1. Financial Statement Analysis 15 0 Revised by Judy Beebe, Western Oregon University

2. Horizontal Analysis The percentage analysis of increases and decreases in related items in comparative financial statements is calledhorizontal analysis . 15-1 0 3.

Assets

Current assets $550,000 $533,000 $17,0003.2%

Long-term investments 95,000 177,500 (82,500) (46.5%)

Prop., plant, and equip. (net) 444,500 470,000 (25,500) (5.4%)

Intangible assets 50,000 50,000

Total assets$1,139,500 $1,230,500 $(91,000) (7.4%)

Liabilities

Current liabilities $210,000 $243,000 $(33,000) (13.6%)

Long-term liabilities 100,000 200,000 100,000) (50.0%)

Total liabilities$310,000 $443,000 $(133,000 ) (30.0%)

Stockholders Equity

Preferred 6% stock, $100 par $150,000 $150,000

Common stock, $10 par 500,000 500,000

Retained earnings 179,500 137,500 $42,000 30.5%

Total stockholders equity$829,500 $787,500 $42,0005.3%

Total liab. & stockholders eq. $1,139,500 $1,230,500 $(91,000) (7.4%)

Exhibit 1Comparative Balance Sheets 2 008 2007 Amount Percent Increase (Decrease) Lincoln Company Comparative Balance Sheet December 31, 2008 and 2007 15-1 0 4.

Assets

Current assets $550,000 $533,000 $17,0003.2%

Long-term investments 95,000 177,500 (82,500) (46.5%)

Prop., plant, and equip. (net) 444,500 470,000 (25,500) (5.4%)

Intangible assets 50,000 50,000

Total assets$1,139,500 $1,230,500 $(91,000) (7.4%)

Liabilities

Current liabilities $210,000 $243,000 $(33,000) (13.6%)

Long-term liabilities 100,000 200,000 100,000) (50.0%)

Total liabilities$310,000 $443,000 $(133,000 ) (30.0%)

Stockholders Equity

Preferred 6% stock, $100 par $150,000 $150,000

Common stock, $10 par 500,000 500,000

Retained earnings 179,500 137,500 $42,000 30.5%

Total stockholders equity$829,500 $787,500 $42,0005.3%

Total liab. & stockholders eq. $1,139,500 $1,230,500 $(91,000) (7.4%)

2 008 2007 Amount Percent Lincoln Company Comparative Balance Sheet December 31, 2008 and 2007 Increase (Decrease) Horizontal Analysis:15-1 0 Difference $17,000 Base year (2007) $533,000 =3.2% 5.

Assets

Current assets $550,000 $533,000 $17,0003.2%

Long-term investments 95,000 177,500 (82,500) (46.5%)

Prop., plant, and equip. (net) 444,500 470,000 (25,500) (5.4%)

Intangible assets 50,000 50,000

Total assets$1,139,500 $1,230,500 $(91,000) (7.4%)

Liabilities

Current liabilities $210,000 $243,000 $(33,000) (13.6%)

Long-term liabilities 100,000 200,000 100,000) (50.0%)

Total liabilities$310,000 $443,000 $(133,000 ) (30.0%)

Stockholders Equity

Preferred 6% stock, $100 par $150,000 $150,000

Common stock, $10 par 500,000 500,000

Retained earnings 179,500 137,500 $42,000 30.5%

Total stockholders equity$829,500 $787,500 $42,0005.3%

Total liab. & stockholders eq. $1,139,500 $1,230,500 $(91,000) (7.4%)

