Income Statement

The income statement provides a financial summary of the firm’s operating results
during a specified period. Most common are income statements covering a 1-year
period ending at a specified date, ordinarily December 31 of the calendar year.

Barlett Company Income Statement ($000)

For Year ended December 31

2012

Sales Revenue $3,074,000

Less: Cost of Goods Sold 2088000
Gross Profit 986000
Less: Operating Expenses
Selling Expense 100000
General and Administrative Expense 194000
Lease Expense 35000
Depreciation Expense 239000
Total Operating Expense 568000

Operating Profits (EBIT) 418000

Less: Interest Expense 93000

Net Profit Before Tax 325000

Less: Taxes 94000

Net Profit after Tax 231000

Less: Preferred Stock Dividends 10000
Earnings available for common Stockholders $221,000

Earnings per Share (EPS) $2.90

Dividend Per Share (DPS) 1.29

Bartlett Company Statement of Retained Earnings ($000)

 Retained Earnings
Plus: Net Profit After Tax
Less : Cash Dividend (for 2012)
Preferred Stock
Common Stock
Total Dividends Paid
Retained Earnings balance (Dec 31, 2012

Liquidity Ratio:
The liquidity of a firm is measured by its ability to satisfy its short-term obligations
as they come due. Liquidity refers to the solvency of the firm’s overall financial
position—the ease with which it can pay its bills.

Current Ratio:
The current ratio, one of the most commonly cited financial ratios, measures the
firm’s ability to meet its short-term obligations. It is expressed as follows:

Current ratio = Current assets /Current liabilities

=1223000/620000
= $1.97
A higher current ratio indicates a greater degree of liquidity. How much liquidity
a firm needs depends on a variety of factors, including the firm’s size, its
access to short-term financing sources like bank credit lines, and the volatility of
its business. The more predictable a firm’s cash flows, the lower the acceptable
current ratio. Because Bartlett Company is in a business with a relatively predictable
ratio of 1.97 should be quite acceptable.annual cash flow, its current

QUICK (ACID-TEST) RATIO

The quick (acid-test) ratio is similar to the current ratio except that it excludes
inventory, which is generally the least liquid current asset. The generally low liquidity
of inventory results from two primary factors: (1) Many types of inventory
cannot be easily sold because they are partially completed items, special-purpose
items, and the like; and (2) inventory is typically sold on credit, which means that
it becomes an account receivable before being converted into cash.

Quick ratio = (Current assets - Inventory)/Current liabilities

The quick ratio for Bartlett Company in 2012 is

 = ($1,223,000 - $289,000)/$620,000
= 1.51

ACTIVITY RATIOS:

Activity ratios measure the speed with which various accounts are converted into
sales or cash—inflows or outflows. In a sense, activity ratios measure how efficiently
a firm operates along a variety of dimensions such as inventory management,
disbursements, and collections. A number of ratios are available for measuring the
activity of the most important current accounts, which include inventory, accounts
receivable, and accounts payable. The efficiency with which total assets are used
can also be assessed.

INVENTORY TURNOVER
Inventory turnover commonly measures the activity, or liquidity, of a firm’s
inventory. It is calculated as follows:

Inventory turnover = Cost of goods sold / Inventory

Applying this relationship to Bartlett Company in 2012 yields

= $2,088,000/$289,000
= 7.22 Times

The resulting turnover is meaningful only when it is compared with that of other
firms in the same industry or to the firm’s past inventory turnover. An inventory
turnover of 20 would not be unusual for a grocery store, whose goods are highly
perishable and must be sold quickly, whereas an aircraft manufacturer might turn
its inventory just four times per year.

Average age of = 365/Inventory Turnover

Inventory = 365/7.22
= 50.52
This value can also be viewed as the average number of days’ sales in inven

AVERAGE COLLECTION PERIOD

The average collection period, or average age of accounts receivable, is useful in
evaluating credit and collection policies. It is arrived at by dividing the average
daily sales into the accounts receivable balance
Average Collection = Accounts Receivable /Average Sales Per Day
Period = Accounts Receivable /(Annual Sales/365)
= 503000/(3074000/365)
= 59.73

On the average, it takes the firm 59.7 days to collect an account receivable.
The average collection period is meaningful only in relation to the firm’s credit
terms. If Bartlett Company extends 30-day credit terms to customers, an average
collection period of 59.7 days may indicate a poorly managed credit or collection
department, or both. It is also possible that the lengthened collection period resulted
from an intentional relaxation of credit-term enforcement in response to competitive
pressures. If the firm had extended 60-day credit terms, the 59.7-day average collection
period would be quite acceptable. Clearly, additional information is needed to
evaluate the effectiveness of the firm’s credit and collection policies.

