Financial Statement analysis:

What is common size of financial statement? Differentiate between

vertical and horizontal analysis of financial statement. Explain in brief.
Answer:
A common-size financial statement is a financial report that displays all line items
as a percentage of a base figure, making it easier to compare financial performance
across different periods or companies, regardless of size. Common-size analysis
helps in understanding the relative significance of various accounts on the financial
statements and facilitates comparisons by eliminating the impact of size
differences.

Common-Size Financial Statement:

a. Income Statement: Each line item is expressed as a percentage of total sales.
b. Balance Sheet: Each line item is expressed as a percentage of total assets.

Vertical Analysis:
Vertical analysis, also known as common-size analysis, involves comparing each
item on a financial statement to a base item within the same period. This analysis
helps to understand the proportional relationship of each line item to the base item,
providing insights into the structure and composition of financial statements.

Key Points of Vertical Analysis:

a. Income Statement: Each line item is expressed as a percentage of total
sales/revenue.
b. Balance Sheet: Each line item is expressed as a percentage of total assets,
liabilities, or equity.
c. Purpose: To analyze the internal structure of financial statements and to
understand the relative significance of each item.

Example: If sales are Rs.100,000 and the cost of goods sold (COGS) is Rs.40,000,
the COGS as a percentage of sales is 40%.

Horizontal Analysis:
Horizontal analysis, also known as trend analysis, involves comparing financial data
across multiple periods. This analysis helps to identify trends, growth patterns, and
changes in financial performance over time.

Key Points of Horizontal Analysis:

a. Base Year Comparison: Financial statements from different periods are
compared to a base year to identify changes.
b. Percentage Change: Each line item is expressed as a percentage change
from the base year.
c. Purpose: To evaluate the growth or decline in financial performance and to
identify trends over time.

Example: If sales in Year 1 are Rs.100, 000 and sales in Year 2 are Rs.120, 000, the
percentage change in sales is = ×100% = 20%
Differences between Vertical and Horizontal Analysis:

Vertical analysis Horizontal analysis

Definition Analysis of financial statement Analysis of financial
items within a single period as statement items across
a percentage of a base item multiple periods to identify
trends and changes.
Base item Total sales (Income Statement) Corresponding item in the
or Total assets (Balance Sheet). base year.
Focus Proportional relationship of Changes and trends in items
items within a single period. over multiple periods.
Purpose Understanding the internal Evaluating growth, trends,
structure and composition of and changes over time.
financial statements.
Application Common-size financial Trend analysis and
statements. comparative statements.
Example COGS as a percentage of sales. Year-over-year change in
sales.

In Summary:
Vertical Analysis: Focuses on the relative size of each item within a single period,
useful for assessing the internal structure.
Horizontal Analysis: Focuses on the changes in each item over multiple periods,
useful for identifying trends and growth patterns.

The ratios are classified into three categories.

1. Liquidity Ratio:
Liquidity is a relative measure of the nearness to cash of the assets and
liabilities of a company. Nearness to cash deals with the length of time
before cash is realized. Current assets are assets that will be converted
into cash or consumed within one year or within one operating cycle. The
operating cycle of manufacturing company is the length of time between
the purchase of raw materials and the eventual collection of any
outstanding account receivable from the sale of product. Current liabilities
are a company’s obligations that require the use of current assets or the
creation of other current liabilities to satisfy the obligations.
Current assets Current liabilities
Cash Accounts payable
Accounts receivable Salary payable
Inventory Interest payable
Prepaid Tax payable
Supplies Short term notes payable
Marketable securities Unearned revenue
Quick assets
Cash, Accounts receivable,
marketable securities

a. Current Ratio
 Current ratio is the test of liquidity. It evaluates short term debt paying
ability of the firm. It measures the availability of current assets for
meeting current liabilities.
Current Ratio =
b. Quick Ratio/Acid Test Ratio
Quick ratio is stricter test of a company’s ability to pay its current
debts as they are due.
Quick Ratio =
c. Accounts Receivable Turnover Ratio:
Trade receivable is the result of credit sales. It measures the efficiency
of cash collection through credit sales. Higher the turnover indicates
cash collection very fast or more efficient management and lower the
turnover indicates slowly cash collection.
Accounts Receivable Turnover Ratio =
Average Receivable =
d. No. of days’ sales in receivable: Average collection period is
calculated to know the average numbers of days/ month for which a
firm has to wait before trade debtors are converted into a cash
No. of Days’ Sales in Receivable =

e. Inventory Turnover ratio:

A measure of the number of times inventory is sold during a period.