Horizontal Analysis:15-1 0 2 008 2007 Amount Percent Lincoln Company Comparative Balance Sheet December 31, 2008 and 2007 Increase (Decrease) Difference $(82,500) Base year (2007) $177,500 =(46.5%) 6. Comparative Schedule ofCurrent Assets 15-1 0 Lincoln Company Comparative Schedule of Current Assets December 31, 2008 and 2007 Increase (Decrease ) Cash $90,500 $64,700 $ 25,800 39.9% Marketable securities 75,000 60,000 15,000 25.0% Accounts receivable (net) 115,000 120,000 (5,000) (4.2%) Inventories 264,000 283,000 (19,000) (6.7%) Prepaid expenses 5,500 5,300 200 3.8% Total current assets $550,000 $533,000 $17,000 3.2% 2008 2007 Amount Percent 7. 9 Horizontal Analysis:15-1 0 Lincoln Company Comparative Schedule of Current Assets December 31, 2008 and 2007 Increase (Decrease ) Cash $90,500 $64,700 $ 25,800 39.9% Marketable securities 75,000 60,000 15,000 25.0% Accounts receivable (net) 115,000 120,000 (5,000) (4.2%) Inventories 264,000 283,000 (19,000) (6.7%) Prepaid expenses 5,500 5,300 200 3.8% Total current assets $550,000 $533,000 $17,000 3.2% 2008 2007 Amount Percent Difference $25,800 Base year (2007) $64,700 = 39.9% 8. Lincoln Company Comparative Income Statement For the Year Ended December 31, 2008 and 2007 Sales $1,530,500 $1,234,000 $296,50024.0% Sales returns and allowances 32,500 34,000 (1,500 ) (4.4%) Net sales $1,498,000 $1,200,000 $298,000 24.8% Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit$455,000 $380,000 $75,000 19.7% Selling expenses $191,000 $147,000 $44,000 29.9% Administrative expenses 104,000 97,400 6,600 6.8% Total operating expenses $295,000 $244,400 $50,600 20.7% Income from operations $160,000 $135,600 $24,400 18.0% Other income8,500 11,000 (2,500 ) (22.7%) $168,500 $146,600 $21,900 14.9% Other expense (interest) 6,000 12,000 (6,000) (50.0%) Income before income tax $162,500 $134,600 $27,900 20.7% Income tax expense 71,500 58,100 13,400 23.1% Net income $91,000 $76,500 $14,500 19.0% 2 008 2007 Amount Percent Increase (Decrease) Comparative Income Statement 15-1 0 9. Lincoln Company Comparative Income Statement For the Year Ended December 31, 2008 and 2007 Current assets $1,530,500 $1,234,000 $296,50024.0% Sales returns and allowances 32,500 34,000 (1,500 ) (4.4%) Net sales $1,498,000 $1,200,000 $298,000 24.8% Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit$455,000 $380,000 $75,000 19.7% Selling expenses $191,000 $147,000 $44,000 29.9% Administrative expenses 104,000 97,400 6,600 6,.8% Total operating expenses $295,000 $244,400 $50,600 20.7% Income from operations $160,000 $135,600 $24,400 18.0% Other income8,500 11,000 (2,500 ) (22.7%) $168,500 $146,600 $21,900 14.9% Other expense (interest) 6,000 12,000 (6,000) (50.0%) Income before income tax $162,500 $134,600 $27,900 20.7% Income tax expense 71,500 58,100 13,400 23.1% Net income $91,000 $76,500 $14,500 19.0% 2 008 2007 Amount Percent Increase (Decrease) 15-1 0 Horizontal Analysis: Increase amount $296,500 Base year (2007 )$1,234,000 = 24.0% 10. Comparative Retained Earnings Statement 15-1 0 A percentage analysis that shows the relationship of each component to the total within a single statement is calledvertical analysis. Lincoln Company Comparative Retained Earnings Statement December 31, 2008 and 2007 Increase (Decrease ) Retained earnings, Jan. 1 $137,500 $100,000 $37,500 37.5% Net income for year 91,000 76,500 14,500 19.0% Total $228,500 $176,500 $52,000 29.5%) Dividends: On preferred stock $9,000 $9,000 On common stock 40,000 30,000 10,000 33.3% Total $49,000 $39,000 $10,000 25.6% Total current assets $179,500 $137,500 $42,000 30.5% 2008 2007 Amount Percent 11. 