AVERAGE PAYMENT PERIOD

The average payment period, or average age of accounts payable, is calculated in
the same manner as the average collection period:

Average Payment = Accounts Payable / Average purchases per day

Period = Accounts Payable /(Annual Purchase/365)

The difficulty in calculating this ratio stems from the need to find annual purchases,
3 a value not available in published financial statements. Ordinarily, purchases
are estimated as a given percentage of cost of goods sold. If we assume
that Bartlett Company’s purchases equaled 70 percent of its cost of goods sold
2012, its average payment period is

$382,000 $382,000
= =
.70*2088000 4004.38
365

This figure is meaningful only in relation to the average credit terms extended to
the firm. If Bartlett Company’s suppliers have extended, on average, 30-day
credit terms, an analyst would give Bartlett a low credit rating because it was
taking too long to pay its bills.

TOTAL ASSET TURNOVER

The total asset turnover indicates the efficiency with which the firm uses its assets
to generate sales. Total asset turnover is calculated as follows:

Total asset turnover = Sales / Total assets

The value of Bartlett Company’s total asset turnover in 2012 is

$3,074,000 / $3,597,000 = 0.85460106

This means the company turns over its assets 0.85 times per year.

Generally, the higher a firm’s total asset turnover, the more efficiently its assets
have been used. This measure is probably of greatest interest to management
because it indicates whether the firm’s operations have been financially efficient.

……………………………………………………………………
 MRE Balance Sheet
operating results The balance sheet presents a summary statement of
vering a 1-year a given time. The statement balances the firm’s asse
alendar year. financing, which can be either debt (what it owes) or
by owners).
00) Bartlett Com

ear ended December 31

2011 Assets
Cash
$2,567,000 Marketable Securities
1711000 Account Receivable
856000 Inventories
Total Current Assets
108000 Land and Buildings
187000 Machinery and Equipment
35000 Furniture and Fixtures
223000 Vehicles
553000 Other (Includes Financial Lease)
Total gross Fixed Assets (at Cost)
303000 Less: Accumulated Depreciations
Net Fixed Assets
91000 Total Assets

212000 Liabilities and Stockholders Equity

Accounts Payable
64000 Notes Payable
Accruals
148000 Total Current Liabilities
10000 Long-term Debt (Including Financial Leases)
$138,000 Total Liabilities

$1.81 Preferred Stock (Cumulative 5%, $100 par,

0.75 2,000 shares authorised and issued)

Common Stock - $2.5 par, 100000 shares

ings ($000) authorised, shares issued and outstanding
Dec-12 in 2012 76262 in 2011
 $1,012,000
231000 Paid in Capital - in excess of par
(common stock)
10000 Retained earnings
98000
108000 Total Stockholders Equity
$1,135,000
Total Liability and stockholders Equity

DEBT RATIO:
term obligations The debt position of a firm indicates the amount of o
rall financial used to generate profits. In general, the financial ana
long-term debts because these commit the firm to a
MRE over the long run. The more debt a firm has, the gre
unable to meet its contractual debt payments. Becau
measures the satisfied before the earnings can be distributed to sh
Cash prospective shareholders pay close attention to the fi
Receivables Lenders are also concerned about the firm’s indebted
Inventories
Short tem investment In general, the more debt a firm uses in relation to it
its financial leverage. Financial leverage is the magni
much liquidity through the use of fixed-cost financing, such as debt
more fixed-cost debt a firm uses, the greater will be
he volatility of
he acceptable DEBT RATIO
atively predictable The debt ratio measures the proportion of total asset
The higher this ratio, the greater the amount of othe
used to generate profits. The ratio is calculated as fo

t it excludes Debt Ratio = Total Liabilities / Tota

nerally low liquidity
The debt ratio for Bartlett Company in 2012 is
special-purpose Debt Ratio = 1643000/3597000
hich means that = 0.45677
or 45.68%
This value indicates that the company has financed c
debt. The higher this ratio, the greater the firm’s deg
more financial leverage it has.
You have the capacity to pay current
liability
 TIMES INTEREST EARNED RATIO
depend on industry The times interest earned ratio, sometimes called the
measures the firm’s ability to make contractual intere
value, the better able the firm is to fulfill its interest o
interest earned ratio is calculated as follows:
converted into
ure how efficiently Times interest earned ratio = Earnings before interes
anagement,
r measuring the
ntory, accounts The figure for earnings before interest and taxes (EB
ssets are used operating profits shown in the income statement. Ap
Company yields the following 2012 value:

