Chapter 17, Problem 1FSA

Financial statement analysis

The financial statements for Nike, Inc., are presented in Appendix D at the end of the text. Use the following additional information (in thousands):

Instructions

1. 1. Determine the following measures for the fiscal years ended May 31, 2016, and May 31, 2015. Round ratios and percentages to one decimal place.
   1. a. Working capital
   2. b. Current ratio
   3. c. Quick ratio
   4. d. Accounts receivable turnover
   5. e. Number of days’ sales in receivables
   6. f. Inventory turnover
   7. g. Number of days’ sales in inventory
   8. h. Ratio of liabilities to stockholders’ equity
   9. i. Asset turnover
   10. j. Return on total assets.
   11. k. Return on common stockholders’ equity
   12. l. Price-earnings ratio, assuming that the market price was $54.90 per share on May 29, 2016, and $52.81 per share on May 30, 2015
   13. m. Percentage relationship of net income to sales
2. 2. What conclusions can be drawn from these analyses?

To determine

Determine the following ratios for the fiscal years ended May 31, 2016 and May 31, 2015:

1. (a) Working capital
2. (b) Current ratio
3. (c) Quick ratio
4. (d) Accounts receivable turnover ratio
5. (e) Number of days’ sales in receivables
6. (f) Inventory turnover ratio
7. (g) Number of days’ sales in inventory
8. (h) Ratio of liabilities to stockholders’ equity
9. (i) Asset turnover ratio
10. (j) Return on total assets
11. (k) Return on common stockholders’ equity
12. (l) Price-earnings ratio
13. (m) Percentage relationship of net income  to sales 

Explanation of Solution

Financial Ratios: Financial ratios are the metrics used to evaluate the liquidity, capabilities, profitability, and overall performance of a company.

(a)

Working capital is determined as the difference between current assets and current liabilities.

Formula:

$\text{Working capital = Current assets – }\text{}\text{Current liabilities }$

Calculate working capital for May 31, 2015 and May 31, 2016.

$\begin{array}{c}\text{Working capital }\left(\text{2016}\right)\text{= Current assets – }\text{}\text{Current liabilities }\\ \text{= \$15,025}\text{.0 – \$5,358}\text{.0}\\ \text{= \$9,667}\text{.0}\end{array}$

$\begin{array}{c}\text{Working capital }\left(\text{2015}\right)\text{= Current assets – }\text{}\text{Current liabilities }\\ \text{= \$15,587}\text{.0 – \$6,332}\text{.0}\\ \text{= \$9,255}\text{.0}\end{array}$

Thus, working capital for 2016 and 2015 is $9,667.0 and $9,255.0

b)

Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.  Current assets include cash and cash equivalents, short-term investments, net, accounts and notes receivables, net, inventories, and prepaid expenses and other current assets. Current liabilities include short-term obligations and accounts payable.  

Formula:

$\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}$

Current ratio for 2016 and 2015

$\begin{array}{c}\text{Current ratio}\left(\text{2016}\right)=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\text{\$15,025}\text{.0}}{\text{\$5,358}\text{.0}}\\ =2.8\end{array}$

 $\begin{array}{c}\text{Current ratio}\left(\text{2015}\right)=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\text{\$15,587}\text{.0}}{\text{\$63,320}}\\ =2.5\end{array}$

Thus, current ratio for 2016 and 2015 is 2.8 and 2.5

c)

Acid-Test Ratio is the ratio denotes that this ratio is a more rigorous test of solvency than the current ratio. It is determined by dividing quick assets and current liabilities. The acceptable acid-test ratio is 0.90 to 1.00. Use the following formula to determine the acid-test ratio:

$\text{Acid Ratio}=\frac{\text{Quick assets}}{\text{Current}\text{liabilities}}$

Acid-test ratio for 2016

$\begin{array}{c}\text{Acid-test ratio }\left(\text{2016}\right)=\frac{\text{Quick assets }}{\text{Current}\text{liabilities}}\\ =\frac{\$8,698.0}{\$5,358.0}\\ =1.6\end{array}$