15-1 0 A percentage analysis that shows the relationship of each component to the total within a single statement is calledvertical analysis. Lincoln Company Comparative Retained Earnings Statement December 31, 2008 and 2007 Increase (Decrease ) Retained earnings, Jan. 1 $137,500 $100,000 $37,500 37.5% Net income for year 91,000 76,500 14,500 19.0% Total $228,500 $176,500 $52,000 29.5%) Dividends: On preferred stock $9,000 $9,000 On common stock 40,000 30,000 10,000 33.3% Total $49,000 $39,000 $10,000 25.6% Total current assets $179,500 $137,500 $42,000 30.5% 2008 2007 Amount Percent Horizontal Analysis: Increase amount $37,500 Base year (2007 )$100,000 = 37.5% 12. 15-1 The comparative cash and accounts receivable for a company are provided below: 2008 2007 Cash $62,500 $50,000 Accounts receivable (net) 74,400 80,000 Based on this information, what is the amount and percentage of increase or decrease that would be shown in a balance sheet with horizontal analysis? 0 Example Exercise 15-1 13. For Practice:PE 15-1A, PE 15-1B 15-1 Cash $12,500 increase ($62,500$50,000), or 25% AccountsReceivable $5,600 decrease ($74,400 $80,000)or 7% 0 Follow My Example 15-1 14. Vertical Analysis A percentage analysis used to show the relationship of each component to the total within a single statement is calledvertical analysis . 15-1 0 15. In a vertical analysis of thebalance sheet , each asset item is stated as a percent of thetotal assets .Each liability and stockholders equity item is stated as a percent of the total liabilities and stockholders equity. Vertical Analysis of Balance Sheet 15-1 0 16. Lincoln Company Comparative Balance Sheet For the Years Ended December 31, 2008 and 2007 Assets Current assets $550,000 48.3% $533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Property, plant, & equip. (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 Total assets $1,139,500 100.0% $1,230,500 100.0% Liabilities Current liabilities $210,000 18.4% $243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 Total liabilities $310,000 27.2% $443,000 36.0% Stockholders Equity Preferred 6% stock, $100 par $150,000 13.2% $150,000 12.2% 2.2% Common stock, $10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 Total stockholders equity $829,500 72.8% $787,500 64.0% Total liab. & Stockholders equity $1,139,500 100.0% $1,230,500 100.0% AmountPercentAmountPercent 20082007Total assets$1,139,500100.0% $1,230,500 100.0%Total liab. & stockholders equity$1,139,500100.0% $1,230,500 100.0%15-1 0 17. To demonstrate how vertical analysis percentages are calculated for the balance sheet, lets see how the 48.3 percent was calculated for the 2008 current assets in the next slide.15-1 0 18. Lincoln Company Comparative Balance Sheet For the Years Ended December 31, 2008 and 2007 Assets Current assets $550,000 48.3% $533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Property, plant, & equip. (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 Total assets $1,139,500 100.0% $1,230,500 100.0% Liabilities Current liabilities $210,000 18.4% $243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 Total liabilities $310,000 27.2% $443,000 36.0% Stockholders Equity Preferred 6% stock, $100 par $150,000 13.2% $150,000 1 2.2% Common stock, $10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 Total stockholders equity $829,500 72.8% $787,500 64.0% Total liab. & Stockholders equity $1,139,500 100.0% $1,230,500 100.0% AmountPercentAmountPercent 20082007Total assets$1,139,500100.0% $1,230,500 100.0%Total liab. & stockholders equity$1,139,500100.0% $1,230,500 100.0%15-1 0 Vertical Analysis:Current assets$550,000 Total assets $1,139,500 =48.3% 19. In a vertical analysis of theincome statement , each item is stated as a percent ofnet sales .As an example, lets see how the percent of 12.8% was calculated for 2008 selling expenses. Vertical Analysis of Income Statement 15-1 0 20. 