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Transcript of Horizontal Analysis Formula
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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Financial Statement AnalysisChapter 15
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15-2
Limitations of Financial StatementAnalysis
We use the LIFO method to
value inventory.
We use the average cost
method to value inventory.
Differences in accounting methodsbetween companies sometimes make
comparisons difficult.
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15-3
Limitations of Financial StatementAnalysis
Analysts should look beyond the ratios.
Economicfactors
Industrytrends
Changes withinthe company
Technologicalchanges
Consumertastes
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15-4
Learning Objective 1
Prepare and interpret
financial statements incomparative and
common-size form.
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15-5
Statements in Comparative andCommon-Size Form
Dollar and percentagechanges on statements
Common-sizestatements
Ratios
An item on a financialstatement has little
meaning by itself. Themeaning of the numbers
can be enhanced bydrawing comparisons.
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15-6
Dollar and Percentage Changes onStatements
Horizontal analysis (or trend analysis) shows thechanges between years in the financial data in
both dollar and percentage form.
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15-7
Horizontal Analysis
The following slides illustrate a horizontalanalysis of Clover Corporations
comparative balance sheets andcomparative income statements for this
year and last year.
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15-8
CLOVER CORPORATIONComparative Balance Sheets
December 31
Increase (Decrease)This Year Last Year Amount %
AssetsCurrent assets: Cash 12,000$ 23,500$
Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700 Property and equipment: Land 40,000 40,000
Buildings and equipment, net 120,000 85,000 Total property and equipment 160,000 125,000 Total assets 315,000$ 289,700$
Horizontal Analysis
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15-9
Horizontal Analysis
DollarChange
Current YearFigure
Base YearFigure=
The dollaramounts for
last yearbecome thebase year
figures.
Calculating Change in Dollar Amounts
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15-10
PercentageChange
Dollar ChangeBase Year Figure
100%=
Horizontal Analysis
Calculating Change as a Percentage
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15-11
CLOVER CORPORATIONComparative Balance Sheets
December 31
Increase (Decrease)This Year Last Year Amount %
AssetsCurrent assets: Cash 12,000$ 23,500$ (11,500)$ (48.9) Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000 Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700 Property and equipment: Land 40,000 40,000
Buildings and equipment, net 120,000 85,000 Total property and equipment 160,000 125,000 Total assets 315,000$ 289,700$
Horizontal Analysis
($11,500 $23,500) 100% = (48.9%)
$12,000 $23,500 = $(11,500)
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15-12
CLOVER CORPORATIONComparative Balance Sheets
December 31
Increase (Decrease)This Year Last Year Amount %
AssetsCurrent assets: Cash 12,000$ 23,500$ (11,500)$ (48.9) Accounts receivable, net 60,000 40,000 20,000 50.0 Inventory 80,000 100,000 (20,000) (20.0) Prepaid expenses 3,000 1,200 1,800 150.0
Total current assets 155,000 164,700 (9,700) (5.9)Property and equipment: Land 40,000 40,000 - 0.0 Buildings and equipment, net 120,000 85,000 35,000 41.2Total property and equipment 160,000 125,000 35,000 28.0Total assets 315,000$ 289,700$ 25,300$ 8.7
Horizontal Analysis
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15-13
Horizontal Analysis
We could do thisfor the liabilities
and stockholdersequity, but nowlets look at the
income statementaccounts.
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15-14
Horizontal AnalysisCLOVER CORPORATION
Comparative Income StatementsFor the Years Ended December 31
Increase(Decrease)
This Year Last Year Amount %Sales 520,000$ 480,000$Cost of goods sold 360,000 315,000 Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net operating income 31,400 39,000 Interest expense 6,400 7,000 Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600 Net income 17,500$ 22,400$
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15-15
Horizontal AnalysisCLOVER CORPORATION
Comparative Income StatementsFor the Years Ended December 31
Increase(Decrease)
This Year Last Year Amount %Sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income 17,500$ 22,400$ (4,900)$ (21.9)
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15-16
CLOVER CORPORATIONComparative Income Statements
For the Years Ended December 31Increase
(Decrease)This Year Last Year Amount %
Sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income 17,500$ 22,400$ (4,900)$ (21.9)
Horizontal Analysis
Sales increased by 8.3%, yetnet income decreased by 21.9%.
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15-17
CLOVER CORPORATIONComparative Income Statements
For the Years Ended December 31Increase
(Decrease)This Year Last Year Amount %
Sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income 17,500$ 22,400$ (4,900)$ (21.9)
Horizontal AnalysisThere were increases in both cost of goodssold (14.3%) and operating expenses (2.1%).These increased costs more than offset the
increase in sales, yielding an overalldecrease in net income.
