3%
Net income	$10,000	$9,000	$1,000	11.1%
Balance sheet:
Cash	$4,000	$8,000	($4,000)	(50.0%)
Accounts receivable	$19,000	$23,000	($4,000)	(17.4%)
Inventory	$40,000	$35,000	$5,000	14.3%
Property and equipment	$45,000	$38,000	$7,000	18.4%
Total assets	$108,000	$104,000	$4,000	3.8%
Current liabilities	$16,000	$19,000	($3,000)	(15.8%)
Long term notes payable	$45,000	$45,000	$0	0.0%
Common stock	$30,000	$30,000	$0	0.0%
Additional paid in capital	$5,000	$5,000	$0	0.0%
Retained earnings	$12,000	$5,000	$7,000	140.0%
Total liabilities and stockholders' equity	$108,000	$104,000	$4,000	3.8%

Table (1)

To determine

To Compute: The earnings per share for the current year and previous year.

Explanation of Solution

Earnings per share:

Earnings per share help to measure the profitability of a company. Earnings per share are the amount of profit that is allocated to each share of outstanding stock.

Calculate the earnings per share for the previous year.

$\begin{array}{c}\text{EPS= }\frac{\text{Net Income }-\text{Preferred Dividends}}{\text{Average Number of shares of Common stock outstanding}}\\ =\frac{\$9,000-\$0}{\$6000(1)}\\ =\text{1}\text{.50}\end{array}$

Calculate theearnings per share for the current year.

$\begin{array}{c}\text{EPS= }\frac{\text{Net Income }-\text{Preferred Dividends}}{\text{Average Number of shares of Common stock outstanding}}\\ =\frac{\$10,000-\$0}{\$6000(1)}\\ =\text{1}\text{.67}\end{array}$

Company’s earnings per share has an Eps of ($1.40)which is comparatively higher than previous year earnings per share ($1.09), there is an increased Eps by 0.31cents($1.40 -$1.09). Increase in the EPS value shows a good profit for the stockholder’s for the investment made by them.

Working Notes:

$\begin{array}{c}\begin{array}{l}\text{Average Number of shares of}\\ \text{ Common stock outstanding}\end{array}\}=\frac{\text{Common Stock Balance}}{\text{Per share value}}\\ =\frac{\$30,000}{5}\\ =\$6,000\end{array}$ (1)

To determine

To Compute: The return on equity for current and previous each year.

Explanation of Solution

Return on equity:

Return on equity is used to determine the relationship between the net income available for the common stockholders’ and the average common equity that are invested in the company.

Calculate the return on equity for the previous year.

$\begin{array}{c}\text{Return on Equity(ROE) = }\frac{\text{Net Income }-\text{Preferred Dividends}}{\text{Average Common Stockholders' Equity}}\times \text{ 100}\\ =\frac{\text{\$9,000}-\text{\$0}}{\$35,000(2)}\times \text{ 100}\\ =25.7\%\end{array}$

Calculate the return on equity for the current year.

$\begin{array}{c}\text{Return on Equity(ROE) = }\frac{\text{Net Income }-\text{Preferred Dividends}}{\text{Average Common Stockholders' Equity}}\times \text{ 100}\\ =\frac{\$10,000-\text{\$0}}{\$43,500(3)}\times \text{ 100}\\ =23.0\%\end{array}$

Company has generated less return on equity in current year (23.0%) which is comparatively lower than the return on equity of previous year (25.7%). Decrease in the return on equity decrease the net profit margin of Corporation G.

Working Notes:

Calculate Average stockholder’s equity for the previous year.

$\begin{array}{c}\text{Average stockholder's Equity = }\frac{\text{Opening stockholder' s equity + Closing Stockholder's equity}}{\text{2}}\\ =\frac{\$40,000+\$30,000}{2}\\ =\text{}\text{}\text{\$35,000}\end{array}$ (2)

Calculate Average stockholder’s equity for the current year.

$\begin{array}{c}\text{Average stockholder's Equity = }\frac{\text{Opening stockholder' s equity + Closing Stockholder's equity}}{\text{2}}\\ =\frac{\$47,000+\$40,000}{2}\\ =\text{}\text{}\text{\$43,500}\end{array}$ (3)

To determine

To Compute: The fixed asset turnover for current and previous year.

Explanation of Solution

Fixed Asset turnover:

Fixed asset turnover is a ratio that measures the productive capacity of the fixed assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

 Calculate the fixed asset turnover for the previous year.