15-1 Comparative Income Statement 0 Sales $1,530,500 102.2%$1,234,000 102.8% Sales returns and allow. 32,500 2.2 34,000 2.8 Net sales $1,498,000 100.0% $1,200,000 100.0% Cost of goods sold 1,043,000 69.6 820,000 68.3 Gross profit $455,000 30.4% $380,000 31.7% Selling expenses $191,000 12.8% $147,000 12.3% Administrative expenses 104,000 6.9 97,400 8.1 Total operating expenses $295,000 19.7% $244,400 20.4% Income from operations $160,000 10.7 $135,600 11.3% Other income 8,500 0.6 11,000 0.9 $168,500 11.3% $146,600 12.2% Other expense (interest) 6,000 0.4 12,000 1.0 Income before income tax $162,500 10.9% $134,600 11.2% Income tax expense 71,500 4.8 58,100 4.8 Net income $91,000 6.1% $76,500 6.4% 20082007 AmountPercentAmountPercent Lincoln Company Comparative Income Statement For the Years Ended December 31, 2008 and 2007 21. Vertical Analysis:Selling expenses$191,000 Net sales$1,498,000 = 12.8% 15-1 0 Sales $1,530,500 102.2%$1,234,000 102.8% Sales returns and allow. 32,500 2.2 34,000 2.8 Net sales $1,498,000 100.0% $1,200,000 100.0% Cost of goods sold 1,043,000 69.6 820,000 68.3 Gross profit $455,000 30.4% $380,000 31.7% Selling expenses $191,000 12.8% $147,000 12.3% Administrative expenses 104,000 6.9 97,400 8.1 Total operating expenses $295,000 19.7% $244,400 20.4% Income from operations $160,000 10.7 $135,600 11.3% Other income 8,500 0.6 11,000 0.9 $168,500 11.3% $146,600 12.2% Other expense (interest) 6,000 0.4 12,000 1.0 Income before income tax $162,500 10.9% $134,600 11.2% Income tax expense 71,500 4.8 58,100 4.8 Net income $91,000 6.1% $76,500 6.4% 20082007 AmountPercentAmountPercent Lincoln Company Comparative Income Statement For the Years Ended December 31, 2008 and 2007 22. Common-Size Statements In acommon-sized statements , all items are expressed as a percentage.Common-sized statements are useful in comparing the current period with prior periods, individual businesses, or one business with with industry percentages. 15-1 0 23. Common-Size Income Statement 15-1 0 24. 15-1 Income statement information for Lee Corporation is provided below: Lee Corporation Sales $100,000 Cost of goods sold 65,000 Gross profit $35,000 Prepare a vertical analysis of the income statement for Lee Corporation. 0 Example Exercise 15-2 25. For Practice:PE 15-2A, PE 15-2B 15-1 Sales $100,000 100% ($100,000/ $100,000) Cost of goods sold 65,000 65 ($65,000/$100,000) Gross profit 35,000 35% ($35,000/$100,000) Amount Percentage 0 Follow My Example 15-2 26. Solvency Analysis The ability of a business to meet its financial obligations (debts) is calledsolvency . The ability of a business to earn income is calledprofitability . 15-2 0 27. Current Position Analysis Using measures to assess a businesss ability to pay its current liabilities is calledcurrent position analysis .Such analysis is of special interest to short-term creditors. 15-2 0 28. Working Capital The excess of current assets of a business over its current liabilities is calledworking capital .The working capital is often used in evaluating a companys ability to meet currently maturing debts. 15-2 0 29. Working capital (a b)$340,000