Time interest earned ratio = $418,000 / $93,000 = 4

The times interest earned ratio for Bartlett Company

large margin of safety.least 3.0—and preferably clos

FIXED-PAYMENT COVERAGE RATIO

The fixed-payment coverage ratio measures the firm

obligations, such as loan interest and principal, lease
stock dividends. As is true of the times interest earne
h that of other value the better. The formula for the fixed-payment c
An inventory
oods are highly Fixed -
urer might turn Payment Earnin
Coverage Interest + Lease Paymen
Ratio

=
The lesser the no of days, the $93000+
better it is
453
=
242084.5

ble, is useful in =
the average
Because the earnings available are nearly twice as la
 $3,074,000 the firm appears safely able to meet the latter.
age Sales Per Day $8,421.92
ual Sales/365) Like the times interest earned ratio, the fixed-paymen
503000 risk. The lower the ratio, the greater the risk to both
$59.73 greater the ratio, the lower the risk. This ratio allows
firm’s ability to meet additional fixed-payment obligat
eceivable. into bankruptcy.
firm’s credit
ers, an average
it or collection PROFITABLITY RATIOS:
on period resulted
nse to competitive GROSS PROFIT MARGIN
day average collection The gross profit margin measures the percentage of
needed to after the firm has paid for its goods. The higher the g
(that is, the lower the relative cost of merchandise so

The gross profit margin is calculated as follows:

is calculated in

Gross profit margin =

Cost of Goods Sold
e purchases per day =Purchase
Purchase/365) Bartlett Company’s gross profit margin for 2012 is

nnual purchases,
Gross profit margin =
y, purchases

s cost of goods sold in =

OPERATING PROFIT MARGIN

95.40
Days The operating profit margin measures the percentage
remaining after all costs and expenses other than int
ms extended to stock dividends are deducted. It represents the “pure
e, 30-day sales dollar. Operating profits are “pure” because the
ause it was earned on operations and ignore interest, taxes, and
high operating profit margin is preferred.

The operating profit margin is calculated as follows:

m uses its assets
Operating profit margin = Operating pro

Bartlett Company’s operating profit margin for 2012 i

1 dollars
.85 dollar Operating profit margin

NET PROFIT MARGIN

ntly its assets
management The net profit margin measures the percentage of ea
cially efficient. all costs and expenses, including interest, taxes, and
have been deducted. The higher the firm’s net profit
profit margin is calculated as follows:

Net profit margin = Earnings available fo

Bartlett Company’s net profit margin for 2012 is:

$221,000
3074000

EARNINGS PER SHARE (EPS)

The firm’s earnings per share (EPS) is generally of in
stockholders and management. As we noted earlier,
number of dollars earned during the period on behalf
of common stock.

Earnings per share =

Earnings per share =

=
This figure represents the dollar amount earne
share of common stock.
RETURN ON TOTAL ASSETS (ROA)

The return on total assets (ROA), often called the ret

measures the overall effectiveness of management in
available assets. The higher the firm’s return on total

ROA = Earnings available for commo

= 221000/3597000

This value indicates that the company earned 6.1 cen

investment.

RETURN ON COMMON EQUITY (ROE)

The return on common equity (ROE) measures the re

stockholders’ investment in the firm. Generally, the o
higher is this return.

ROE = Earnings available for common stockholders /

= 221000/1754000

The calculated ROE of 12.6 percent indicates that du

12.6 cents on each dollar of common stock equity.