Inventory Turnover Ratio =

Average Inventory =
f. No. of days sales’ sales in inventory:
A measure of how long it takes to sell inventory
No. of days’ sales in inventory =

Example:
Income statement for 2023
Particulars Amount Amount
Sales revenue 25,00,00
Less: Cost of goods 0
sold 15,00,00
0
Gross margin 10,00,00
Less: Operating 0
expenses 350,000
General 50,000
expenses 25,000
Depreciation 425,000
 Interest
Net income before tax 575,000
Less: Tax expenses 115,000
(20%)
Net income after tax 460,000
Partial balance sheet
Current assets 2023 2022
Cash 140,000 120,000
Accounts receivable 300,000 200,000
Inventory 150,000 100,000
Prepaid insurance 45,000 20,000
Office supplies 5,000 15,000
Marketable securities 60,000 80,000
Total 700,000 535,000
Current liabilities 2023 2022
Accounts payable 80,000 120,000
Salary payable 30,000 60,000
Interest payable 15,000 25,000
Tax payable 50,000 40,000
Unearned revenue 25,000 30,000
Total liabilities 200,000 275,000
Required: Calculate following ratio and interpret the result
a. Current ratio
b. Quick ratio
c. Inventory turnover ratio
d. No. of days sales of inventory
e. Accounts turnover ratio
f. No. of days sales of receivable

Solution:
a. Current Ratio = = = 3.5
A current ratio of 3.5 indicates that the company has Rs.3.50 in
current assets for every Rs.1.00 of current liabilities. This suggests
strong liquidity and implies that the company is in a good position
to cover its short-term obligations.

b. Quick Ratio =
= = 2.5
A quick ratio of 2.5 indicates that the company has Rs.2.5 in liquid
assets for every Rs.1.00 of current liabilities. This is a strong
indicator of liquidity, suggesting the company can easily meet its
short-term obligations without relying on the sale of inventory.

c. A/R Turnover Ratio =

= =10
Average Receivable =
= = 250,000
An accounts receivable turnover ratio of 10 means the company
collects its average receivables 10 times a year. This high ratio
indicates efficient credit policies and effective collection processes,
 suggesting that the company is good at managing its receivables
and converting sales into cash.

d. No. of Days’ Sales in A/R =

= = 36 days
The company takes approximately 36 days to collect its
receivables. This is a reasonable collection period, indicating that
the company is efficiently managing its receivables and maintaining
a healthy cash flow. It suggests that customers are paying their
invoices in just over a month.

e. Inventory Turnover Ratio = = = 12

Average Inventory =
= = 125,000
An inventory turnover ratio of 12 means the company sells and
replaces its inventory 12 times a year. This high turnover rate
suggests efficient inventory management, implying that the
company is effectively converting its inventory into sales.

f. No. of days’ sales in inventory =

= = 30 days
The company takes approximately 30 days to sell its entire
inventory. This indicates that the inventory is being turned over
roughly once a month, which is a positive sign of inventory
management efficiency. It suggests that the company is not holding
on to excess or obsolete stock and can quickly convert inventory
into sales.

2. Solvency Ratio :
The ability of a company to remain in business over long term
a. Debt- Equity Ratio: It is test of long term solvency of a firm. The ratio
indicates the relationship between debt and equity. It is related to
shareholder’s equity indicating the degree of protection against long
term creditors.
Debt to Equity Ratio =
Current Long term liabilities
liabilities
Accounts payable Long term bank loan
Salary payable Bonds payable
Interest payable Debenture
Tax payable Long term notes payable
Short term notes payable
Unearned revenue
Total liabilities = Current liabilities + long term liabilities
Total shareholders’ equity
Common stock + Additional paid in capital + Retained earnings

b. Times Interest Earned ratio: It indicates the company’s ability to

meet the current year’s interest payments out of the current year’s
earnings.
 Times Interest Earned Ratio =

c. Debt Service Coverage: A statement of cash flows measure of the

ability of company to meet the interest and principal payments.
Debt coverage ratio =

Cash flow from operation before interest and Amount

tax
Cash from a sales and receivable xxx
Cash paid to suppliers (xxx)
Cash paid for operating expenses (xxx)

Income statement for 2023

Particulars Amount Amount
Sales revenue 25,00,00
Less: Cost of goods 0
sold 15,00,00
0
Gross margin 10,00,00
Less: Operating 0
expenses 350,000
General 50,000
expenses 25,000
Depreciation 425,000
Interest
Net income before tax 575,000
Less: Tax expenses 115,000
(20%)
Net income after tax 460,000

