University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

479

Pages:

18
Author:

katakomba7mk

Chapter 14 “How Well Am I Doing?” Financial Statement Analysis Learning Objective LO3 To compute and interpret financial ratios that would be useful to a short-term creditor 14-55 Ratio Analysis – The Short–Term Creditor Use this information to calculate ratios to measure the well-being of the short-term creditors for Norton Corporation. NORTON CORPORATION 2005 Cash $ 30,000 Accounts receivable, net Beginning of year 17,000 End of year 20,000 Inventory Beginning of year 10,000 End of year 12,000 Total current assets 65,000 Total current liabilities 42,000 Sales on account 500,000 Cost of goods sold 140,000 14-56 Working Capital The excess of current assets over current liabilities is known as working capital. Working capital is not free. It must be financed with long-term debt and equity. 14-57 Working Capital December 31, 2005 Current assets $ Current liabilities Working capital 65,000 (42,000) $ 23,000 14-58 Current Ratio Current Ratio = Current Assets Current Liabilities The current ratio measures a company’s short-term debt paying ability. A declining ratio may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories. 14-59 Current Ratio Current Ratio = Current Assets Current Liabilities Current Ratio = $65,000 $42,000 = 1.55 : 1 The current ratio measures a company’s short-term debt paying ability. 14-60 Acid-Test (Quick) Ratio Acid-Test = Ratio Quick Assets Current Liabilities Acid-Test = Ratio $50,000 $42,000 = 1.19 : 1 Quick assets include Cash, Marketable Securities, Accounts Receivable and current Notes Receivable. This ratio measures a company’s ability to meet obligations without having to liquidate inventory. Norton Corporation’s quick assets consist of cash of $30,000 and accounts receivable of $20,000. 14-61 Accounts Receivable Turnover Accounts Receivable Turnover = Sales on Account Average Accounts Receivable Accounts $500,000 = 27.03 times Receivable = ($17,000 + $20,000) ÷ 2 Turnover This ratio measures how many times a company converts its receivables into cash each year. 14-62 Average Collection Period Average 365 Days Collection = Accounts Receivable Turnover Period Average Collection = Period 365 Days 27.03 Times = 13.50 days This ratio measures, on average, how many days it takes to collect an account receivable. 14-63 Inventory Turnover Inventory Turnover = Cost of Goods Sold Average Inventory This ratio measures how many times a company’s inventory has been sold and replaced during the year. If a company’s inventory turnover Is less than its industry average, it either has excessive inventory or the wrong types of inventory. 14-64 Inventory Turnover Inventory Turnover Inventory Turnover = Cost of Goods Sold Average Inventory $140,000 = 12.73 times = ($10,000 + $12,000) ÷ 2 This ratio measures how many times a company’s inventory has been sold and replaced during the year. 14-65 Average Sale Period Average Sale Period Average = Sale Period = 365 Days Inventory Turnover 365 Days 12.73 Times = 28.67 days This ratio measures how many days, on average, it takes to sell the inventory. 14-66 Learning Objective LO4 To compute and interpret financial ratios that would be useful to a long-term creditor 14-67 Ratio Analysis – The Long–Term Creditor Use this information to calculate ratios to measure the well-being of the longterm creditors for Norton Corporation. NORTON CORPORATION 2005 Earnings before interest expense and income taxes This is also referred to as net operating income. Interest expense $ 84,000 7,300 Total stockholders' equity 234,390 Total liabilities 112,000 14-68 Times Interest Earned Ratio Times Interest = Earned Times Interest = Earned Earnings before Interest Expense plus Income Taxes Interest Expense $84,000 = 11.5 times 7,300 This is the most common measure of the ability of a firm’s operations to provide protection to the long-term creditor. 14-69 Debt-to-Equity Ratio Debt–to– Total Liabilities Equity = Stockholders’ Equity Ratio This ratio indicates the relative proportions of debt to equity on a company’s balance sheet. Stockholders like a lot of debt if the company can take advantage of positive financial leverage. Creditors prefer less debt and more equity because equity represents a buffer of protection. 14-70 Debt-to-Equity Ratio Debt–to– Total Liabilities Equity = Stockholders’ Equity Ratio Debt–to– Equity = Ratio $112,000 $234,390 = 0.48 This ratio indicates the relative proportions of debt to equity on a company’s balance sheet. 14-71