Module 2 - Financial Statement Analysis and Planning (Chapters Two and Three)
All page numbers are references to Corporate Finance: A Focused Approach, 5th edition by Ehrhardt and Brigham (Cengage, 2013)
In Chapter 2, we learn the structure and terms of financial statements. In Chapter 3, we analyze financial statements using ratio analysis. The more important, and difficult, material is Chapter 2. Major changes are occurring in Accounting; our textbooks are often years behind these changes. In my videos, I will discuss some of these changes.
Chapter 2 Things to absorb - For Chapter 2, the main focus is on the format and purpose of balance sheet and income statement, and the names of items that might appear in these statements (e.g., depreciation is on income statement and accumulated depreciation may be on balance sheet), names of four required financial statements, the basics of tax calculations, and understand how to identify/calculate cash flow.
Do not need to absorb - NA.
Things to Read - You will need to read the chapter. You will need to search for terms using a search engine.
Things to Do - Make 100 on the quiz. Be able to answer End of Chapter Questions 1-4, 6, and 7 and Problems 1, 2, 4, 6, and 9-11.
Note, I will ask you to know the names of many financial accounts that are not listed in the chapter, so expect to do some Internet searches. Many account names in financial statements vary by company (Income Statement = Profit and Loss Statement = Statement of Income = Statement of Operations), thus part of learning this chapter is learning potential account names. When solving problems for this chapter, use the Internet to look up terms with which you are unfamiliar. This is especially applicable when solving the scrambled income statement/ balance sheet problems.
1. Watch the Chapter 2 Overview. You can download the PowerPoint slides from these videos from here.
2. Read pages 51-59.
3. Watch this video on the Balance Sheet and Income Statement. Most people find this video to be very useful in identifying the various accounts for these two statements.
4. Be able to answer end of Chapter 2 Questions 1-4 and Problems 4 and 6.
5. Read pages 59-72.
6. Watch this video on the Statement of Cash Flows and Calculating Cash Flows. Most people find this video to be very useful in identifying the various accounts for these two statements.
7. Be able to answer end of Chapter 2 Questions 6, 7 and Problems 10 and 11.
8. Read pages 72-76.
9. If you would like a review of a bunch of accounting terms and Economic Value Added, watch the Economic Value Added video. Hint, unless your company uses EVA, you can probably ship this video and learn the terms/concepts by doing the Chapter quiz multiple times.
10. Read the rest of the chapter.
11. Watch the videos on Corporate Taxes video. Do not focus on the tax code details as these often change. Do be able to use the equation that Pretax return (1- tax rate) = After tax return (similar to end of chapter problems 1, 2 and 9), as there is often an exam question on this topic.
12. Since the main focus is the on the format of statements, the most complex quiz problems require you to unscramble and solve for missing numbers in the income statement and balance sheet. To solve these big problems, you must be able to solve smaller segments of the statements. Here are audio solutions that focus on the smaller components:
a. Audio solution to: In its recent income statement, Smith Software Inc. reported $26 million of net income, and in its year-end balance sheet, Smith reported $353 million of retained earnings. The previous year, its balance sheet showed $339 million of retained earnings. What were the total dividends paid to shareholders during the most recent year? (Answers are in $ millions.)
b. Audio solution to: In its recent income statement, Smith Software Inc. reported paying $10 million in dividends to common shareholders, and in its year-end balance sheet, Smith reported $365 million of retained earnings. The previous year, its balance sheet showed $354 million of retained earnings. What was the firm's net income during the most recent year? (Answers are in $ millions.)
c. Audio solution to: Cox Corporation recently reported an EBITDA of $66 million and $8 million of net income. The company has $11 million interest expense and the corporate tax rate is 40.0% percent. What was the company's depreciation and amortization expense? (Answers are in $ millions.)
d. Audio solution to: Brooks Sisters' operating income (EBIT) is $140 million. The company's tax rate is 40.0%, and its operating cash flow is $115.3 million. The company's interest expense is $28 million. What is the company's net cash flow? (Assume that depreciation is the only non-cash item in the firm's financial statements.) (Answers are in $ millions.)
8. Here is an audio solution to a complex scramble/unscramble Balance Sheet Income Statement Problem: Fill in the missing numbers. Prepaid expenses _________ Additional paid-in capital _______ Property, plant and equipment, net ________ Total Liabilities and Equity ________ Net income _______ Tax payable _______ Interest expense ________ Net sales __________ Deferred (Long term) income tax liabilities ________ Operating expenses _________ Change in Retained Earnings 177 Total current assets 2495 Cash 660 Trade Receivables 749 Operating income 557 Income before provision for income taxes 538 Inventories 872 Income taxes receivable 100 Other long term assets 384 Accounts payable 407 Deferred revenue 38 Accrued program costs 536 Total Assets 4474 Other long term Liabilities 43 Retained earnings 1945 Total liabilities 1896 Cost of sales 2097 Gross profit 1713 Intangible assets, net 1071 Income taxes expense 199 Dividends 162 Total current liabilities 1104 Long-term debt 516 Accrued expenses 101 Common stock 31
13. Be prepared for a quiz over the Chapter 2 material.
Chapter 3 Need to Absorb - Purpose of financial statement analysis, common size analysis versus ratio analysis, trend/historical analysis versus benchmarking/competitive analysis, focus on calculating and interpreting ratios, also on ratio algebra (i.e., how changes in financial statements affects ratios), and limitations of ratio analysis.
Do not need to absorb - Dupont equation and how to use or interpret Dupont equation (Note, many people find the Dupont discussion useful in understanding ratio algebra) and qualitative factors in section 3-11.
Need to Read - Read the Chapter.
