Chapter 02

Financial Statements and Analysis

The Four Key Financial Statements

The Four Key Financial Statements are:

(a) The Income Statement

(b) The Balance Sheet

(c) The Statement Of Retained earnings

(d) The Statement Of Cash Flows

Balance sheet

Current assets Short term assets, expected to be converted into cash within 1 year or

less

Current Liabilities Short term liabilities expected to be paid within 1 year or less

Long term debt Debt for which payment is not due in the current year

Paid in capital in excess of par The amount of proceeds in excess of the par value received from the

original sale of the common stock

Retained earnings The cumulative total of all earnings, net of dividends that have retained

and reinvested in the firm since its inception

Statement of Retained Earnings

Statement of stockholder equity

Shows all equity account transaction that occurred during the given year

Statement of retained earnings

Reconciled the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year.

Barlett company statement of retained Earnings ($000)

For the year ended December 31,2006

Retained earnings Balance (January1,2006) $1012

Plus: Net profits after taxes (for 2006) 231

less : Cash dividends (paid during the 2006)

Preferred stock 10

Common stock 98

Total dividends paid 108

Retained earnings balance (Dec. 31, 2006) 1135

Exercises

2.1: Nowras began 2006 with a retained earnings balance of 928,000 OR. During 2006, the firm earned RO 377,000 after taxes. From this amount, preferred and common stock holders were paid RO 47,000 and RO 210,000 respectively in dividends.

Required: prepared a statement of retained earning for the year ended 2006, for Nowras.

2.2: Lulu Hypermarket began 2008 with a retained earning balance of 900,000 OR. during 2008, the firm earned RO 377,000 after taxes. From this amount preferred and common stock holders are paid RO 50,000 and 150,000 respectively in dividends.

Required: Prepared a statement of retained earning for the year ended 2006, for Lulu Hypermarket.

Question# 03; In year 2008, income statement of Omantel mention earning available to common stock holders is 600,000 OR and the number of shares outstanding is 320,000.

Required: Calculate Earning per share to common

stockholders

Statement of Cash Flow

Provides a summary of the firm’s operating, investment and financing cash flows and reconciles them with the changes in its cash and marketable securities during the period.

Ratio Analysis (Financial)

• Ratio are used much in our daily life. We buys cars based o miles per gallon, we evaluate baseball players by earned run averages and batting averages. These all ratios are constructed to judge comparative performance.

• The analysis of financial statements based on the use of ratios or relative values.

• The basic inputs to ratio analysis are the firm’s income statement and the balance sheet.

Ratio Classification

A. Profitability Ratio

1. Gross Margin

2. Return on Equity

3. Return on Total Asset

C. Assets Utilization Ratio6. Average Collection period

7. Average payment period

8. Inventory turnover.

9. Total Asset turnover

B. Liquidity Ratio4. Current ratio.

5. Quick Ratio.

D. Debt Utilization ratio

10. Debt to total Assets

11.Book value ratio

12. Price earning ratio

13. Times interest earn ratio

A. Profitability Ratios

1. Gross Profit margin = Sales – Cost of goods sold / Sales

= Gross profits / sales

= 3074,000 – 2088,000 / 3074,000

= 32.1%

It represent the pure profits earned on each sales dollar

2. Return on common equity (ROE) = Earning available for common stockholders / Common stock

equity = 250,000 / 391,000 = 63.5 % Higher this return, the better off are the owners.

3. Return on Total Asset = Earning Available for Common stockholders / Total assets = 221,000 / 4,653,000 = 4.74 %

This Value indicates that the company earned 6.1 cents on each dollar.

B. Liquidity Ratio

The liquidity of a firm is measured by its ability to satisfy its short term obligation as they come due.

1. Current ratio:

Current ratio = Current assets / current liabilities

= 1,223,000 / 620,000 = 1.97

2. Quick ratio:

Quick ratio = Current assets – inventory / current liabilities

= 1223,000 – 289,000 / 620,000

= 934,000 / 620,000 = 1.51

Activity ratio A measure the speed with which various accounts are converted into

sales or cash inflows or out flows.

1.Inventory turnover = cost of goods sold / Inventory

= 2,088,000 / 289,000 = 7.2

2. Average collection period = Accounts receivable / Average sales per day

= Accounts receivable / Annual sales / 365

= 503,000 / 3074,000 / 365

= 59.7 days

Ratio continue…….

3. Average payment period = Accounts payable / Average

purchases per day = Accounts payable / Annual

Purchases / 365 = 382,000 / 0.70 × 2088,000/365 = 382,000 / $4,004 = 95.4 days

4. Total Assets turnover = Sales / total Assets = 3074,000 / 4,653,000 = 0.67 times

The total asset turnover indicates the efficiency with which firm uses its assets to generate sales.

Question # 01: The GMC financial statement shows annual sales of OR 1,200,000 account receivables of OR 250,000

Required: Calculate Average Collection Period

Question# 02: The Suzuki company income statement shows cost of goods sold to 2050,000 and inventory RO.370,000

Required: Calculate inventory turnover ratio

Question # 03: The Carrefour income statement shows accounts payable of RO.250,000, the cost of goods is RO.1,050,000 and the purchases are 75% of the cost of the goods sold.

Required: Calculate the Average payment period

Question# 04: The GMC financial statement shows sales amounted to RO 2,050,000 and the total assets are RO 2,687,000.

Required: Calculate total Asset turnover.

D. Debt Utilization Ratios

The debt ratio measures the proportion of total assets financed by the firm’s creditors.

1.Debt ratio = Total liabilities / Total assets

=1643,000 / 4,653,000

= 0.35 = 35 %

This value indicates that the company has financed close to half of its assets with debt.

2. Time Interest Earned Ratio

= Earning before interest and taxes / Interest

= 453,000 / 93,000

= 4.87 times

Measure the firm’s ability to make contractual interest payment. The higher its value, the better the firm is to fulfill its interest obligation

Market Ratios3.Return on Common equity =

Earnings Available for common stock holders / Common stock equity

= 250,000 / 391,000

= 63.6%

4. Price / earning ratio =

Market price per share of common stock / Earning per

share

= 32.25 / 3.34

= $ 9.65 This figure indicates that investor were paying $11.10 for each $1.00 of

earning

Question#01:The Hayak shopping center financial statement shows Total Assets to RO 4,700,000 and total liabilities are RO 2,700,000

Required: Calculate Debt Ratio for Hayak shopping Center

Question # 02: The Kia Motors financial Statement shows Sales amounted to RO 3,500,000 and cost of goods sold is RO 2,756,000

Required: Calculate Gross profit Margin

Question# 03: The Al Safeer financial statement shows operating profit amount to R0 5,894,500 and sales shows RO 98,679,000

Required: Calculate the operating profit margin

Question# 04: The Toyota financial statement shows earning available to common stock holders to RO 1,572,000 and total assets are RO 9,654,000

Required: Calculate the Return on total Assets.

Question # 05: The Sultan center financial statement shows Earning available to common stock holders to RO 560,000 and common stock equity is RO 3,578,000

Required: Calculate Return on Equity

Book value ratio =

Common stock equity / Number of shares of common stock outstanding

= $391,000 / 75,000

= $ 5.21