$\begin{array}{c}\text{Acid-test ratio }\left(\text{2015}\right)=\frac{\text{Quick assets }}{\text{Current}\text{liabilities}}\\ =\frac{\$9,282.0}{\$6,332.0}\\ =1.5\end{array}$

Working notes:

Quick Assets are those assets that are most liquid. The examples of quick assets include cash and bank balances, marketable securities, and sundry debtors. Use the following formula to determine the Quick assets:

$\begin{array}{c}\text{Quick assets for 2016}=\left(\begin{array}{l}\text{Cash + Short-term investments }\\ \text{+ Net accounts and notes receivables}\end{array}\right)\\ =\$3,138.0+\$2,319.0+\$3,241.0\\ =\$8,698.0\end{array}$

$\begin{array}{c}\text{Quick assets for 2015}=\left(\begin{array}{l}\text{Cash + Short-term investments }\\ \text{+ Net accounts and notes receivables}\end{array}\right)\\ =\$3,852.0+\$2,072.0+\$3,358.0\\ =\$9,282.0\end{array}$

Hence, quick ratio for 2016 and 2015 are 1.6 and 1.5 respectively.

d)

Accounts receivable turnover ratio for 2016 and 2015

$\begin{array}{c}\begin{array}{l}\text{Accounts receivables}\\ \text{ turnover ratio }\left(\text{2016}\right)\end{array}\}=\frac{\text{Net credit sales}}{\text{Average accounts receivables}}\\ =\frac{\$32,376.0}{\$3,299.5}\\ =9.8\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Accounts receivables}\\ \text{ turnover ratio }\left(\text{2015}\right)\end{array}\}=\frac{\text{Net credit sales}}{\text{Average accounts receivables}}\\ =\frac{\$30,601.0}{\$3,237.5}\\ =9.5\end{array}$

Description:

Accounts receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. Main purpose of accounts receivable turnover ratio is to manage the working capital of the company. This ratio is determined by dividing credit sales and sales return.

Formula:

$\begin{array}{l}\text{Accounts receivables}\\ \text{ turnover ratio}\end{array}\}=\frac{\text{Net credit sales}}{\text{Average accounts receivables}}$

Average accounts receivable, net for 2016 and 2015 is determined as follows:

$\begin{array}{c}\begin{array}{l}\text{Average accounts }\\ \text{receivables }\left(\text{2016}\right)\end{array}\}\text{= }\frac{\left(\begin{array}{l}\text{Opening accounts receivables }\\ \text{+ Closing accounts receivables }\end{array}\right)}{2}\\ =\frac{\$3,358.0+\$3,241.0}{2}\\ =\$3,299.50\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Average accounts }\\ \text{receivables }\left(\text{2015}\right)\end{array}\}\text{= }\frac{\left(\begin{array}{l}\text{Opening accounts receivables }\\ \text{+ Closing accounts receivables }\end{array}\right)}{2}\\ =\frac{\$3,117.0+\$3,358.0}{2}\\ =\$3,237.50\end{array}$

Hence, the accounts receivable turnover ratio for 2016 and 2015 is 9.8 times and 9.5 times.

e)

Number of days’ sales in receivables for 2016 and 2015

$\begin{array}{c}\begin{array}{l}\text{Number of days’ sales }\\ \text{in receivable }\left(\text{2016}\right)\end{array}\}=\frac{\text{Average accounts receivable }}{\text{Average daily sales}}\\ =\frac{\$3,299.50}{88.7}\\ =37.2\text{days}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of days’ sales }\\ \text{in receivable }\left(\text{2015}\right)\end{array}\}=\frac{\text{Average accounts receivable }}{\text{Average daily sales}}\\ =\frac{\$3,237.50}{83.8}\\ =38.6\text{days}\end{array}$

Description:

Number of days’ sales in receivables is used to determine the number of days a particular company takes to collect accounts receivables.

