Income Statement (GAAP Format, Using Formula-Based Item Names)

Item Year 1 Year 2 Year 3

Net Sales 500,000 600,000 700,000

Cost of Goods Sold

300,000 360,000 420,000
(COGS)

Gross Profit 200,000 240,000 280,000

Operating Expenses

– Selling, General &

Administrative 50,000 60,000 70,000
(SG&A) Expenses

Earnings Before
Interest and Taxes 150,000 180,000 210,000
(EBIT)

(22,000
Interest Expense (20,000) (25,000)
)

Income Before
130,000 158,000 185,000
Taxes

Income Tax Expense (47,400

(39,000) (55,500)
(Assume 30%) )

Net Profit 91,000 110,600 129,500

Balance Sheet (Detailed Breakdown)

Item Year 1 Year 2 Year 3

ASSETS
Item Year 1 Year 2 Year 3

200,00
Current Assets 240,000 280,000
0

– Cash and Cash

70,000 80,000 90,000
Equivalents

– Accounts Receivable 80,000 100,000 120,000

– Inventory 50,000 60,000 70,000

400,00
Non-Current Assets 480,000 560,000
0

– Property, Plant & 350,00

420,000 490,000
Equipment 0

– Intangible Assets 50,000 60,000 70,000

600,00
Total Assets 720,000 840,000
0

LIABILITIES

100,00
Current Liabilities 120,000 140,000
0

– Accounts Payable 40,000 50,000 60,000

– Short-term Debt 30,000 40,000 50,000

– Accrued Liabilities 30,000 30,000 30,000

Non-Current 200,00
240,000 280,000
Liabilities 0
 Item Year 1 Year 2 Year 3

180,00
– Long-term Debt 220,000 260,000
0

– Deferred Tax
20,000 20,000 20,000
Liabilities

300,00
Total Liabilities 360,000 420,000
0

OWNER’S EQUITY

150,00
– Common Stock 180,000 210,000
0

150,00
– Retained Earnings 180,000 210,000
0

300,00
Total Owner’s Equity 360,000 420,000
0

Total Liabilities and 600,00

720,000 840,000
Equity 0

Computing For Ratio Analysis

Let’s compute the liquidity ratios based on the provided balance sheet and income
statement.
1. Current Ratio:
 Formula: Current Assets / Current Liabilities
 Interpretation: The current ratio measures a company’s ability to cover its short-
term obligations with its current assets. A ratio above 1 indicates that the
company has more current assets than current liabilities, which is a positive
indicator of liquidity.
Year 1:
 Current Assets = 200,000
  Current Liabilities = 100,000
 Current Ratio = 200,000 / 100,000 = 2.0
Year 2:
 Current Assets = 240,000
 Current Liabilities = 120,000
 Current Ratio = 240,000 / 120,000 = 2.0
Year 3:
 Current Assets = 280,000
 Current Liabilities = 140,000
 Current Ratio = 280,000 / 140,000 = 2.0
Interpretation:
For all three years, the current ratio is 2.0. This suggests the company has twice the
amount of current assets compared to its current liabilities. The company is in a good
liquidity position to meet its short-term obligations.

2. Quick Ratio:
 Formula: (Current Assets – Inventory) / Current Liabilities
 Interpretation: The quick ratio measures the company’s ability to meet its short-
term obligations without relying on the sale of inventory. A higher ratio indicates
better liquidity.
Year 1:
 Current Assets = 200,000
 Inventory = 50,000
 Current Liabilities = 100,000
 Quick Ratio = (200,000 – 50,000) / 100,000 = 150,000 / 100,000 = 1.5
Year 2:
 Current Assets = 240,000
 Inventory = 60,000
 Current Liabilities = 120,000
 Quick Ratio = (240,000 – 60,000) / 120,000 = 180,000 / 120,000 = 1.5
Year 3:
 Current Assets = 280,000
 Inventory = 70,000
 Current Liabilities = 140,000
 Quick Ratio = (280,000 – 70,000) / 140,000 = 210,000 / 140,000 = 1.5
Interpretation:
The quick ratio for all three years is 1.5, indicating that the company has 1.5 times more
liquid assets than its current liabilities, even without considering its inventory. This
suggests the company is in a strong liquidity position, capable of meeting its short-term
obligations without needing to sell its inventory.