Current asset:

Cash $90,500

Marketable securities75,000

Accounts receivable (net) 115,000

Inventories264,000

Prepaid expenses 5,500

Total current assets $550,000

Current liabilities 210,000

Lincoln Company 15-2 0 30. Current Ratio Thecurrent ratio , sometimes called theworking capital ratioorbankers ratio , is computed by dividing the total current assets by the total current liabilities. 15-2 0 31. Current ratio (a/ b)2.62.2 a.Current assets$550,000 $533,000 b.Current liabilities 210,000 243,000 Working capital (a b) $340,000 $290,000 20082007 Lincoln Company 15-2 0 32. Quick Ratio A ratio that measures the instant debt-paying ability of a company is called thequick ratiooracid-test ratio . 15-2 0 33. 2008 2007 Quick ratio (a/ b)1.31.0 Quick assets: Cash $90,500 $64,700 Marketable securities75,000 60,000 Accounts receivable (net) 115,000 120,000 a.Total quick assets $280,500 $244,700 b.Current liabilities $210,000 $243,000 Lincoln Company Quick assetsare cash and other current assets that can be quickly converted to cash . 15-2 0 34. 15-2 The following items are reported on a companys balance sheet: Cash $300,000 Marketable securities 100,000 Accounts receivable (net) 200,000 Inventory 200,000 Accounts payable 400,000 Determine (a) the current ratio and (b) the quick ratio.0 Example Exercise 15-3 35. For Practice:PE 15-3A, PE 15-3B

Current Ratio = Current Assets/Current Liabilities

Current Ratio = ($300,000 + $100,000 + $200,000 +$200,000)/$400,000

Current Ratio = 2.0

Quick Ratio =Quick Assets (cash, marketable securities, andaccounts receivable)/Current Liabilities(accounts payable)

Quick Ratio = ($300,000 + $100,000 + $200,000)/$400,000

Quick Ratio =1.5

15-2 0 Follow My Example 15-3 36. Accounts Receivable Turnover The relationship between sales and accounts receivable may be stated as theaccounts receivable turnover .The ratio is to assess the efficiency of the firm in collecting receivables and in the managing of credit. 15-2 0 37. Accounts receivable turnover(a/ b)12.79.2

a.Net sales$1,498,000 $1,200,000

Accounts receivable (net):

Beginning of year $120,000 $140,000

End of year 115,500 120,000

Total $235,000 $260,000

Average (Total/ 2) $117,500 $130,000

2008 2007 Lincoln Company 15-2 0 38. Number of Days Sales in Receivables The number of days sales in receivablesis an estimate of the length of time (in days) the accounts receivable have been outstanding.Comparing this measure with the credit terms provides information on the efficiency in collecting receivables. 15-2 0 39. Number of days sales in receivables (a/ b)28.639.5 a. Average (Total/ 2) $117,500 $130,000 Net sales $1,498,000 $1,200,000 b. Average daily sales on account (Sales/365) $4,104 $3,288 2008 2007 Lincoln Company 15-2 0 40. 15-2 A company reports the following: Net sales $960,000 Average accounts receivable (net)48,000 Determine (a) the accounts receivable turnover and (b) the number of days sales in receivables.Round to one decimal place. 0 Example Exercise 15-4 41. For Practice:PE 15-4A, PE 15-4B15-2

Accounts Receivable Turnover = Sales/Average accountsreceivable

Accounts Receivable Turnover = $960,000/$48,000

Accounts Receivable Turnover =20.0

Number of Days Sales in Receivables= Average accountsreceivable/Averagedaily sales

Number of Days Sales in Receivables =$48,000/($960,000/365)

Number of Days Sales in Receivables =$48,000/$2,630

Number of Days Sales in Receivables =18.3 days

0 Follow My Example 15-4 42. Inventory Turnover The relationship between the volume of goods (merchandise) sold and inventory may be stated as the inventory turnover .The purpose of this ratio is to assess the efficiency of the firm in managing its inventory. 15-2 0 43. 2008 2007 Inventory turnover (a/ b)3.82.8

a. Cost of goods sold $1,043,000 $ 820,000

Inventories:

Beginning of year $283,000 $ 311,000

End of year 264,000 283,000

Total $547,000 $ 594,000

Average (Total/ 2) $273,500 $ 297,000

Lincoln Company 15-2 0 44. Number of days sales in inventory (a/ b)95.7132.2

a. Average (Total/ 2) $273,500 $297,000

Cost of goods sold $1,043,000 $820,000

Average daily cost of goods

sold (COGS/ 365 days) $2,858 $2,247

2008 2007 Number of Days Sales in Inventory Lincoln Company 15-2 0 45. 15-2 A company reports the following: Cost of goods sold $560,000 Average inventory 112,000 Determine (a) the inventory turnover and (b) the number of days sales in inventory.Round to one decimal place. 0 Example Exercise 15-5 46. For Practice:PE 15-5A, PE 15-5B 15-2 a. Inventory Turnover = Cost of Goods Sold/AverageInventory Inventory Turnover = $560,000/$112,000 Inventory Turnover =5.0

