accounting assignement

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Ratios and Formulas in Customer Financial Analysis

Financial statement analysis is a judgmental process. One of the primary objectives is identification of major changes in trends, and relationships and the investigation of the reasons underlying those changes. The judgment process can be improved by experience and the use of analytical tools. Probably the most widely used financial analysis technique is ratio analysis, the analysis of relationships between two or more line items on the financial statement. Financial ratios are usually expressed in percentage or times. Generally, financial ratios are calculated for the purpose of evaluating aspects of a company’s operations and fall into the following categories:

· Liquidity ratios measure a firm’s ability to meet its current obligations.

· Profitability ratios measure management’s ability to control expenses and to earn a return on the resources committed to the business.

· Leverage ratios measure the degree of protection of suppliers of long-term funds and can also aid in judging a firm’s ability to raise additional debt and its capacity to pay its liabilities on time.

· Efficiency, activity or turnover ratios provide information about management’s ability to control expenses and to earn a return on the resources committed to the business.

A ratio can be computed from any pair of numbers. Given the large quantity of variables included in financial statements, a very long list of meaningful ratios can be derived. A standard list of ratios or standard computation of them does not exist. The following ratio presentation includes ratios that are most often used when evaluating the credit worthiness of a customer. Ratio analysis becomes a very personal or company driven procedure. Analysts are drawn to and use the ones they are comfortable with and understand.

1.

Liquidity Ratios

Working Capital
Working capital compares current assets to current liabilities, and serves as the liquid reserve available to satisfy contingencies and uncertainties. A high working capital balance is mandated if the entity is unable to borrow on short notice. The ratio indicates the short-term solvency of a business and in determining if a firm can pay its current liabilities when due.

 Formula

Current Assets – Current Liabilities

Acid Test or Quick Ratio
A measurement of the liquidity position of the business. The quick ratio compares the cash plus cash equivalents and accounts receivable to the current liabilities. The primary difference between the current ratio and the quick ratio is the quick ratio does not include inventory and prepaid expenses in the calculation. Consequently, a business’s quick ratio will be lower than its current ratio. It is a stringent test of liquidity.

 Formula

Cash + Marketable Securities + Accounts Receivable
Current Liabilities

Current Ratio
provides an indication of the liquidity of the business by comparing the amount of current assets to current liabilities. A business’s current assets generally consist of cash, marketable securities, accounts receivable, and inventories. Current liabilities include accounts payable, current maturities of long-term debt, accrued income taxes, and other accrued expenses that are due within one year. In general, businesses prefer to have at least one dollar of current assets for every dollar of current liabilities. However, the normal current ratio fluctuates from industry to industry. A current ratio significantly higher than the industry average could indicate the existence of redundant assets. Conversely, a current ratio significantly lower than the industry average could indicate a lack of liquidity.

 Formula

Current Assets
Current Liabilities

Cash Ratio
Indicates a conservative view of liquidity such as when a company has pledged its receivables and its inventory, or the analyst suspects severe liquidity problems with inventory and receivables.

 Formula

Cash Equivalents + Marketable Securities
Current Liabilities

2.

Profitability Ratios

Net Profit Margin (Return on Sales)
A measure of net income dollars generated by each dollar of sales.

 Formula

Net Income *
Net Sales

* Refinements to the net income figure can make it more accurate than this ratio computation. They could include removal of equity earnings from investments, “other income” and “other expense” items as well as minority share of earnings and nonrecurring items.

Return on Assets
Measures the company’s ability to utilize its assets to create profits.

 Formula

Net Income *
(Beginning + Ending Total Assets) / 2

Operating Income Margin
A measure of the operating income generated by each dollar of sales.

 Formula

Operating Income
Net Sales

Return on Investment
Measures the income earned on the invested capital.

 Formula

Net Income *
Long-term Liabilities + Equity

Return on Equity
Measures the income earned on the shareholder’s investment in the business.

 Formula

Net Income *
Equity

Du Pont Return on Assets
A combination of financial ratios in a series to evaluate investment return. The benefit of the method is that it provides an understanding of how the company generates its return.

 Formula

Net Income *
Sales

x

Sales
Assets

x

Assets
Equity

Gross Profit Margin
Indicates the relationship between net sales revenue and the cost of goods sold. This ratio should be compared with industry data as it may indicate insufficient volume and excessive purchasing or labor costs.

 Formula

Gross Profit
Net Sales

3.

Financial Leverage Ratio

Total Debts to Assets
Provides information about the company’s ability to absorb asset reductions arising from losses without jeopardizing the interest of creditors.

 Formula

Total Liabilities
Total Assets

Capitalization Ratio
Indicates long-term debt usage.

 Formula

Long-Term Debt
Long-Term Debt + Owners’ Equity

Debt to Equity
Indicates how well creditors are protected in case of the company’s insolvency.

 Formula

Total Debt
Total Equity

Interest Coverage Ratio (Times Interest Earned)
Indicates a company’s capacity to meet interest payments. Uses EBIT (Earnings Before Interest and Taxes)

 Formula

EBIT
Interest Expense

Long-term Debt to Net Working Capital
Provides insight into the ability to pay long term debt from current assets after paying current liabilities.