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15-18
Trend Percentages
Trend percentages
state several yearsfinancial data in termsof a base year , whichequals 100 percent.
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15-19
Trend Analysis
TrendPercentage
Current Year AmountBase Year Amount
100%=
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15-20
Trend Analysis
Look at the income information for BerryProducts for the years 2007 through 2011. We
will do a trend analysis on these amounts tosee what we can learn about the company.
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Trend Analysis
The baseyear is 2007, and its amounts
will equal 100%.
Year Item 2011 2010 2009 2008 2007
Sales 400,000$ 355,000$ 320,000$ 290,000$ 275,000$Cost of goods sold 285,000 250,000 225,000 198,000 190,000 Gross margin 115,000 105,000 95,000 92,000 85,000
Berry ProductsIncome Information
For the Years Ended December 31
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Year Item 2011 2010 2009 2008 2007
Sales 105% 100%Cost of goods sold 104% 100%Gross margin 108% 100%
Trend Analysis
2008 Amount 2007 Amount 100% ( $290,000 $275,000 ) 100% = 105%( $198,000 $190,000 ) 100% = 104%( $ 92,000 $ 85,000 ) 100% = 108%
Berry ProductsIncome Information
For the Years Ended December 31
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15 23
Trend Analysis
By analyzing the trends for Berry Products, wecan see that cost of goods sold is increasing
faster than sales, which is slowing the increasein gross margin.
Year Item 2011 2010 2009 2008 2007
Sales 145% 129% 116% 105% 100%Cost of goods sold 150% 132% 118% 104% 100%Gross margin 135% 124% 112% 108% 100%
Berry ProductsIncome Information
For the Years Ended December 31
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Trend Analysis
100
110
120
130
140
150
160
2007 2008 2009 2010 2011
P e r c e n t a g e
Year
Sales
COGS
GM
We can use the trendpercentages to constructa graph so we can see the
trend over time.
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Common-Size Statements
Vertical analysis focuseson the relationships
among financial
statement items at agiven point in time. Acommon-size financialstatement is a verticalanalysis in which each
financial statement itemis expressed as a
percentage.
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Common-Size Statements
In incomestatements , allitems usuallyare expressed
as a percentageof sales .
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Gross Margin Percentage
Gross MarginPercentage
Gross MarginSales
=
This measure indicates how muchof each sales dollar is left after
deducting the cost of goods sold tocover expenses and provide a profit.
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Common-Size Statements
In balancesheets , all items
usually areexpressed as apercentage oftotal assets .
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Common-Size Statements
Burger King McDonald's
(d o l l a r s i n m i l l i o n s) Dollars Percentage Dollars Percentage2008 Net income 190$ 7.70% 4,313$ 18.30%
Common-size financial statements areparticularly useful when comparing
data from different companies.
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Common-Size Statements
Lets take another look at the informationfrom the comparative income statements
of Clover Corporation for this year andlast year.
This time, lets prepare common -sizestatements.
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CLOVER CORPORATIONComparative Income Statements
For the Years Ended December 31Common-SizePercentages
This Year Last Year This Year Last Year Sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net operating income 31,400 39,000 Interest expense 6,400 7,000 Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600
Net income 17,500$ 22,400$
Common-Size Statements
Sales is
usually thebase and isexpressedas 100%.
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Common-Size StatementsCLOVER CORPORATION
Comparative Income StatementsFor the Years Ended December 31
Common-SizePercentages
This Year Last Year This Year Last Year Sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000 30.8 34.4 Operating expenses 128,600 126,000 24.8 26.2 Net operating income 31,400 39,000 6.0 8.2 Interest expense 6,400 7,000 1.2 1.5 Net income before taxes 25,000 32,000 4.8 6.7 Less income taxes (30%) 7,500 9,600 1.4 2.0
Net income 17,500$ 22,400$ 3.4 4.7
What conclusions can we draw?
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Quick Check Which of the following statements describeshorizontal analysis?a. A statement that shows items appearing
on it in percentage and dollar form.b. A side-by-side comparison of two ormore years financial statements.
c. A comparison of the account balances onthe current years financial statements.
d. None of the above.
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Quick Check Which of the following statements describeshorizontal analysis?a. A statement that shows items appearing
on it in percentage and dollar form.b. A side-by-side comparison of two ormore years financial statements.
c. A comparison of the account balances onthe current years financial statements.
d. None of the above.Horizontal analysis shows the changes
between years in the financial data in bothdollar and percentage form.