Partial balance sheet

Current liabilities 2023 2022
Accounts payable 80,000 120,000
Salary payable 30,000 60,000
Interest payable 15,000 25,000
Tax payable 50,000 40,000
Unearned revenue 25,000 30,000
Total liabilities 200,000 275,000
Debenture 100,000 200,000
Total liabilities 300,000 475,000
Capital stock @ Rs.100 900,000 700,000
par 300,000 300,000
10% preferred stock @ 400,000 235,000
Rs.100 180,000 55,000
Additional paid in capital
Retained earnings
Total 18,80,00 12,90,00
0 0

Cash flow statement:

 Cash from operating activities Amount
Cash from sales and receivable 24,00,000
Cash paid to suppliers (14,10,000)
Cash paid for operating activities (350,000)
Interest expenses (35,000)
Tax expenses (105,000)
Cash from operating activities 500,000
Annual principal amount paid 100,000
Required: Calculate ratio and interpret the result
a. Debt to equity ratio
b. Time interest earned ratio
c. Debt service coverage ratio

Solution:

a. Debt to Equity Ratio =

= = 0.1898
A debt to equity ratio of 0.1898 indicates that for every Rs. of
equity, the company has approximately 19 paisa in debt. This low
ratio suggests that the company is not heavily reliant on debt
financing, implying lower financial risk and a strong equity position.
It indicates conservative leverage, which can be appealing to
investors seeking stable and low-risk investments.

b. Times Interest Earned Ratio =

= = 24
A TIE ratio of 24 means that the company earns 24 times its
interest expense before taxes. This high ratio suggests that the
company is generating significantly more than enough income to
cover its interest obligations. It indicates strong financial health and
implies that the company is at low risk of defaulting on its debt.

c. Debt coverage ratio =

= = 5.12
A debt coverage ratio of 5.12 indicates that the company generates
over 5 times its required debt payments from its operational cash flow.
This high ratio suggests that the company has a strong capacity to
meet its debt obligations, reflecting good cash flow management and
financial stability.

3. Profitability ratio
a. Gross Profit Ratio: This ratio establishes the relationship between
gross profit and net sales and shows the efficiency of management to
earn profit through sales.
Gross Margin Ratio =
b. Return on sales: This ratio establishes a relationship between net
profits to net sales and shows the efficiency of management to earn
net profit through sales. This ratio helps to determine the operational
efficiency of the management.
Return on sales ratio =
 c. Return on Total Assets (ROA): This ratio shows the relationship of
Net profit and total assets and is to determine how efficiency the
assets have been used by management. This ratio indicates the ability
of generating profit per rupees of total assets.
d. Return on Assets =
Average assets =
e. Assets Turnover Ratio: This ratio measures the efficiency of utilizing
total assets towards contribution of sales. Higher the total assets
turnover ratio indicates better business performance and lower ratio
indicates lower performance of business.
Assets Turnover Ratio =
Average assets =
f. Return on Common Stockholder’ Equity: This ratio measures the
relationship between net profit after interest and tax and shareholder’s
fund. The objectives of computing this ratio is to determine how
efficiently the funds supplied by shareholders have been used. It
indicates the firm’s ability of generating profit per rupees of
shareholder’s funds.
Return on Common Stockholder’s Equity =

Average common stockholders’ equity =

Example:
Income statement for 2023
Particulars Amount Amount
Sales revenue 25,00,00
Less: Cost of goods 0
sold 15,00,00
0
Gross margin 10,00,00
Less: Operating 0
expenses 350,000
General 50,000
expenses 25,000
Depreciation 425,000
Interest
Net income before tax 575,000
Less: Tax expenses 115,000
(20%)
Net income after tax 460,000

Comparative balance sheet

Assets 2023 2022
Cash 140,000 120,000
Accounts receivable 300,000 200,000
Inventory 150,000 100,000
Prepaid insurance 45,000 20,000
Office supplies 5,000 15,000
Marketable securities 60,000 80,000
Total current assets 700,000 535,000
Investment 400,000 300,000
Land 600,000 500,000
Building 300,000 300,000
less: acc. depreciation (50,000) (25,000)
Furniture and machine 150,000 150,000
Less: Acc. depreciation (45,000) (25,000)
Intangible assets 25,000 30,000
Total long term assets 13,80,00 12,30,00
0 0
Total assets 20,80,00 17,65,00
0 0
Accounts payable 80,000 120,000
Salary payable 30,000 60,000
Interest payable 15,000 25,000
Tax payable 50,000 40,000
Unearned revenue 25,000 30,000
Total current liabilities 200,000 275,000
Debenture 100,000 200,000
Total liabilities 300,000 475,000
Contributed capital and retained earnings
Capital stock @ Rs.100 par 900,000 700,000
10% preferred stock @ Rs.100 300,000 300,000
Additional paid in capital 400,000 235,000
Retained earnings 180,000 55,000
Total 17,80,00 12,90,00
0 0
Total liabilities and stockholder equity 20,80,00 17,65,00
0 0