Summary:
 The current ratio of 2.0 and quick ratio of 1.5 over the three years show that
the company is in a healthy liquidity position. It has sufficient current assets to
cover both its current liabilities and can meet its obligations even without relying
on inventory sales. These ratios indicate sound financial health and liquidity
management.
Profitability Ratios Computation and Interpretation
1. Gross Profit Margin:
 Formula: (Gross Profit/Net Sales) × 100
 Year 3: 40%
 Computation: (280,000/700,000) × 100 = 40%
 Interpretation: For every $1 in sales, the company retains $0.40 as gross
profit.
2. Net Profit Margin:
 Formula: (Net Profit/Net Sales)×100
 Year 3: 18.5%
 Computation: (129,500/700,000) × 100=18.5%
 Interpretation: For every $1 in sales, the company generates $0.185 in
net profit.
3. Return on Assets (ROA):
 Formula: (Net Profit/Total Assets) × 100
  Year 3: 15.42%
 Computation: (129,500/840,000) × 100 = 15.42%
 Interpretation: For every $1 of total assets, the company
earns $0.1542 in profit.
4. Return on Equity (ROE):
 Formula: (Net Profit/Average Shareholders’ Equity) × 100
 Year 3: 33.91%
 Computation: (129,500/380,000) × 100 = 33.91%
 Interpretation: For every $1 of equity, the company returns $0.3391 in
profit.
Summary
The profitability ratios indicate that the company generates profits relative to its sales,
assets, and equity investments. Specifically, it retains $0.40 of gross profit for each
dollar in sales, generates $0.185 of net profit per dollar in sales, earns $0.1542 in profit
for each dollar of assets, and returns $0.3391 for every dollar of equity. This showcases
robust financial performance and effective resource management.
Solvency Ratios Computation and Interpretation
1. Debt-to-Equity Ratio:
 Formula: Total Liabilities/Total Equity
 Year 3:
 Computation:
 Total Liabilities = $420,000
 Total Equity = $420,000
 Debt-to-Equity Ratio=420,000/420,000 = 1.0
 Interpretation: For every $1 of equity, the company has $1 of debt. This
indicates that the company is using an equal amount of debt and equity to
finance its operations, suggesting a balanced approach to leveraging.
However, it may also indicate moderate risk, as an increase in liabilities
could affect financial stability.
2. Interest Coverage Ratio:
 Formula: EBIT/Interest Expense
 Year 3:
  Computation:
 EBIT = $210,000
 Interest Expense = $25,000
 Interest Coverage Ratio=210,000/25,000 = 8.4
 Interpretation: The company earns $8.40 for every $1 of interest
expense. This indicates a strong ability to cover interest payments,
reflecting a healthy financial position and suggesting that the company can
comfortably meet its interest obligations without straining its resources.
Summary
The solvency ratios reveal that the company maintains a 1.0 debt-to-equity ratio,
indicating a balanced use of debt and equity financing. Meanwhile, the 8.4 interest
coverage ratio highlights a robust capacity to service interest payments, suggesting low
financial risk related to its long-term obligations. Overall, the company demonstrates
sound financial health with a manageable level of debt.
Efficiency Ratios Computation and Interpretation
1. Inventory Turnover Ratio:
 Formula: Cost of Goods Sold (COGS)/Average Inventory
 Year 3:
 Average Inventory = (Year 2 Inventory+Year 3 Inventory)/2
 =(60,000+70,000)/2 = 65,000
 Computation:
 COGS (Year 3) = $420,000
 Inventory Turnover Ratio = 420,000/65,000 ≈ 6.46
 Interpretation: The inventory turnover ratio of 6.46 means that the
company sells and replaces its inventory approximately 6.46 times within
the year. This indicates efficient inventory management and strong sales
performance. A higher turnover ratio suggests that products are selling
quickly, reducing holding costs.
2. Accounts Receivable Turnover Ratio:
 Formula: Net Credit Sales/Average Accounts Receivable
 Assumption: Assuming all sales are on credit.
 Year 3:
  Average Accounts Receivable = (Year 2 Accounts Receivable +
Year 3 Accounts Receivable) / 2
 =(100,000+120,000) / 2 = 110,000
 Computation:
 Net Sales (Year 3) = $700,000
 Accounts Receivable Turnover Ratio=700,000/110,000 ≈
6.36
 Interpretation: The accounts receivable turnover ratio of 6.36 implies that
the company collects its average receivables about 6.36 times a year.
This indicates effective credit management and a strong ability to convert
credit sales into cash. A higher ratio signifies quicker collection of
receivables, improving cash flow.
3. Asset Turnover Ratio:
 Formula: Net Sales/Average Total Assets
 Year 3:
 Average Total Assets = (Year 2 Total Assets +
Year 3 Total Assets) / 2
 =(720,000+840,000) / 2= 780,000
 Computation:
 Net Sales (Year 3) = $700,000
 Asset Turnover Ratio=700,000/780,000 ≈ 0.90
 Interpretation: The asset turnover ratio of 0.90 indicates that the
company generates approximately $0.90 in sales for every dollar of
assets. This reflects the company’s efficiency in utilizing its assets to
generate revenue. A ratio close to 1 or above indicates effective asset use,
while lower ratios suggest potential inefficiencies.
Summary
The efficiency ratios reveal that the company exhibits strong performance in managing
its inventory and receivables, with an inventory turnover ratio of 6.46 and an accounts
receivable turnover ratio of 6.36. These figures suggest effective inventory management
and collection practices. Meanwhile, the asset turnover ratio of 0.90 indicates that the
company is generating nearly $0.90 in revenue for every dollar of assets, suggesting
efficient use of its asset base to drive sales, although there may be room for
improvement to optimize asset utilization.