Formula:

$\text{Number of days’ sales in receivable}\text{=}\frac{\text{Average accounts receivable }}{\text{Average daily sales}}$

Average daily sales are determined by dividing sales by 365 days. Average accounts receivables for 2016 and 2015 are determined in previous requirement. Thus, average daily sales for 2016 and 2015 are determined as follows:

$\begin{array}{c}\text{Average daily sales }\left(\text{2016}\right)\text{= }\frac{\text{Sales}}{\text{365}\text{days}}\\ =\frac{\$32,376.0}{365\text{days}}\\ =\$88.7\end{array}$

$\begin{array}{c}\text{Average daily sales }\left(\text{2015}\right)\text{= }\frac{\text{Sales}}{\text{365}\text{days}}\\ =\frac{\$30,601.0}{365\text{days}}\\ =\$83.8\end{array}$

Hence, the number of days’ sales in receivable for 2016 and 2015 are 9.8 days and 9.5 days respectively.

f)

Inventory turnover ratio for 2016 and 2015

$\begin{array}{c}\text{Inventory turnover ratio }\left(\text{2016}\right)=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$17,405.0}{\$4,587.5}\\ =3.8\text{times}\end{array}$

$\begin{array}{c}\text{Inventory turnover ratio }\left(\text{2015}\right)=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$16,534.0}{\$4,142.0}\\ =4.0\text{times}\end{array}$

Description:

Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

Formula:

$\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Average inventory for 2016 and 2015 is determined as below:

 $\begin{array}{c}\begin{array}{l}\text{Average inventory }\\ \left(\text{2016}\right)\end{array}\}\text{= }\frac{\left(\text{Opening inventory + Closing inventory }\right)}{2}\\ =\frac{\$4,337.0+\$4,838.0}{2}\\ =\$4,587.50\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Average inventory}\\ \left(\text{2015}\right)\end{array}\}\text{= }\frac{\left(\text{Opening inventory + Closing inventory }\right)}{2}\\ =\frac{\$3,947.0+\$4,337.0}{2}\\ =\$4,142.0\end{array}$

Hence, the inventory turnover ratio for 2016and 2015 is 3.8 and 4.0 respectively.

g)

Number of days sales in inventory for 2016 and 2015 

$\begin{array}{c}\begin{array}{l}\text{Number of days’ }\\ \text{sales in inventory }\left(\text{2016}\right)\end{array}\}=\frac{\text{Average inventory }}{\text{Average daily cost of goods sold}}\\ =\frac{\$4,587.5}{\$47.7}\\ =96.2\text{days}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of days’ }\\ \text{sales in inventory }\left(\text{2015}\right)\end{array}\}=\frac{\text{Average inventory }}{\text{Average daily cost of goods sold}}\\ =\frac{\$4,142.0}{\$45.3}\\ =91.4\text{days}\end{array}$

Description:

Number of days’ sales in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

Formula:

$\text{ Number of days’ sales in invenotry}=\frac{\text{Average inventory }}{\text{Average daily cost of goods sold}}$

Average daily cost of goods sold are determined by dividing cost of goods sold by 365 days. Thus, average daily cost of goods sold are determined as follows:

$\begin{array}{c}\text{Average daily cost of goods sold }\left(\text{2016}\right)\text{= }\frac{\text{Cost of goods sold}}{\text{365}\text{days}}\\ =\frac{\$17,405.0}{365\text{days}}\\ =\$47.7\end{array}$

$\begin{array}{c}\text{Average daily cost of goods sold }\left(\text{2015}\right)\text{= }\frac{\text{Cost of goods sold}}{\text{365}\text{days}}\\ =\frac{\$16,534}{365\text{days}}\\ =\$45.3\end{array}$

Hence, the number of days’ sales in inventory for 2016 and 2015 are 96.2 days and 91.4 days respectively.

h)

Ratio of liabilities to stockholders’ equity for 2016 and 2015.