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Now, lets look atNorton
Corporations
financial statementsfor this year andlast year.
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NORTON CORPORATIONBalance Sheets
December 31
This Year Last Year Assets
Current assets:
Cash 30,000$ 20,000$Accounts receivable, net 20,000 17,000 Inventory 12,000 10,000 Prepaid expenses 3,000 2,000
Total current assets 65,000 49,000
Property and equipment: Land 165,000 123,000
Buildings and equipment, net 116,390 128,000 Total property and equipment 281,390 251,000 Total assets 346,390$ 300,000$
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NORTON CORPORATION Balance Sheets
December 31
This Year Last Year Liabilities and Stockholders' Equity
Current liabilities: Accounts payable 39,000$ 40,000$
Notes payable, short-term 3,000 2,000 Total current liabilities 42,000 42,000 Long-term liabilities: Notes payable, long-term 70,000 78,000 Total liabilities 112,000 120,000 Stockholders' equity: Common stock, $1 par value 27,400 17,000
Additional paid-in capital 158,100 113,000 Total paid-in capital 185,500 130,000 Retained earnings 48,890 50,000
Total stockholders' equity 234,390 180,000
Total liabilities and stockholders' equity 346,390$ 300,000$
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NORTON CORPORATIONIncome Statements
For the Years Ended December 31
This Year Last Year Sales 494,000$ 450,000$
Cost of goods sold 140,000 127,000 Gross margin 354,000 323,000 Operating expenses 270,000 249,000 Net operating income 84,000 74,000 Interest expense 7,300 8,000
Net income before taxes 76,700 66,000 Less income taxes (30%) 23,010 19,800 Net income 53,690$ 46,200$
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Learning Objective 2
Compute and interpret
financial ratios thatwould be useful to acommon stockholder.
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Ratio Analysis The CommonStockholder NORTON CORPORATION
Number of common sharesoutstanding
Beginning of year 17,000 End of year 27,400
Net income 53,690$
Stockholders' equity
Beginning of year 180,000
End of year 234,390
Dividends per share 2
Dec. 31 market price per share 20 Interest expense 7,300
Total assets
Beginning of year 300,000
End of year 346,390
This Year The ratios thatare of the most
interest to
stockholdersinclude those
ratios that focus onnet income,
dividends, andstockholders
equities.
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Earnings Per Share
Earnings per Share Net Income Preferred DividendsAverage Number of CommonShares Outstanding
=
Earnings per Share $53,690 $0($17,000 + $27,400)/2
= = $2.42
This measure indicates how muchincome was earned for each share of
common stock outstanding.
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Price-Earnings Ratio
Price-EarningsRatio
Market Price Per ShareEarnings Per Share=
Price-EarningsRatio
$20.00$2.42= = 8.26 times
A higher price-earnings ratio means thatinvestors are willing to pay a premiumfor a companys stock because of
optimistic future growth prospects.
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Dividend Payout Ratio
DividendPayout Ratio
Dividends Per ShareEarnings Per Share=
DividendPayout Ratio
$2.00$2.42= = 82.6%
This ratio gauges the portion of currentearnings being paid out in dividends. Investorsseeking dividends (market price growth) would
like this ratio to be large (small).
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Dividend Yield Ratio
Dividend Yield Ratio
Dividends Per ShareMarket Price Per Share=
Dividend Yield Ratio
$2.00$20.00= = 10.00%
This ratio identifies the return, in termsof cash dividends, on the current
market price of the stock.
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Return on Total Assets
Adding interest expense back to net incomeenables the return on assets to be comparedfor companies with different amounts of debt
or over time for a single company that haschanged its mix of debt and equity.
Return onTotal Assets
$53,690 + [$7,300 (1 .30)]($300,000 + $346,390) 2
= = 18.19%
Return onTotal Assets
Net Income + [Interest Expense (1 Tax Rate)]Average Total Assets
=
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Return on Common Stockholders
Equity
Return on CommonStockholders Equity
Net Income Preferred DividendsAverage Stockholders Equity
=
Return on CommonStockholders Equity
$53,690 $0($180,000 + $234,390) 2
= = 25.91%
This measure indicates how well thecompany used the owners
investments to earn income.
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Quick Check Which of the following statements is true?a. Negative financial leverage is when the
fixed return to a companys creditors andpreferred stockholders is greater than thereturn on total assets.
b. Positive financial leverage is when thefixed return to a companys creditors andpreferred stockholders is greater than thereturn on total assets.
c. Financial leverage is the expression ofseveral years financial data inpercentage form in terms of a base year.