$\begin{array}{c}\text{Fixed asset turnover = }\frac{\text{Net Revenue}}{\text{Average Net Fixed Assets}}\\ =\frac{\$180,000}{\$36,500(4)}\\ =4.52\end{array}$

Calculate the fixed asset turnover for the current year.

$\begin{array}{c}\text{Fixed asset turnover = }\frac{\text{Net Revenue}}{\text{Average Net Fixed Assets}}\\ =\frac{\$180,000}{\$41,500(5)}\\ =4.34\end{array}$

Corporation G has utilized its fixed assets in previous year than current year as the fixed asset turnover ratio is higher in previous year (4.52) comparing to the current year (4.34)

Working Notes:

Calculate the fixed asset turnover for the previous year.

$\begin{array}{c}\text{Average net fixed assets = }\frac{\text{Opening + Closing }}{\text{2}}\\ =\frac{\$35,000+\$38,000}{2}\\ =\text{}\text{}\text{\$36,500}\end{array}$ (4)

Calculate the fixed asset turnover for the current year.

$\begin{array}{c}\text{Average net fixed assets = }\frac{\text{Opening + Closing }}{\text{2}}\\ =\frac{\$38,000+45,000}{2}\\ =\text{}\text{}\text{\$41,500}\end{array}$ (5)

To determine

To Compute: The debt –to-asset for current and previous year.

Explanation of Solution

Debt to Asset Ratio:

Debt to asset ratio is the ratio between total asset and total liability of the company. Debt ratio reflects the finance strategy of the company. It is used to evaluate company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.

Compute the debt – to - asset for the previous year.

$\begin{array}{c}\text{Debt -to -asset = }\frac{\text{Total Liabilities}}{\text{Total Assets}}\\ =\frac{\$64,000}{\$104,000}\\ =0.62\end{array}$

Compute the debt – to - asset for the current year.

$\begin{array}{c}\text{Debt -to -asset = }\frac{\text{Total Liabilities}}{\text{Total Assets}}\\ =\frac{\$61,000}{\$108,000}\\ =0.56\end{array}$

The debt-to-asset asset ratio of current year is decreased (0.56) comparing to the previous year (0.62). The Corporation’s assets are financed less by debt, so the company is functioning better in the current year.

To determine

To Compute: The times interest earned for current and previous year.

Explanation of Solution

Times Interest Earned Ratio:

It’s a measure to evaluate the net income for interest payment on debt of a company. It is a part of solvency ratios.

Compute the time interest earned for previous year.

$\begin{array}{c}\text{Times Interest Earned = }\frac{\text{Net Income }+\text{ Interest Expense + Income tax expense}}{\text{Interest Expense}}\\ =\frac{\$9,000+\$2,600+\$3,000}{\$2,600}\\ =5.6\end{array}$

Compute the time interest earned for current year.

$\begin{array}{c}\text{Times Interest Earned = }\frac{\text{Net Income }+\text{ Interest Expense + Income tax expense}}{\text{Interest Expense}}\\ =\frac{\$10,000+\$2,700+\$4,000}{\$2,700}\\ =6.2\end{array}$

The times interest earned ratio has improved by 0.6 cents (6.2-5.6). Corporation G times interest earned ratio for the current year(6.2) shows that the company has enough net income which is earned before paying interest and income taxes to meet out their interest expense for the year.

To determine

To Compute: The price earnings ratio for current and previous year.

Explanation of Solution

Price/Earnings Ratio:

It depicts the relation of market price of a share to earnings per share of that company. The price/earnings ratio presents the market value of the amount invested to earn $1 by a company. It is major tool to be used by investors before the decisions related to investments in a company.

Compute the price earnings ratio for previous year.

$\begin{array}{c}\text{Price earning ratio = }\frac{\text{Stock Price (per share)}}{\text{Earnings per share (annual)}}\\ =\frac{\$21}{\$1.50}\\ =14.0\end{array}$

Compute the price earnings ratio for current year.

$\begin{array}{c}\text{Price earning ratio = }\frac{\text{Stock Price (per share)}}{\text{Earnings per share (annual)}}\\ =\frac{\$30}{\$1.67}\\ =18.0\end{array}$

The price earnings ratio of Corporation G is increased in current year (18.0) comparing to the previous year (14.0) . The investors believe that the Corporation has great potential for future growth and profitability.