Note that the value for common stock equity ($1,754

the $200,000 of preferred stock equity from the total
equity of $1,954,000

……………………………………………………
 MRE
ummary statement of the firm’s financial position at
lances the firm’s assets (what it owns) against its
debt (what it owes) or equity (what was provided

Bartlett Company Balance Sheet ($000)

December 31
2012 2011

$363,000 $288,000
68000 51000
503000 365000
289000 300000
$1,223,000 $1,004,000
$2,072,000 $1,903,000
1866000 1693000
358000 316000
275000 314000
98000 96000
(at Cost) $4,669,000 $4,322,000
eciations 2295000 2056000
$2,374,000 $2,266,000
$3,597,000 $3,270,000

382000 270000
79000 99000
159000 114000
620000 483000
ng Financial Leases) 1023000 967000
1643000 1450000

tive 5%, $100 par, $200,000 200000

sed and issued)

r, 100000 shares 191000 190000

d and outstanding
76244
 428000 418000

1135000 1012000

$1,954,000 $1,820,000

ders Equity $3,597,000 $3,270,000

cates the amount of other people’s money being

neral, the financial analyst is most concerned with
commit the firm to a stream of contractual payments
bt a firm has, the greater its risk of being
debt payments. Because creditors’ claims must be
n be distributed to shareholders, current and
ose attention to the firm’s ability to repay debts.
ut the firm’s indebtedness.

m uses in relation to its total assets, the greater

everage is the magnification of risk and return
nancing, such as debt and preferred stock. The
s, the greater will be its expected risk and return.

oportion of total assets financed by the firm’s creditors.

er the amount of other people’s money being
atio is calculated as follows:

Total Liabilities / Total Assets

pany in 2012 is
1643000/3597000

45.68%
mpany has financed close to half of its assets with
greater the firm’s degree of indebtedness and the
 sometimes called the interest coverage ratio,
ake contractual interest payments. The higher its EBIT 100
s to fulfill its interest obligations. The times Interest 10
ed as follows:

arnings before interest and taxes / Interest

Sale 150
Purchase price 45
nterest and taxes (EBIT) is the same as that for Gross Profit 105
ncome statement. Applying this ratio to Bartlett operational expense 60
012 value: Operating Profti 45
Interest 4
18,000 / $93,000 = 4.5 Tax 12
Net Income 29
for Bartlett Company seems acceptable. A value of at
0—and preferably closer to 5.0—is often suggested.

tio measures the firm’s ability to meet all fixedpayment

st and principal, lease payments, and preferred
e times interest earned ratio, the higher this
or the fixed-payment coverage ratio is

Earnings before interest and taxes + Lease payments

Interest + Lease Payments + {(principal Payments + Preferred stock Dividend) x [1/[1-T]}

$418000+$35000
$93000+$35000+{(71000+10000)*[1/(1-.29)]}

453000
242084.507042254

1.87

are nearly twice as large as its fixed-payment obligations,

meet the latter.

atio, the fixed-payment coverage ratio measures

eater the risk to both lenders and owners, and the
risk. This ratio allows interested parties to assess the
fixed-payment obligations without being driven

es the percentage of each sales dollar remaining

oods. The higher the gross profit margin, the better
ost of merchandise sold).

lated as follows:

Sales - Cost of sales Gross Profits

=
Sales Sales

margin for 2012 is

3074000-2088000 986000
=
3074000 3074000

32.075%

asures the percentage of each sales dollar

penses other than interest, taxes, and preferred
t represents the “pure profits” earned on each
re “pure” because they measure only the profits
e interest, taxes, and preferred stock dividends. A
preferred.

alculated as follows:
in = Operating profits / Sales

ofit margin for 2012 is

= $418000/3074000

= 13.60%

the percentage of each sales dollar remaining after

g interest, taxes, and preferred stock dividends,
r the firm’s net profit margin, the better. The net

arnings available for common stockholders / Sales

argin for 2012 is:

= 7.19%

EPS) is generally of interest to present or prospective

As we noted earlier, EPS represents the
g the period on behalf of each outstanding share

Earnings available for Common Stockholders

Number of shares of Common Stok Outstanding

$221,000
76262

$2.90
e dollar amount earned on behalf of each outstanding
 Net Income
Net profit
), often called the return on investment (ROI), Earnings
ess of management in generating profits with its Return
firm’s return on total assets the better.

available for common stockholders / Total assets

/3597000 = 6.14%

mpany earned 6.1 cents on each dollar of asset

TY (ROE)

ROE) measures the return earned on the common

firm. Generally, the owners are better off the

ommon stockholders / Common stock equity

/1754000 = 12.60%

cent indicates that during 2012 Bartlett earned

mmon stock equity.