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities }\\ \text{to stockholders' equity }\left(\text{2016}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$9,138.0}{\$12,258.0}\\ =0.7\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities }\\ \text{to stockholders' equity }\left(\text{2015}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$8,890.0}{\$12,707.0}\\ =0.7\end{array}$

Description:

Ratio of liabilities to stockholders’ equity is determined by dividing liabilities and stockholders’ equity.

Formula:

$\text{ Ratio of liabilities to stockholders' equity}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}$

Hence, the ratio of liabilities to stockholders’ equity for 2016 and 2015 is 0.7.

i)

Asset turnover ratio for 2016 and 2015

$\begin{array}{c}\text{Asset turnover }\left(\text{2016}\right)=\frac{\text{Sales}}{\text{Average total assets}}\\ =\frac{\$32,376.0}{\$21,496.5}\\ =1.5\end{array}$

$\begin{array}{c}\text{Asset turnover }\left(\text{2015}\right)=\frac{\text{Sales}}{\text{Average total assets}}\\ =\frac{\$300,601.0}{\$20,095.5}\\ =1.5\end{array}$

Description:

Asset turnover ratio is used to determine the asset’s efficiency towards sales.

Formula: $\text{Asset turnover }=\frac{\text{Net}\text{revenue}}{\text{Average total assets}}$

Working notes for average total assets for 2016 and 2015 are as follows:

$\begin{array}{c}\text{Average total assets }\left(\text{2016}\right)\text{=}\frac{\text{Beginning total assets + Ending total assets }}{2}\\ =\frac{\$21,597.0+\$21,396.0}{2}\\ =\$21,496.5\end{array}$

$\begin{array}{c}\text{Average total assets }\left(\text{2015}\right)\text{=}\frac{\text{Beginning total assets + Ending total assets }}{2}\\ =\frac{\$18,594.0+\$21,597.0}{2}\\ =\$20,095.5\end{array}$

Hence, asset turnover ratio for 2016 and 2015 is 1.5.

j)

Return on total assets for 2016 and 2015

$\begin{array}{c}\text{Rate of return on assets }\left(\text{2016}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$3,760.0+\$19.0}{\$21,496.5}\\ =17.6\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets }\left(\text{2015}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$3,273.0+\$28.0}{\$20,095.5}\\ =16.4\%\end{array}$

Description:

Return on assets determines the particular company’s overall earning power. It is determined by dividing sum of net income and interest expense and average total assets.

Formula:

$\text{Rate of return on assets}=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}$

Hence, rate of return on assets for 2016 and 2015 are 17.6% and 16.4% respectively.

k)

Return on common stockholders’ equity for 2016 and 2015

 $\begin{array}{c}\begin{array}{l}\text{Return on }\\ \text{stockholders' equity}\\ \left(\text{2016}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$3,760.0}{\$12,482.5}\\ =30.1\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Return on }\\ \text{stockholders' equity}\\ \left(\text{2015}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$32,730.0}{\$12,353.5}\\ =26.5\%\end{array}$

Description:

Rate of return on stockholders’ equity is used to determine the relationship between the net income and the average common equity that are invested in the company.

Formula: $\text{Rate of return on stockholders' equtiy }=\frac{\text{Net income}}{\text{Average stockholder’s equity}}$

Average stockholders’ equity is determined as follows:

$\begin{array}{c}\text{Average stockholders' equity }\left(\text{2016}\right)\text{=}\left(\frac{\begin{array}{l}\text{Beginning stockholders' equity }\\ \text{ + Ending stockholders' equity }\end{array}}{2}\right)\\ =\frac{\$12,707.0+\$12,258.0}{2}\\ =\$12,482.5\end{array}$