Required: Calculate following ratio and interpret the result

a. Gross Profit Ratio:
b. Return on sales:
c. Return on Total Assets (ROA):
d. Return on Assets
e. Assets Turnover Ratio:
f. Return on Common Stockholder’ Equity:

Solution:
a. Gross Margin Ratio = = ×100% = 40%
At 40%, the company retains 40 cents for every rupee of sales after
accounting for the cost of goods sold, indicating a strong gross
margin.
b. Return on sales ratio =
= × 100% = 19.2%
At 19.2% ROS means the company earns Rs.0.192 for every rupee
of sales, reflecting efficient control over expenses relative to sales.

c. Return on Total Assets =

= = 0.2497
 A 24.97% ROA suggests the company generates Rs.0.2497 in net
income for every rupee invested in assets, demonstrating effective
use of assets.

Average assets =
= = 19, 22,500
d. Assets Turnover Ratio =
= = 1.3
At approximately 1.3, the company generates Rs.1.3 in sales for
every rupee invested in assets, indicating efficient use of assets to
generate revenue.
e. Return on Common Stockholder’s Equity =
= × 100% = 34.82%
A 34.82% ROE shows that the company generates Rs.0.3482 for
every rupee of common equity, indicating strong profitability for
common shareholders.

Average common stockholders’ equity =

= = 12, 35,000
Year 2023 2022
Capital stock @ Rs.100 par 900,000 700,000
Additional paid in capital 400,000 235,000
Retained earnings 180,000 55,000
Total 14,80,0 990,000
00

g. Earnings per share (EPS): It measures the profit available to equity

shareholders on per share basis i.e. the amount they can get on each
share held. The objective of computing this ratio is to measure the
profitability of the firm on per equity share basis.
Earnings per share =
h. Dividend per share: Whole earning in not distributed as dividend to
shareholders so that earning per share and dividend per share is not
equal. The amount of earning distributed and paid as cash dividend is
considered as dividend per share.
Dividend per share =
i. Dividend payout ratio: This ratio measures the relationship between
the earning related to equity shareholders and dividend paid to them.
Dividend payout ratio =
j. Dividend yield ratio: This ratio show the relationship between
dividend per share and market value per share
Dividend yield ratio =
k. Earning yield ratio: This ratio shows the relationship between
earning per share and market value per share
Earning yield ratio =
l. Price to earnings ratio: The price-to-earnings (P/E) ratio is the
proportion of a company's market price per share to its earnings per
share.
Price to earnings ratio =

Income statement for 2023

Particulars Amount Amount
Sales revenue 25,00,00
Less: Cost of goods 0
sold 15,00,00
0
Gross margin 10,00,00
Less: Operating 0
expenses 350,000
General 50,000
expenses 25,000
Depreciation 425,000
Interest
Net income before tax 575,000
Less: Tax expenses 115,000
(20%)
Net income after tax 460,000

Partial balance sheet 2023 2022

Capital stock @ Rs.100 par 800,000 400,00
10% preferred stock @ Rs.100 300,000 0
Additional paid in capital 400,000 200,00
Retained earnings 380,000 0
200,00
0
155,00
0
Total 18,80,00 955,00
0 0
Dividend paid to common 205,000
stock 180
Market price per share

Required: Calculate and interpret the result

a. Earnings per share
b. Dividend per share
c. Dividend payout ratio
d. Earning yield ratio
e. Dividend yield ratio
f. Price earnings ratio

Solution:
a. Earnings per share =
= = Rs.53.75
At Rs.53.75, the company is generating significant earnings
for each share of common stock.
b. Dividend per share =
= = Rs.25.625
At Rs.25.625, the company is returning a portion of its
earnings to shareholders.
 c. Dividend payout ratio =
= × 100% = 47.67%
A ratio of approximately 47.66% indicates that almost half of
the company's earnings are distributed as dividends to
common shareholders.

d. Dividend yield ratio =

= ×100% = 14.24%
At approximately 14.24%, this ratio shows a relatively high
return in the form of dividends relative to the stock price.

e. Earning yield ratio =

= ×100% = 29.86 %
At approximately 29.86%, this ratio indicates a high return on
the investment based on current earnings.

f. Price to earnings ratio =

= = 3.35
A P/E ratio of 3.35 suggests that investors are paying Rs.3.35
for every rupee of earnings, indicating the market's valuation
of the company's earnings potential.