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Which of the following statements is true?a. Negative financial leverage is when the
fixed return to a companys creditors andpreferred stockholders is greater than thereturn on total assets.
b. Positive financial leverage is when thefixed return to a companys creditors andpreferred stockholders is greater than thereturn on total assets.
c. Financial leverage is the expression ofseveral years financial data inpercentage form in terms of a base year.
Quick Check
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Book Value Per Share
Book Valueper Share
Common Stockholders EquityNumber of Common Shares Outstanding=
This ratio measures the amount that would bedistributed to holders of each share of common
stock if all assets were sold at their balance sheetcarrying amounts after all creditors were paid off.
= $8.55Book Valueper Share $234,39027,400=
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Learning Objective 3
Compute and interpret
financial ratios thatwould be useful to ashort-term creditor.
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Ratio Analysis The Short TermCreditor
Cash 30,000$
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 494,000
Cost of goods sold 140,000
This Year NORTON CORPORATION
Short-termcreditors, such assuppliers, want tobe paid on time.Therefore, they
focus on thecompanys cash
flows and workingcapital.
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Working Capital
Working capital is notfree. It must be
financed with long-term debt and equity.
The excess of current assets overcurrent liabilities is known as
working capital.
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Working Capital
December 31This Year
Current assets 65,000$
Current liabilities (42,000) Working capital 23,000$
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Current Ratio
A declining ratio may be asign of deteriorating
financial condition, or itmight result from eliminating
obsolete inventories.
CurrentRatio
Current AssetsCurrent Liabilities
=
The current ratio measures acompanys short -term debt paying
ability.
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Current Ratio
CurrentRatio
$65,000$42,000
= = 1.55
CurrentRatio
Current AssetsCurrent Liabilities
=
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Acid-Test (Quick) Ratio
Quick AssetsCurrent Liabilities=
Acid-TestRatio
Quick assets include Cash,Marketable Securities, Accounts Receivable, and
current Notes Receivable.This ratio measures a companys ability to meet
obligations without having to liquidate inventory.
$50,000$42,000 = 1.19=Acid-TestRatio
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Accounts Receivable Turnover
Sales on AccountAverage Accounts Receivable
AccountsReceivableTurnover
=
This ratio measures how manytimes a company converts its
receivables into cash each year.
= 26.7 times$494,000($17,000 + $20,000) 2AccountsReceivableTurnover
=
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Average Collection Period
AverageCollection
Period=
365 DaysAccounts Receivable Turnover
This ratio measures, on average,how many days it takes to collect
an account receivable.
= 13.67 daysAverage
CollectionPeriod
= 365 Days26.7 Times
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Inventory Turnover
If a companys inventory
turnover Is less than itsindustry average, it eitherhas excessive inventory or
the wrong types of inventory.
Cost of Goods SoldAverage Inventory
InventoryTurnover =
This ratio measures how many times a
companys inventory has been sold andreplaced during the year.
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Inventory Turnover
Cost of Goods SoldAverage Inventory
InventoryTurnover =
= 12.73 times$140,000($10,000 + $12,000) 2InventoryTurnover =
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Average Sale Period
AverageSale Period =
365 DaysInventory Turnover
This ratio measures how manydays, on average, it takes to sell
the entire inventory.
= 28.67 daysAverageSale Period =365 Days
12.73 Times
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Learning Objective 4
Compute and interpret
financial ratios thatwould be useful to along-term creditor.
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Ratio Analysis The Long TermCreditor
Earnings before interestexpense and income taxes 84,000$
Interest expense 7,300
Total stockholders' equity 234,390
Total liabilities 112,000
NORTON CORPORATIONThis Year
This is also referredto as net operating
income.
Long-term creditors are concerned with acompanys ability to repay its loans over the
long-run.
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Times Interest Earned Ratio
This is the most common
measure of a companys abilityto provide protection for its long-term creditors. A ratio of less
than 1.0 is inadequate.
TimesInterestEarned
Earnings Interest Expenseand Income TaxesInterest Expense=
TimesInterestEarned
$84,000$7,300= = 11.51 times
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Debt-to-Equity Ratio
$112,000$234,390
Debt to EquityRatio
= = 0.48
Total LiabilitiesStockholders Equity
Debt to EquityRatio
=
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Published Sources That Provide Comparative Ratio Data
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End of Chapter 15