PRACTICE QUESTIONS

RATIOS & TREND ANALYSIS

Exercise 1.3
Computing Common Size Percents
Express the following income statement information in common-size percents
and access whether situation is favourable or unfavourable

Harbison Corporation
Comparative Income Statement
For Years Ended Dec 31, 2000 and 1999
2000
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Net income

720,000
(475,200)
244,800
(151,200)
93,600

1999
535,000
(280,340)
254,660
(103,790)
150,870

Harbison Corporation
Comparative Income Statement
For Years Ended Dec 31, 2000 and 1999
2000
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Net income

720,000 100.0%
(475,200) -66.0%
244,800 34.0%
(151,200) -21.0%
93,600 13.0%

1999

Changes

535,000
(280,340)
254,660
(103,790)
150,870

100.0% 185,000 34.6%

-52.4% (194,860) 69.5%
47.6% (9,860) -3.9%
-19.4% (47,410) 45.7%
28.2% (57,270) -38.0%

Analysis
The situation appears to be unfavourable:

Both COGS and operating expenses are

taking a larger percentage of each dollar
of sales in 2000 compared to 1999.
Even though sales volume increased, net
income both decreased in absolute terms
and declined to only 13% of sales
compared to 28.2% the year before.

Exercise 1-4 : Evaluating Short Term Liquidity

Mixon Company's year end balance sheets show the following :

Cash
Accounts Receivable, Net
Merchandise inventory
Prepaid Expenses
Plant assets, Net

2001
30,800
88,500
111,500
9,700
277,500

2000
35,625
62,500
82,500
9,375
255,000

1999
36,800
49,200
53,000
4,000
229,500

Total Assets

518,000

445,000

372,500

Accounts Payable
128,900
Long-Term notes payable secured by mortgages
on plant assets
97,500
Common stock ($10 par value)
162,500
Retained Earnings
129,100

75,250

49,250

102,500
162,500
104,750

82,500
162,500
78,250

Total Liabilities & Equity

445,000

372,500

518,000

Compare the short-term liquidity position of this company at the end of 2001,
2000 and 1999 by computing the following :
a) Current ratio
b) Acid- Test Ratio

Analysis
2001
240,500
119,300
128,900

2000
190,000
98,125
75,250

1999
143,000
86,000
49,250

Current Ratio
= Current Assets/ Current Liabilities

1.9

2.5

2.9

Acid Test Ratio

= Quick Assets/ Current Liabilities

0.9

1.3

1.7

Current Assets
Quick Assets = Cash + A/R
Current Liabilities

Short term liquidity position has weakened over the 2-year period
as both current and acid test ratios show decreasing trends

Exercise 1-5 : Common Size Percents

Refer to Mixon Company's balance sheets in Exercise 1-4. Express the balance sheet in common-size percents. Round to the nearest one-tenth
percent.
2001
2000
1999
Cash
Accounts Receivable, Net
Merchandise inventory
Prepaid Expenses
Plant assets, Net

30,800
88,500
111,500
9,700
277,500

35,625
62,500
82,500
9,375
255,000

36,800
49,200
53,000
4,000
229,500

Total Assets

518,000

445,000

372,500

Accounts Payable
128,900
Long-Term notes payable secured by mortgages
on plant assets
97,500
Common stock ($10 par value)
162,500
Retained Earnings
129,100

75,250

49,250

102,500
162,500
104,750

82,500
162,500
78,250

Total Liabilities & Equity

445,000

372,500

518,000

Cash
Accounts Receivable, Net
Merchandise inventory
Prepaid Expenses
Plant assets, Net

2001
30,800
88,500
111,500
9,700
277,500

2000
8%
14%
19%
2%
57%

1999
36,800
49,200
53,000
4,000
229,500

6%
17%
22%
2%
54%

35,625
62,500
82,500
9,375
255,000

9.9%
13.2%
14.2%
1.1%
61.6%

Total Assets

518,000

100%

445,000

100%

372,500

100.0%

Accounts Payable
Long-Term notes payable secured by mortgages
on plant assets
Common stock ($10 par value)
Retained Earnings

128,900

25%

75,250

17%

49,250

13.2%

97,500
162,500
129,100

19%
31%
25%

102,500
162,500
104,750

23%
37%
24%

82,500
162,500
78,250

22.1%
43.6%
21.0%

Total Liabilities & Equity

518,000

100%

445,000

100%

372,500

100.0%

Analysis
Current asset increased Due to
increasing receivables and inventory

Fixed assets increased

Debt increased Due to short term

debts rising

Equity increased

Exercise 1-6
Refer to the information in Exercise 1-4 about Mixon Company. The company's income
statement for the years ended December 31, 2001 and 2000 show the following :
2001
Sales
Cost of goods sold
Other operating expenses
Interest expense
Income Taxes
Total costs and expenses
Net income
Earnings Per Share

2000

672,500
410,225
208,550
11,100
8,525

530,000
344,500
133,980
12,300
7,845

638,400
34,100

498,625
31,375

2.10

1.93

Analysis
Accounts Receivable Turnover
= Sales/ Ave Accounts Receivable
No of days in receivables
= 365/ A/R Turnover
Inventory Turnover
= COGS/ Ave Inventory
No of days in inventory = 365/ Inventory Turnover

2001

2000

8.91

9.49

41

38

4.23

5.08

86

72

The firm is becoming less efficient in managing its inventory and in collecting its receivables.
The number of days in sales uncollected has increased and the A/R turnover has declined.
Also, the inventory turnover has decreased and days in inventory has increased.