Exercise
1. The accounting staff of CCB Enterprises has completed the financial
statements for the 2010 calendar year. The statement of income for
the current year and the comparative statements of financial position
for 2010 and 2009 follow.
CCB Enterprises
Income statement
For the year ended December 31, 2010
Particulars Amount
Revenue 800,000
Net sales 60,000
Other income 860,000
Total revenue
Less: Expenses
Cost of goods sold 540,000
Research and development 25,000
Selling and administration 155,000
Interest expenses 20,000
Total expenses 740,000
Income before income tax 120,000
Income tax 48,000
Net income 72,000
CCB
Comparative statement of financial position
December 31, 2009 and 2010
Assets 2010 2009
Current assets
Cash and short term investment 26,000 21,000
Receivables 48,000 50,000
Inventories 65,000 62,000
Prepaid 5,000 3,000
Total current assets 144,000 136,000
Other assets
Investment 106,000 106,000
Deposits 10,000 8,000
Total other assets 116,000 114,000
Property, plant and equipment
Land 12,000 12,000
Building and equipment 394,000 370,000
Less: Accumulated depreciation (126,000) (122,000)
Total property, plant and equipment 280,000 260,000
Total assets 540,000 510,000

Liabilities and owners ‘equity 2,010 2,009

Current liabilities

Short term loan 22,000 24,000

Accounts payable 72,000 71,000

Salaries and wages payable 26,000 27,000

Total current liabilities 120,000 122,000
Long term debt 160,000 171,000
Total liabilities 280,000 293,000
Owners' equity

Common stock at par 44,000 42,000

 Paid in capital excess in par 64,000 61,000
Total paid in capital 108,000 103,000
Retained earnings 152,000 114,000
Total owners ‘equity 260,000 217,000
Total liabilities and owners' equity 540,000 510,000
Required:
1. Calculate the following financial ratio for 2010 for CCB Enterprises
a. Times interest earned ratio
b. Return on total assets
c. Return on common stockholders’ equity
d. Debt to equity ratio ( at December 31, 2010)
e. Current ratio ( at December 31, 2010)
f. Quick ratio ( at December 31, 2010)
g. Accounts receivable turnover ratio ( assume that all sales are on
credit)
h. Number of days’ sales in receivable
i. Inventory turnover ratio (assume that all purchases are on credit)
j. Number of days’ sales in inventory
2. Prepare a few brief comments on the overall financial health of CCB
Enterprises.

Solution:
Financial ratios for 2010 for CCB Enterprises
a. Times Interest Earned Ratio =
= ==7
Interpretation:
This ratio indicates that CCB Enterprises can cover its interest expenses 7
times with its earnings before interest and taxes (EBIT). A higher ratio
suggests better financial stability and a lower risk of defaulting on interest
payments.

b. Return on Total assets =

= = = 16%
Average Total Assets = = Rs.525,000
Tax rate = Income taxes/Income before tax = $48,000/$120,000 = 40%.
Interpretation:
This ratio indicates that CCB Enterprises is generating a return of 16% on
its total assets. It reflects the company's efficiency in using its assets to
generate earnings.

c. Return on Common Stockholder’s Equity =

= =30.19%
Interpretation:
 This ratio shows that CCB Enterprises is generating a return of
approximately 30.19% on the equity invested by common stockholders. It
indicates strong profitability and effective use of equity capital.
Average stockholders’ Equity = = Rs.238, 500
a. Debt to Equity Ratio =
= = 1.08: 1
Interpretation:
This ratio implies that CCB Enterprises has Rs.1.08 in debt for every dollar
of equity. It indicates a balanced approach to financing with both debt and
equity.
b. Current Ratio = = = 1.2
Interpretation:
This ratio suggests that CCB Enterprises has Rs.1.20 in current assets for
every dollar of current liabilities. A ratio above 1 indicates good short-term
financial health.

c. Quick Ratio =
= = = 0.62
Interpretation:
This ratio indicates that CCB Enterprises has Rs.0.62 in liquid assets for
every Rs. of current liabilities. It shows the company's ability to cover
short-term liabilities without relying on inventory and prepaid.
d. Accounts Receivable Turnover Ratio =
= = 16.3 times
Average Receivable =
= = Rs.49, 000
Interpretation:
This ratio indicates that CCB Enterprises collects its average receivables
about 16.3 times a year, suggesting efficient credit and collection policies.

e. Number of days’ sales in receivables =

= = 22 days
Interpretation:
This metric shows that it takes CCB Enterprises about 22 days to collect
its receivables, indicating good liquidity and efficient collection processes.

f. Inventory Turnover Ratio = = = 8.5 times

Average inventory = = Rs.63, 500
Interpretation:
This ratio indicates that CCB Enterprises turns over its inventory
approximately 8.5 times a year, suggesting effective inventory
management.
g. No. of days’ sales in inventory = = = 42 days
Interpretation:
This metric shows that CCB Enterprises takes about 42 days to sell its
inventory, indicating efficient inventory management and sales processes.