Need to Do - Make 100 on the quiz. I do not list suggested questions and problems below. This is because many of the questions are comprehensive rather than focused. But, after studying this chapter, you should be able to solve all of the end of chapter questions and problems, and self-test review questions. However, rather than spending time completing those questions, I suggest you focus on the Chapter Quiz. Almost all of the end of chapter questions and problems are in my quiz database.
1. Watch the Chapter Introduction and Overview video. The Powerpoints for all of this chapter's videos are located here. While not explicitly stated in the videos, videos two to five closely follow the end of chapter minicase.
2. Read pages 95-103.
3. Watch the videos on Liquidity Ratios and Asset Management Ratios. While not explicitly stated in the videos, the next four videos closely follow the end of chapter minicase.
4. Read pages 103-109.
5. Watch the videos on Leverage Ratios and Profitability Ratios.
6. Read pages 110-115.
7. Watch the videos on Market Ratios and Common Size Analysis.
8. Read the rest of the chapter
9. Watch the videos on DuPont Equation and Limitations of Ratio Analysis.
10. Here are audio solutions, created by Dr. Ronald Best, to several types of ratio problems:
a. Audio Solution to: TCBW last year had an average collection period (days sales outstanding) of 35 days based on accounts receivable of $460,000. All of the firm's sales are made on credit. The firm expects sales this year to be the same as last year. However, the company has begun a new credit policy that should lower the average collection period to 28 days. If the new average collection period is attained, what will the firm's accounts receivable balance equal?
b. Audio Solution to:The RRR Company has a target current ratio of 3.2. Presently, the current ratio is 4.4 based on current assets of $6,556,000. If RRR expands its inventory using short-term liabilities (maturities less than one year), how much additional funding can it obtain before its target current ratio is reached?
c. Audio Solution to:AAA's inventory turnover ratio is 22.30 based on sales of $25,200,000. The firm's current ratio equals 10.21 with current liabilities equal to $290,000. If the firm's cash and marketable securities equal $732,342, what is the firm's days sales outstanding?
d. Audio Solution to:U KNO, Inc. uses only debt and common equity funds to finance its assets. This past year the firm's return on total assets was 19%. The firm financed 39% percent of its assets using equity. What was the firm's return on common equity?
e. Audio Solution to:Last year YYY Company had a 5.00% net profit margin based on $21,000,000 in sales and $14,000,000 of total assets. During the coming year, the president has set a goal of attaining a 8% return on total assets. If YYY finances 56% of its assets by borrowing, what will its return on common equity be next year if the return on assets goal is achieved?
f. Audio Solution to:The RRR Company has a target current ratio of 3.6. Presently, the current ratio is 4.5 based on current assets of $8,505,000. If RRR expands its fixed assets using short-term liabilities (maturities less than one year), how much additional funding can it obtain before its target current ratio is reached?
g. Audio Solution to:AAA's inventory turnover ratio is 22.30 based on sales of $25,200,000. The firm's current ratio equals 10.21 with current liabilities equal to $290,000. What is the firm's quick ratio?
h. Audio Solution to: Use the information below to calculate the firm's return on common equity. (State your answer as a percentage with two decimal places.) Net profit margin = 11.88%; Debt ratio = 44.29%; Fixed asset turnover = 7.54; Total asset turnover = 3.50 ; Inventory turnover = 22.3.
i. Audio Solution to:U KNO, Inc. uses only debt and common equity funds to finance its assets. This past year the firm's return on total assets was 19%. The firm financed 30% percent of its assets using debt. What was the firm's return on common equity?
j. Audio Solution to:Last year YYY Company had a 7.00% net profit margin based on $24,000,000 in sales and $13,000,000 of total assets. During the coming year, the president has set a goal of attaining a 14% return on total assets. How much must firm sales equal, other things being the same, for the goal to be achieved?
k. Audio Solution to:Russell Securities has $267 million in total assets and its corporate tax rate is 40%. The company recently reported that its basic earning power (BEP) ratio was 50% and its return on assets (ROA) was 13%. What was the company's interest expense? (Answers are in millions.)
l. Audio Solution to:You are given the following information: Stockholders' equity = $205 million; price/earnings ratio = 43 shares outstanding = 11,080,000; and market/book ratio =6.75. Calculate the market price of a share of the company's stock.
m. Audio Solution to:Strack Houseware Supplies Inc. has $866 million in total assets. The other side of its balance sheet consists of $95.26 million in current liabilities, $251.14 million in long-term debt, and $519.60 million in common equity. The company has 16,100,000 shares of common stock outstanding, and its stock price is $59 per share. What is Strack's market-to-book ratio?
n. Audio Solution to:Moss Motors has $108 million in assets, and its tax rate is 40%. The company's basic earning power (BEP) ratio is 42%, and its return on assets (ROA) is 11%. What is Moss' times-interest-earned (TIE) ratio?
o. Audio Solution to:The Wilson Corporation has the following relationships: Sales/Total assets = 3;Return on assets (ROA) = 15%; Return on equity (ROE) = 17%. What is Wilson's profit margin?
p. Audio Solution to:Cleveland Corporation has 13,240,000 shares of common stock outstanding, its net income is $241 million and its P/E is 15.1. What is the company's stock price?
q. Audio Solution to:Peterson Packaging Corp. has $2,072 million in total assets. The company's basic earning power (BEP) ratio is 13%, and its times-interest-earned ratio is 4.32. Peterson's depreciation and amortization expense totals $73 million. It has $55 million in lease payments and $39 million must go towards principal payments on outstanding loans and long-term debt. What is Peterson's EBITDA coverage ratio?
r. Audio Solution to:The Wilson Corporation has the following relationships: Sales/Total assets = 5; Return on total assets (ROA) = 13%; Return on common equity (ROE) = 16%. What is Wilson's debt ratio?
11. Take the Chapter 3 quiz.
Updated January 17, 2016
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