Number of Days Sales in Inventory = Average Inventory/Average Daily Costof Goods Sold

Number of Days Sales in Inventory = $112,000/($560,000/365)

Number of Days Sales in Inventory = $112,000/$1,534

Number of Days Sales in Inventory =73.0 days

0 Follow My Example 15-5 47. Ratio of Fixed Assets to Long-Term Liabilities Theratio of fixed assets to long-term liabilitiesis a solvency measure that indicates the margin of safety of the noteholders or bondholders.It also indicates the ability of the business to borrow additional funds on a long-term basis. 15-2 0 48. 2008 2007 Ratio of fixed assets to long-term liabilities (a/ b)4.42.4 a.Fixed assets (net) $444,500 $470,000 b. Long-term liabilities $100,000 $200,000 Lincoln Company 15-2 0 49. Ratio of Liabilities to Stockholders Equity The relationship between the total claims of the creditors and owners theratio of liabilities to stockholders equity is a solvency measure that indicates the margin of safety for creditors. 15-2 0 50. Ratio of liabilities to stockholders equity (a/ b)0.40.6 a. Total liabilities $310,000 $443,000 b. Total stockholders equity $829,500 $787,500 2008 2007 Lincoln Company 15-2 0 51. 15-2 The following information was taken from Acme Companys balance sheet: Fixed assets (net) $1,400,000 Long-term liabilities 400,000 Total liabilities 560,000 Total stockholders equity 1,400,000 Determine the companys (a) ratio of fixed assets to long-term liabilities and (b) ratio of liabilities to stockholders equity.0 Example Exercise 15-6 52. For Practice:PE 15-6A, PE 15-6B 15-2

Ratio of Fixed Assets to Long-Term Liabilities = Fixed Assets/Long-TermLiabilities

Ratio of Fixed Assets to Long-Term Liabilities = $1,400,000/$400,000

Ratio of Fixed Assets to Long-Term Liabilities =3.5

Ratio of Liabilities to Total Stockholders Equity = TotalLiabilities/Total Stockholders Equity

Ratio of Liabilities to Total Stockholders Equity = $560,000/$1,400,000

Ratio of Liabilities to Total Stockholders Equity =0.4

0 Follow My Example 15-6 53. Number of Times Interest Charges Earned Corporations in some industries normally have high ratios of debt to stockholders equity.For such corporations, the relative risk of the debtholders is normally measured as thenumber of times interest charges are earned(during the year), sometimes called thefixed charge coverage ratio . 15-2 0 54. 2008 2007

Income before income tax $162,500 $134,600

a. Add interest expense 6,000 12,000

Amount available to meet

interest charges $168,500 $146,600

Lincoln Company Number of times interest charges earned (b/ a)28.112.2 15-2 0 55. 15-2 A company reports the following: Income before income tax $250,000 Interest expense 100,000 Determine the number of times interest charges are earned.0 Example Exercise 15-7 56. For Practice:PE 15-7A, PE 15-7B 15-2 Number of Times Interest Charges are Earned =(Income Before Income Tax + Interest Expense)/Interest Expense Number of Times Interest Charges are Earned=($250,000 + $100,000)/$100,000 Number of Times Interest Charges are Earned=3.5 0 Follow My Example 15-7 57. Profitability Analysis

Profitabilityis the ability of an entity to earn profits.

This ability to earn profits depends on theeffectivenessandefficiencyof operations as well asresourcesavailable as reported in the balance sheet.

Profitability analysis focuses primarily on the relationship betweenoperating resultsreported in the income statement and resources reported in the balance sheet.