Overall, these ratios suggest that CCB Enterprises is in a strong financial

position with good profitability, liquidity, and efficiency in managing its
assets and liabilities.

Case 2:
Heartland Inc. is a medium size company that has been in business for 20
years. The industry has become very competitive in the last few years,
and Heartland has decided that it must grow if it is going to grow to
survive. It has approached the bank for sizable five years loan, and bank
has requested Heartland most recent financial statements as part of the
loan package.
The industry in which Heartland operates consists of approximately 20
companies relatively equal in size. The trade association to which all of
the competitors belong publishes an annual survey of the industry,
including industry averages for selected ratios for the competitors. All
companies voluntarily submit their statements to the association for this
purpose.
Heartland’s controller is aware that the bank has access to this survey and
is very concerned about how the company fared this past year compared
with the rest of the industry. The ratios included in the publication and
averages for past year are as follows:

Ratio Industry
average
Current ratio 1.23
Acid test(quick) ratio 0.75
Accounts receivable turnover ratio 33 times
Inventory turnover ratio 29 times
Debt to equity ratio 0.53
Times interest earned ratio 8.65 times
Return on sales 6.57%
Asset turnover ratio 1.95 times
Return on assets 12.81%
Return on common stockholders’ 17.67%
equity

The financial statements to be submitted to the bank in connection with

loan follow.
Heartland Inc.
Statement of income statement and retained earnings
For the year ended December 31, 2010
Sales revenue Rs.542,75
Less: Cost of goods sold 0
Gross margin 435,650
Less: Selling, general and administrative 107,100
expenses 65,780
Loss on sale of securities 220
Income before interest and taxes 41,100
Interest expenses 9,275
Income before tax 31,825
Income tax expenses 12,730
Net income after tax 19,095
Add: Retained earnings, January 1, 2010 58,485
77,580
Less: Dividend paid to common 12,000
Retained earnings, December 31, 2010 65,580

Heartland Inc.
Comparative statement of financial positions

December December
31, 31,
2010 2009
Assets:
Current assets:
Cash Rs.1,135 Rs.750
Marketable securities 1,250 2,250
Accounts receivable, net of 15,650 12,380
allowance 12,680 15,870
Inventories 385 420
Prepaid items
Total current assets 31,100 31,670
Long term investment 425 425
Property, plant and equipment
Land 32,000 32,000
Building and equipment net 216,000 206,000
Total property, plant and 248,000 238,000
equipment
Total assets Rs.279,525 Rs.270,095
Liabilities and Stockholder’
Equity
Current liabilities Rs.8,750 Rs.12,750
 Short term notes 20,090 14,380
Accounts payable 1,975 2,430
Salaries and wages payable 3,130 2,050
Income tax payable
Total current liabilities 33,945 31,610
Long term bonds payable 80,000 80,000
Stockholder’s equity
Common stock, no par 100,000 100,000
Retained earnings 65,580 58,485
Total stockholders’ equity 165,580 158,485
Total liabilities and stockholders’ 279,525 270,095
equity
Required:
1. Prepare a columnar report for the controller of Heartland Inc.
comparing the industry averages for the ratios published by the
trade association with the comparable ratios for Heartland. For
Heartland, compute the ratios as of December 31, 2010 or, for the
year ending December 31, 2010, whichever is appropriate.
2. Briefly evaluate Heartland’s ratios relative to the industry averages
3. Do you think that bank will approve the loan? Explain your answer.