$\begin{array}{c}\text{Net income to sales }\left(\text{2016 }\right)\text{ = }\frac{\text{Net income}}{\text{Sales}}\\ =\frac{\$3,760.0}{\$32,376.0}\\ =11.6\%\end{array}$

Hence, rate of return on stockholders’ equity for 2016 and 2015 are 30.1% and 26.5% respectively.

l)

Price earnings ratio for 2016 and 2015

$\begin{array}{c}\text{Price earnings ratio }\left(\text{2016}\right)\text{=}\frac{\text{Market price per share}}{\text{Earning per share}}\\ \text{=}\frac{\text{\$54}\text{.90}}{\text{\$2}\text{.21}}\\ \text{=24}\text{.8 times}\end{array}$

$\begin{array}{c}\text{Price earnings ratio }\left(\text{2015}\right)\text{=}\frac{\text{Market price per share}}{\text{Earning per share}}\\ \text{=}\frac{\text{\$52}\text{.81}}{\text{\$1}\text{.85}}\\ \text{=28}\text{.5 times}\end{array}$

Description:

Price/earnings ratio is used to determine the profitability of a company. This ratio is abbreviated as P/E.

Formula:

$\text{Price/earnings ratio}=\frac{\text{Market price per share of common stock}}{\text{Earnings per share}}$

Hence, the calculated price-earnings ratio for 2016 and 2015 is 24.8 and 28.5 respectively.

m)

Net income to sales for 2016 and 2015

$\begin{array}{c}\text{Net income to sales }\left(\text{2016 }\right)\text{ = }\frac{\text{Net income}}{\text{Sales}}\\ =\frac{\$3,760.0}{\$32,376.0}\\ =11.6\%\end{array}$

$\begin{array}{c}\text{Net income to sales }\left(\text{2015}\right)\text{ = }\frac{\text{Net income}}{\text{Sales}}\\ =\frac{\$3,273.0}{\$30,601.0}\\ =10.7\%\end{array}$

Description:

Net income to sales is determined by dividing net income to sales.

Formula:

$\text{Net income to sales = }\frac{\text{Net income}}{\text{Sales}}$

Conclusion

Thus, summary table of determined ratios are below:

Particulars	2016	2015
a. Working capital	$9,667.0	$9,255.0
b. Current ratio	2.8	2.5
c. Acid test ratio	1.6	1.5
d. Accounts receivable turnover ratio	9.8	9.5
e. Number of days’ sales in receivables	37.2 days	38.6 days
f. Inventory turnover ratio	3.8 times	4.0 times
g. Number of days sales in inventory	96.2 days	91.4 days
h. Ratio of liabilities to stockholders’ equity	0.7	0.7
i. Asset turnover ratio	1.5	1.5
j. Return on total assets	17.6%	16.4%
k. Return on common stockholders’ equity	30.1%	26.5%
l. Price earnings ratio	24.8 times	28.5 times
m. Net income to sales	11.6%	10.7%

To determine

Draw conclusion about the analysis made in requirement 1.

Explanation of Solution

• The working capital ratio has increased in the year 2016 when compared with 2015.
• The current ratio and quick ratio of the company have increased during the year 2016.
• The accounts receivable turnover ratio and number of days’ sales in receivables have increased in the year 2016. But, whereas, number of days’ sales receivables have decreased slightly.  Thus, here, company takes over one month to collect the accounts receivables from credit sales. 
• Inventory turnover ratio and number of days’ sales in inventory is increased and it is critical for the company. Thus, it shows a favorable change.
• Creditor’s protection remained constant and thus, it is very sound from the ratio of liabilities to stockholders’ equity.
• Asset turnover ratio indicates assets were used effectively towards generation of revenues for both the years.
• Return on total assets has increased during the year 2016. Net income has increased.
• Return on common stockholders’ equity has increased and it has strong earnings performance in the year 2016.
• The price-earnings ratio has decreased in the year 2016.
• The percentage of net income to sales has increased during 2016.