15-3 0 58. Ratio of Net Sales to Assets Theratio of net sales to assetsis a profitability measure that shows how effectively a firm utilizes its assets. 15-3 0 59. 2008 2007 a. Net sales$1,498,000 $1,200,000 Total assets: Beginning of year $1,053,000 $1,010,000 End of year 1,044,500 1,053,000 Total $2,097,500 $2,063,000 b. Average (Total/2) $1,048,750 $1,031,500 Lincoln Company Excludes long-term investments 15-3 0 60. 2008 2007 a. Net sales$1,498,000 $1,200,000 Total assets: Beginning of year $1,053,000 $1,010,000 End of year 1,044,500 1,053,000 Total $2,097,500 $2,063,000 b. Average (Total/2) $1,048,750 $1,031,500 Lincoln Company Ratio of net sales to assets (a/ b) 1.41.2 15-3 0 61. 15-3 A company reports the following: Net sales $2,250,000 Average total sales 1,500,000 Determine the ratio of net sales to assets.Ratio of Net Sales to Total Assets = Net Sales/Average TotalAssets Ratio of Net Sales to Total Assets = $2,250,000/$1,500,000 Ratio of Net Sales to Total Assets =1.5 For Practice:PE 15-8A, PE 15-8B 0 Example Exercise 15-8 Follow My Example 15-8 62. Rate Earned on Total Assets Therate earned on total assetsmeasures the profitability of total assets, without considering how the assets are financed. 15-3 0 63. 2008 2007 Rate earned on totalassets(a/b)8.2%7.3% Net income $91,000 $76,500 Plus interest expense 6,000 12,000 a. Total $97,000 $88,500 Total assets: Beginning of year $1,230,500 $1,187,500 End of year 1,139,500 1,230,500 Total $2,370,000 $2,418,000 b. Average (Total/2) $1,185,000 $1,209,000 Lincoln Company 15-3 0 64. 15-3 A company reports the following income statement and balance sheet information for the current year: Net income $125,000 Interest expense 25,000 Average total assets 2,000,000 Determine the rate earned on total assets.0 Example Exercise 15-9 65. For Practice:PE 15-9A, PE 15-9B 15-3 Rate Earned on Total Assets = (Net Income + InterestExpense)/Average TotalAssets Rate Earned on Total Assets = ($125,000 +$25,000)/$2,000,000 Rate Earned on Total Assets =7.5% 0 Follow My Example 15-9 66. Rate Earned on Stockholders Equity Therate earned on stockholders equitymeasure emphasizes the rate of income earned on the amount invested by the stockholders. 15-3 0 67. Rate earned on stockholders equity (a/ b) 11.3%10.0%a. Net income $91,000 $76,500 Stockholders equity: Beginning of year $787,500 $750,000 End of year 829,500 787,500 Total $1,617,000 $1,537,500 b. Average (Total/2) $808,500 $768,750 2008 2007 Lincoln Company 15-3 0 68. The difference in the rate earned on stockholders equity and the rate earned on total assets is calledleverage .Leverage 15-3 0 69. 10% 5% 0% Rate earned on total assets Rate earned on stockholders equity 2008 2007 Leverage 15-3 0 8.2% 11.3% Leverage 3.1% 7.3% 10.0% Leverage 2.7% 70. Therate earned on common stockholders equity focuses only on the rate of profits earned on the amount invested by the common stockholders. Rate Earned on Common Stockholders Equity 15-3 0 71. 2008 2007 Net income $91,000 $76,500 Less preferred dividends 9,000 9,000 a. Remaindercommon stock $82,000 $67,500 Common stockholders equity: Beginning of year$637,500 $600,000 End of year 679,500 637,500 Total $1,317,000 $1,237,500 b. Average (Total/2) $658,500 $618,750 Rate earned on common stockholders equity(a/ b) 12.5%10.9% Lincoln Company 15-3 0 72. 15-3 A company reports the following: Net income $125,000 Preferred dividends 5,000 Average stockholders equity 1,000,000 Average common stockholders equity 800,000 Determine (a) the rate earned on stockholders equity and (b) the rate earned on common stockholders equity.0 Example Exercise 15-10 73. For Practice:PE 15-10A, PE 15-10B 15-3 a. Rate Earned on Stockholders Equity= Net Income/Average Stockholders Equity Rate Earned on Stockholders Equity= $125,000/$1,000,000 Rate Earned on Stockholders Equity=12.5% b. Rate Earned on Common Stockholders Equity = (NetIncome Preferred Dividends)/AverageCommon Stockholders Equity Rate Earned on Common Stockholders Equity =($125,000 $5,000)/$800,000 Rate Earned on Common Stockholders Equity =15% 0 Follow My Example 15-10 74. Earnings per Share on Common Stock One of the profitability measures often quoted by the financial press isearning per s hare (EPS) on common stock .It is also normally reported in the income statement in corporate annual reports. 15-3 0 75. 20082007 Earnings per share on commonstock(a/b)$1.64$1.35