Solution:
Calculations for Heartland’s ratios
a. Current Ratio == = 0.92
b. Quick Ratio =
= = = 0.53
c. A/R Turnover Ratio = = = 39 times
Average Receivable =
= = Rs.14,015
d. Inventory Turnover Ratio = = = 31 times
Average inventory = = Rs.14,275
e. Debt to Equity Ratio =
= = 0.69
f. Times Interest Earned Ratio =
= = 4.43 times
g. Return on sales =
= = 4.54%
Tax rate = = 40%
h. Asset turnover ratio = = = 1.98 times
Average total assets = = Rs.274,810
i. Return on assets = = = 8.97 %
j. Return on common stockholders’ equity =
= = 11.78%
Average common stockholders’ equity = = Rs.162,032.5
 Average Heartland Inc.
Current ratio 1.23 0.92
Acid-test (quick) ratio 0.75 0.53
Accounts receivable turnover 33 times 39 times
Inventory turnover 29 times 31 times
Debt-to-equity ratio 0.53 0.69
Times interest earned 8.65 times 4.43 times
Return on sales 6.57% 4.54%
Asset turnover 1.95 times 1.98 times
Return on assets 12.81% 8.97%
Return on common stockholders’ equity 17.67% 11.78%

a. Current Ratio
Interpretation:
Heartland Inc.'s current ratio of 0.92 is below the industry average of 1.23,
indicating that it might have less ability to cover its short-term liabilities
with its short-term assets compared to its peers. This suggests potential
liquidity issues.

b. Acid-test (Quick) Ratio

Interpretation:
Heartland Inc.'s quick ratio of 0.53 is lower than the industry average of
0.75, indicating that it has fewer liquid assets available to cover
immediate liabilities, which might be a concern for its short-term financial
stability.

c. Accounts Receivable Turnover

Interpretation:
Heartland Inc.'s accounts receivable turnover of 39 times is higher than
the industry average of 33 times, suggesting that the company is more
efficient in collecting its receivables and managing its credit policies.

d. Inventory Turnover
Interpretation:
Heartland Inc.'s inventory turnover of 31 times is higher than the industry
average of 29 times, indicating that the company is more efficient in
managing its inventory and converting it into sales.

e. Debt-to-Equity Ratio
Interpretation:
Heartland Inc.'s debt-to-equity ratio of 0.69 is higher than the industry
average of 0.53, suggesting that the company relies more on debt
financing compared to its peers. This could indicate higher financial risk.

f. Times Interest Earned

Interpretation:
Heartland Inc.'s times interest earned ratio of 4.43 is significantly lower
than the industry average of 8.65 times, indicating that the company has
less capacity to cover its interest expenses with its earnings, which could
be a concern for its financial stability.
g. Return on Sales
Interpretation:
Heartland Inc.'s return on sales of 4.54% is below the industry average of
6.57%, suggesting that the company is less efficient in generating profit
from its sales compared to its peers.

h. Asset Turnover
Interpretation:
Heartland Inc.'s asset turnover of 1.98 times is slightly above the industry
average of 1.95 times, indicating that the company is efficient in using its
assets to generate sales.

i. Return on Assets (ROA)

Interpretation:
Heartland Inc.'s return on assets of 8.97% is lower than the industry
average of 12.81%, indicating that the company is less efficient in
generating profit from its assets compared to its peers.

j. Return on Common Stockholders’ Equity (ROE)

Interpretation:
Heartland Inc.'s return on equity of 11.78% is below the industry average
of 17.67%, suggesting that the company is less effective in generating
returns for its shareholders compared to its peers.

Overall Analysis
Heartland Inc. shows strengths in its efficiency metrics (accounts
receivable turnover and inventory turnover) but falls short in liquidity
(current ratio and quick ratio), profitability (return on sales, ROA, and
ROE), and financial stability (times interest earned and debt-to-equity
ratio) compared to the industry average.

Conclusion:
Based on the comparison, Heartland Inc. appears to be less financially
sound than the industry average. The company's lower liquidity,
profitability, and financial stability metrics suggest it faces more
challenges in these areas compared to its peers. To improve its financial
health, Heartland Inc. should focus on enhancing its liquidity, profitability,
and ability to cover interest expenses.

Question:
The accounting staff of SST Enterprises has completed the financial
statements for the 2010 calendar year. The statement of income for the
current year and the comparative statements of financial position for 2010
and 2009 follow.
SST Enterprises
Income statement
December 31, 2010
Particulars Amount
Net sales Rs.
Other income 600,000
45,000
Total revenue 645,000
Less; Expenses
Cost of goods sold 405,000
Research and development 18,000
Selling and administrative 120,000
Interest 15,000
Total expense 558,000
Net income before tax 87,000
Less: tax expenses 27,000
Net income after tax 60,000