 Formula

Long-term Debt
Current Assets – Current Liabilities

4.

Efficiency Ratios

Cash Turnover
Measures how effective a company is utilizing its cash.

 Formula

Net Sales
Cash

Sales to Working Capital (Net Working Capital Turnover)
Indicates the turnover in working capital per year. A low ratio indicates inefficiency, while a high level implies that the company’s working capital is working too hard.

 Formula

Net Sales
Average Working Capital

Total Asset Turnover
Measures the activity of the assets and the ability of the business to generate sales through the use of the assets.

 Formula

Net Sales
Average Total Assets

Fixed Asset Turnover
Measures the capacity utilization and the quality of fixed assets.

 Formula

Net Sales
Net Fixed Assets

Days’ Sales in Receivables
Indicates the average time in days, that receivables are outstanding (DSO). It helps determine if a change in receivables is due to a change in sales, or to another factor such as a change in selling terms. An analyst might compare the days’ sales in receivables with the company’s credit terms as an indication of how efficiently the company manages its receivables.

 Formula

Gross Receivables
Annual Net Sales / 365

Accounts Receivable Turnover
indicates the liquidity of the company’s receivables.

 Formula

Net Sales
Average Gross Receivables

Accounts Receivable Turnover in Days
indicates the liquidity of the company’s receivables in days.

 Formula

Average Gross Receivables
Annual Net Sales / 365

Days’ Sales in Inventory
Indicates the length of time that it will take to use up the inventory through sales.

 Formula

Ending Inventory
Cost of Goods Sold / 365

Inventory Turnover
indicates the liquidity of the inventory.

 Formula

Cost of Goods Sold
Average Inventory

Inventory Turnover in Days
indicates the liquidity of the inventory in days.

 Formula

Average Inventory
Cost of Goods Sold / 365

Operating Cycle
Indicates the time between the acquisition of inventory and the realization of cash from sales of inventory. For most companies the operating cycle is less than one year, but in some industries it is longer.

 Formula

Accounts Receivable Turnover in Days
+ Inventory Turnover in Day

Days’ Payables Outstanding
Indicates how the firm handles obligations of its suppliers.

 Formula

Ending Accounts Payable
Purchases / 365

Payables Turnover
Indicates the liquidity of the firm’s payables.

 Formula

Purchases
Average Accounts Payable

Payables Turnover in Days
Indicates the liquidity of the firm’s payables in days.

 Formula

Average Accounts Payable
Purchases / 365

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BUS 222 Accounting 2

Assignment 2

Submission Date: 5th December 2012 [Week 12 Wednesday]

Introduction:

You now know how to read and prepare financial statements for different types of organizations like sole proprietors, partnerships and corporations. This Assignment is based on your ability to read the Financial Statements of Corporations. You will download the recent financial statements of the corporation allotted to you and would read them to answer questions based on it. The main objective of this project is to give you exposure to corporate financial statements. One primary purpose of publishing the financial statements of the company in the form of Annual Reports is to provide financial information to shareholders, and you will briefly examine some of that information.

Instructions:

1. Start the Assignment with a good Title page and an innovative introduction about your company. You can be as creative as you like. Show that you are really familiar with this company and understand the nature of its operation. The introduction should not be more than 2 pages.

2. Then copy and paste the following questions to the assignment and print it out. You will then answer the following questions as briefly as sensibly possible. The answer to the following questions should be handwritten.

I. General Questions:

1. What is the name of the company?

2. What is the date on the Financial Statements?

3. Name the different statements composed in the financial statement.

4. Who were the auditors?

5. Was the audit opinion “Qualified” or “Unqualified”. What does it mean?

6. What years were presented in the balance sheet?

7. What were total assets for the most recent year presented?

8. What was the retained earnings total for the most recent year presented?

9. What was net income for the most recent year presented?

10. How many footnotes (or notes) were there?

II. Questions from the Financial Statements:

Note: Include a description and interpretation for each ratio. Explain what the results of this ratio indicate about the company’s performance and/or results. You may separate the ratios on the basis of liquidity, profitability, solvency etc. (Refer the attached file for the formulas)

Calculate the following with proper formulas:

1. Current Ratio:

2. Debt/equity ratio:

3. Net Profit Margin,

4. Return on Assets:

5. Return on Equity:

6. Earnings per share:

7. Sales to Net Working Capital Ratio:

8. Asset Turnover Ratio:

9. Inventory Turnover Ratio:

10. Operating cycle:

III. Questions from the Footnotes:

1. Explain briefly any two accounting policies of this company that interests you.

2. Describe the share capital of the corporation in the latest year.

3. Is there any change in the EPS (Earning per Share) that you calculated and that shown in the consolidated statement of income? Give reasons.

4. When is dividends recognized by this corporation.

5. List the intangible assets and explain the accounting treatment.

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Happy Exploring!!

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