Net income $91,000 $76,500

Preferred dividends 9,000 9,000

Remainderidentified with

common stock $82,000 $67,500

b. Shares of common stock 50,000 50,000

Lincoln Company 15-3 0 76. Price-Earnings Ratio Another profitability measure quoted by the financial press is theprice-earnings (P/E) ratioon common stock.The price-earnings ratio is an indicator of a firms future earnings prospects. 15-3 0 77. 20082007 Price-earnings ratio on common stock2520 Market price per share ofcommon stock $41.00 $27.00 Earnings per share on common stock /1.64 /1.35 Lincoln Company 15-3 0 78. 15-3 A company reports the following: Net income $250,000 Preferred dividends $15,000 Shares of common stock outstanding 20,000 Market price per share ofcommon stock $35

Determine the companys earnings per share on common stock.

Determine the companys price-earnings ratio.Round to one decimal place.

0 Example Exercise 15-11 79. 15-3

• (a) Earnings Per Share of Common Stock = (NetIncome Preferred Dividends)/Shares ofCommon Stock Outstanding

• Earnings per Share of Common Stock =($250,000 $15,000)/20,000

• Earnings per Share of Common Stock = $11.75

(Continued) 0 Follow My Example 15-11 80. 15-3 (b) Price-Earnings Ratio = Market Price per Share ofCommon Stock/Earnings perShare onCommon Stock Price-Earnings Ratio = $35.00/$11.75 Price-Earnings Ratio =3.0 For Practice:PE 15-11A, PE 15-11B (Concluded) 0 Follow My Example 15-11 81. Dividends per Share Dividends per sharecan be reported with earnings per share to indicate the relationship between dividends and earnings.Comparing these two per share amounts indicates the extent to which the corporation is retaining its earnings for use in operations. 15-3 0 82. Dividends Earnings 2008 2007 Per share $2.00 $1.50 $1.00 $0.50 $ 0.00 Lincoln Company Dividends and Earning per Share of Common Stock 15-3 0 $0.80 $1.64 $0.60 $1.35 83. Thedividend yieldon common stock is a profitability measure that shows the rate of return to common stockholders in terms of cash dividends. Dividend Yield 15-3 0 84. 2008 2007 Dividend yield on common stock2.0%2.2%Dividends per share of common stock $0.80 $0.60 Market price per share ofcommon stock / 41.00 / 27.00 Lincoln Company 15-3 0 85. Corporate Annual Reports In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections:

Management Discussion and Analysis

Report on adequacy of internal control

Report on fairness of financial statements

15-4 0 86. TheManagement Discussion and Analysis (MD&A)includes an analysis of the results of operations and discusses managements opinion about future performance.It compares the prior years income statement with the current years.It also contains an analysis of the firms financial condition. Management Discussion and Analysis 15-4 0 87. Management isrequiredby the Sarbanes-Oxley Act of 2002 to provide a report stating their responsibility for establishing and maintaining internal control.In addition, the report must state managements conclusion concerning the effectiveness of internal controls over financial reporting. Report on Adequacy of Internal Control 15-4 0 88. All publicly held corporations arerequiredto have an independent audit (examination) of their financial statements.The CPAs who conduct the audit render anopinionon the fairness of the statements. Report on Fairness of Financial Statements 15-4 0