Comparative statement of financial statements

December 31, 2010 and 2009
2010 2009
Assets
Current assets
Cash and short term investments Rs.27,00 Rs.20,00
Receivables, less: allowance for doubtful 0 0
debts
(Rs.1,100 in 2010 and Rs.1,400 in 2009) 36,000 37,000
Inventory 35,000 42,000
Prepaid items and other current assets 2,000 1,000
Total current assets Rs.100,0 100,000
00
Property, plant and equipment:
Land 9,000 9,000
Buildings and equipment, less: Acc.
depreciation 191,000 186,000
(Rs. 74,000 in 2010 and Rs..62,000 in
2009)
Total property, plant and equipment 200,000 195,000
Total assets 300,000 295,000
Liabilities and capital stock
Current liabilities
Short term loans Rs.20,00 Rs.15,00
Accounts payable 0 0
Salaries and wages payable 80,000 68,000
5,000 7,000
Total current liabilities Rs.105,0 Rs.90,00
00 0
Long term debts 15,000 40,000
 Total liabilities Rs.120,0 Rs.130,0
00 00
Stockholders’ equity
Common stock, at par Rs.50,00 Rs.50,00
Paid in capital in excess in par 0 0
25,000 25,000
Total paid in capital Rs.75,00 Rs.75,00
0 0
Retained earnings 105,000 90,000
Total stockholders’ equity Rs.180,0 Rs.165,0
00 00
Total liabilities and stockholders’ equity Rs.300,0 Rs.295,0
00 00
Required:
a. Calculate the following financial ratios for 2010 for SST
1. Times interest earned ratio
2. Return on total assets
3. Return on common stockholders’ equity
4. Debt to equity ratio ( at December 31, 2010)
5. Current ratio ( at December 31, 2010)
6. Quick ratio ( at December 31, 2010)
7. Accounts receivable turnover ratio ( assume that all sales are on
credit)
8. Number of days’ sales in receivable
9. Inventory turnover ratio (assume that all purchases are on credit)
10.Number of days’ sales in inventory
11.Number of days in cash operating cycle
b. Prepare a few brief comments on the overall financial health of SST
Enterprises. For each comment, indicate any information that is not
provided in the problem that you would need to fully evaluate the
company’s financial health.

Question:
Midwest’s controller is aware that the bank has access to this survey and is
very concerned about how the company fared this past year compared with
the rest of the industry. The ratios, included in the publication and averages
for the past year are as follows.
Ratios Industry Average
Current ratio 1.20
Acid test ratio 0.50
Inventory turnover ratio 35 times
Debts to equity ratio 0.50
Times interest earned 25 times
Return on sales 3%
Assets turnover 3.5 times
Return on common stockholders’ 20%
equity
The following statements to be submitted to the bank in connection with the
loan follow:
Midwest Inc.
 Statement of income and retained earnings
For the year ended December 31,2010
Particulars Amounts
Sales revenue Rs.420,5
Less: Cost of goods sold 00
300,000
Gross profit 120,500
Less: Selling and administrative 85,000
Income before interest and tax 35,500
Less: Interest expenses 8,600
Income before tax 26,900
Less: Tax expenses 12,000
Net income after tax 14,900
Add: Retained earnings, January 1, 12,400
2010
Total retained earnings 27,300
Dividend paid on common stock 11,200
Retained earnings, December 31, 16,100
2010

Midwest Inc
Comparative statement of financial position
December 31, December 31,
2010 2009
Assets
Current assets
Cash 1,790 2,600
Marketable securities 1,200 1,700
Accounts receivable, net of 400 600
allowances 8,700 7,400
Inventories 350 400
Prepaid items
Total current assets 12,440 12,700
Long term investments 560 400
Property, plant and equipment
Land 12,000 12,000
Building and equipment, net of
accumulated depreciation 87,000 82,900
Total property, plant and 99,000 94,900
equipment
Total assets 112,000 108,000
Liabilities and stockholders’ equity
Current liabilities
Short term notes 800 600
Accounts payable 6,040 6,775
Salaries and wages payable 1,500 1,200
Income tax payable 1,560 1,025
Total current liabilities 9,900 9,600
Long term bonds payable 36,000 36,000
Stockholders’ equity
 Common stock, no par 50,000 50,000
Retained earnings 16,100 12,400
Total stockholder’s equity 66,100 62,400
Total liabilities and stockholders’ 112,000 108,000
equity
Required:
1. Prepare a columnar report for the controller of Midwest Inc. comparing the
industry averages for the ratios published by the trade association with
the comparable ratios for Midwest. For Midwest, compute the ratios as of
December 31, 2010 or, for the year ending December 31, 2010, whichever
is appropriate.
2. Briefly evaluate Midwest’s ratios relative to the industry averages
3. Do you think that bank will approve the loan? Explain your answer.