Exercise 1-7 : Evaluating Risk and Capital Structure

Refer to Exercises 1-4 and 1-6 about Mixon Company. Compare the long-term risk and
capital stucture positions of the company at the end of 2001 and 2000 by computing the
following ratios :
a) Total debt ratio
b) Times interest earned
Comment on these ratio results

Analysis and interpretation :

2001
Total debt
Total shareholder's equity
Total Assets
EBIT = Net income + Interest + Taxes
Interest expense
Total debt ratio = Total Debt/ Total Assets
Total equity ratio = Total Equity/Total Assets
Times interest earned
= EBIT/Interest expense

2000

226,400 177,750
291,600 267,250
518,000 445,000
53,725
11,100
43.7%
56.3%
4.8

51,520
12,300
39.9%
60.1%
4.2

- Mixon added debt to its capital structure during 2001 with the result that
the debt ratio increased from 39.9% to 43.7%
- The increased profitability of the company allowed it to increase the times
interest earned from 4.2 to 4.8 times. Apparently the company is able
to handle the increased debt.

Exercise 1-8 : Evaluating efficiency and profitability

Refer to the financial statements of Mixon Company in Exercises 1-4 and 1-6.
Evaluate the efficiency and profitability of the company by computing the following :
a) Net Profit Margin
b) Total Asset Turnover
c) Return on Total Assets
Comment on these ratio results

Analysis and interpretation :

2001
Sales
Net Profit
Total Assets

2000

672,500 530,000
34,100 31,375
518,000 445,000

Net Profit Margin = Net Profit/Sales

5.1%
Total Asset Turnover (ATO) = Sales/ Ave Total Assets 1.4

5.9%
1.3

Return on total assets (ROA) = PM X ATO

or Net profit/ Ave Total Assets

7.7%
7.7%

7.1%
7.1%

- The firm's operating efficiency appears to be declining because the ROA decreasing from
7.1% in 2001.
- While ATO favourably increased slightly from 2000 to 2001, the PM unfavourably
decreased from 5.9% to 5.1%
- The decline in profit margin indicates that Mixon's ability to generate net income from
sales has declined.

Source : Wild, Bernstein & Subramanyam (2001)

Problem 1.5
Assume you are an analyst evaluating Mesco Company. The following data are available in your
financial analysis (unless otherwise indicated, all data are as of December 31, Year 5)
Retained Earnings, December 31, Year 4
$98,000
Gross Profit Margin Ratio
25%
Acid Test Ratio
2.5 to 1
Non-current assets
$280,000
Days sales in inventory
45 days
Days in receivables
18 days
Shareholders equity to total debt
4 to 1
Sales (all on credit)
$920,000
Common stock : $15 par value, 10,000 shares issued and outstanding; issued at $21 per share
Required :
Using these data, construct the December 31, Year 5, balance sheet for your analysis. Operating
expenses (excluding taxes and cost of goods sold for Year 5) are $180,000.
The tax rate is 40%. Assume a 360 day year in ratio computations. No cash dividends are paid in
either Year 4 or Year 5. Current assets consist of cash, accounts receivable and inventories.

Mesco Company
Balance Sheet
December 31, Year 5
Assets
Current Assets
Cash
$10,250
Accounts Receivable
46,000
Inventories
86,250
Total Current Assets $142,500
Non-Current assets
280,000
------------$422,500
========
..continued

Mesco Company
Balance Sheet
December 31, Year 5

Liabilities and Stockholders Equity

Current Liabilities
$22,500
Non-current Liabilities
62,000
Total Liabilities
$84,500
StockholdersEquity
Common Stock
$150,000
Additional paid in capital
60,000
Retained Earnings
128,000
Total Stockholders Equity
338,000
Total liabilities & equity
422,500
======

Problem 1-10
Selected ratios for three different companies that operate in three
different industries (merchandising, pharmaceuticals, and utilities) are
reported in the table below. Identify each company A, B & C stating 2
reasons supporting your decision
Ratio

Gross Profit Margin

18%

53%

Net Profit Margin Ratio

2%

14%

8%

Research & Development to sales

0%

17%

0%

Advertising to sales

7%

4%

0%

Interest expense to sales

1%

1%

15%

11%

12%

7%

Return on Assets

NA

Accounts Receivable Turnover

95 times

5 times

11 times

Inventory Turnover

9 times

3 times

NA

Long Term Debt to equity

64%

45%

89%

Company A :

Merchandising industry

Most sales are in cash and accounts receivable

should be minimum causing AR Turnover to be the
highest among the 3 firms.

Rely on high inventory turnover to generate sales.

Has gross profit margin after deducting COGS dealings in inventory.

High advertising expense is characteristic of

merchandising firms.

Company B : Pharmaceutical industry

Highest R&D expense is characteristic of drug
companies.

Drug companies have high profit margins as they

hold patents, trademarks and invest to build up their
brand name e.g. Pfeizer, Merck Highest gross
profit margin and net profit among the three firms.

Low debt as they usually utilize internal funds to

fund growth prospects in line with their high
profitability.

Company C : Utilities industry

No gross profit margin as it does not deal in goods

but a provision of services.
Highest Debt to equity ratio due to high capital
requirement to fund infrastructure of power generation
plants and networks.
High interest expense due to high debt ratio.
Minimal R&D due to inelastic demand for power
supply which is an undifferentiated good.
Low ROA due to high fixed capital assets.