n stock equity ($1,754,000) was found by subtracting

equity from the total stockholders’

……………………………………………………………
Statement of Cash Flows
The statement of cash flows is a summary of the cash flows over the period of
concern. The statement provides insight into the firm’s operating, investment,
and financing cash flows

Bartlett Company Statement of Cash Flows ($000)

Cash Flow from Operating Activities

Net profits after taxes 231,000
Depreciation 239,000
Increase in accounts receivable (138,000)
Decrease in inventories 11,000
Increase in accounts payable 112,000
Increase in accruals 45,000
Cash provided by operating activities

Cash Flow from Investment Activities

Increase in gross fixed assets (347,000)
Change in equity investments in other firms 0
Cash provided by investment activities

Cash Flow from Financing Activities

Decrease in notes payable (20,000)
Increase in long-term debts 56,000
Changes in stockholders’ equityb 11,000
Dividends paid (108,000)
Cash provided by financing activities

Net increase in cash and marketable securities

Statement of Retained Earnings

The statement of retained earnings is an abbreviated form of the statement of
stockholders’ equity. Unlike the statement of stockholders’ equity, which shows
all equity account transactions that occurred during a given year, the statement of
retained earnings reconciles the net income earned during a given year, and any
cash dividends paid, with the change in retained earnings between the start and
the end of that year.

MARKET RATIOS:

Market ratios relate the firm’s market value, as measured by its current share
price, to certain accounting values. These ratios give insight into how investors in
the marketplace feel the firm is doing in terms of risk and return.

PRICE/EARNINGS (P/E) RATIO

The price/earnings (P/E) ratio is commonly used to assess the owners’ appraisal
of share value. The P/E ratio measures the amount that investors are willing to
pay for each dollar of a firm’s earnings. The level of this ratio indicates the
degree of confidence that investors have in the firm’s future performance. The
higher the P/E ratio, the greater the investor confidence.

P/E ratio = Market price per share of common stock / Earnings per share

If Bartlett Company’s common stock at the end of 2012 was selling at $32.25,
using the EPS of $2.90, the P/E ratio at year-end 2012 is

= $32.25 / $2.90 = $11.13

This figure indicates that investors were paying $11.10 for each $1.00 of earnings.
The P/E ratio is most informative when applied in cross-sectional analysis
using an industry average P/E ratio or the P/E ratio of a benchmark firm.

MARKET/BOOK (M/B) RATIO

The market/book (M/B) ratio provides an assessment of how investors view the
firm’s performance. It relates the market value of the firm’s shares to their book—
strict accounting—value. To calculate the firm’s M/B ratio, we first need to find
the book value per share of common stock:

Book value per share Common Stock Equity

=
of common stock Number of Common Stock Outstanding

= 1754000 /76262 = 23.00

Market price per share of common stock

Market/Book (M/B) ratio =
Book value per share of common stock

= 32.25/23 = 1.40

This M/B ratio means that investors are currently paying $1.40 for each $1.00 of
book value of Bartlett Company’s stock.

The stocks of firms that are expected to perform well—improve profits,

increase their market share, or launch successful products—typically sell at
higher M/B ratios than the stocks of firms with less attractive outlooks. Simply
stated, firms expected to earn high returns relative to their risk typically sell at
higher M/B multiples.

DUPONT SYSTEM OF ANALYSIS

The DuPont system of analysis is used to dissect the firm’s financial statements
and to assess its financial condition. It merges the income statement and balance
sheet into two summary measures of profitability, return on total assets (ROA)
and return on common equity (ROE).

The DuPont system first brings together the net profit margin, which measures
the firm’s profitability on sales, with its total asset turnover, which indicates how
efficiently the firm has used its assets to generate sales.

Net Income Sales Assets

ROE = x x
Sales Assets Total Equity

$221,000 $3,074,000 $3,597,000

= x x
$3,074,000 $3,597,000 1754000
 Profit Margin x Asset Turnover x Equity Multiplier

= 0.072 x 0.855 x $2.05

= 12.60%

The DuPont identity tells us that ROE is affected by three things:

1. Operating efficiency (as measured by profit margin).

2. Asset use efficiency (as measured by total asset turnover).
3. Financial leverage (as measured by the equity multiplier).

……………………………………………………………………

Price-Earnings Ratio - Special Note

The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its
share price relative to its per-share earnings. The price-earnings ratio is also sometimes
as the price multiple or the earnings multiple.
The P/E ratio can be calculated as:
Market Value per Share / Earnings per Share

For example, suppose that a company is currently trading at $43 a share and its earni
the last 12 months were $1.95 per share. The P/E ratio for the stock could then be calcu
as 43/1.95, or 22.05.

INTERPRETATIONS:
P/E is sometimes referred to as the multiple because it shows how much investors are w
to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of
interpretation is that an investor is willing to pay $20 for $1 of current earnings.

In general, a high P/E suggests that investors are expecting higher earnings growth in t
compared to companies with a lower P/E. A low P/E can indicate either that a company
currently be undervalued or that the company is doing exceptionally well relative to its p
trends. When a company has no earnings or is posting losses, in both cases P/E will be
expressed as “N/A.” Though it is possible to calculate a negative P/E, this is not the
common convention.

………………………………………………………………………………………
 MRE Practice Exercise 01:
e period of Calculation of EPS and retained earnings Philagem, I
vestment, profit before taxes of $218,000. The company is sub
pay $32,000 in preferred stock dividends before distr
85,000 shares of common stock currently outstandin
$000)
a. Calculate Philagem’s 2012 earnings per share (EPS
b. If the firm paid common stock dividends of $0.80
would go to retained earnings?

Solution:

a Net Profit before tax

Less: Taxes @ 40%
500,000 Net Profit after Taxes
Less: Dividend Paid
Earnings available for Shareholders

Earnings Per Share

(347,000) b. The amount transferred to the retained ea

distributing dividends to the common stoc
common stockholders is $.80 per share. It
lated by multiplying $0.80 with total numb

Total dividend paid to common stockholde

Amount transferred to retained earnings

(61,000) ………………………………
Exercise Problem 02:
92,000 The income statement for the year ended December
and the statement of retained earnings for the year

Income Statement
Year Ended December 31, 2012
Sales revenue
Less: Cost of goods sold
atement of Gross profits
hich shows Less: Operating expenses
e statement of General and administrative expenses
year, and any Depreciation expense
the start and Total operating expense
Operating profits
Less: Interest expense
Net profits before taxes
Less: Taxes
Earnings available for common stockholders
Earnings per share (EPS)

ent share Statement of Retained Earnings

w investors in For the year Ended December 31, 20

Retained earnings (January 1, 2012)

Plus: Net profits after taxes (for 2012)
Less: Cash dividends (2012)
ers’ appraisal Retained earnings (December 31, 2012)
re willing to
Other Information:
mance. The Market Price per Share

Compute and comment of the following ratios:

I Current ratio
at $32.25, II Acid Test Ratio
III Inventory turnover
IV Average age of Inventory
V Average collection period
VI Average payment period
00 of earnings. VII Total Assets turnover
VIII Debt Ratio
IX Times Interest earned
………………………………………………

ors view the Practice Exercise 03:

to their book— Accounts receivable management:
eed to find which follows, gives the end-of-year accounts receiv
to consist of amounts originating in the months indic
sales of $2.4 million. The firm extends 30-day credit
Equity
ock Outstanding Month of origin Amounts receivable
July
August
September
of common stock October
f common stock November
December
Year-end accounts receivable

ach $1.00 of a. Use the year-end total to evaluate the firm’s collec
b. If 70% of the firm’s sales occur between July and
validity of your conclusion in part a? Explain.

Practice Exercise 04:

ks. Simply The relationship between financial leverage and prof
cally sell at and Timberland Forest, Inc., are rivals in the manufa
financial statement values for each company follow.
compares the firms’ financial leverage and profitabili

Item
statements
t and balance Total Assets
sets (ROA) Total Equity (Common)
Total debt
Annual Interest
h measures Total Sales
ndicates how EBIT
Earnings (for common stockh

Assets a. Calculate the following debt and coverage ratios fo

Total Equity their financial risk and ability to cover the costs in re
(1) Debt ratio
$3,597,000 (2) Times interest earned ratio
1754000 b. Calculate the following profitability ratios for the tw
profitability relative to each other.
(1) Operating profit margin
 Equity Multiplier (2) Net profit margin
(3) Return on total assets
(4) Return on common equity
$2.05 c. In what way has the larger debt of Timberland Fo
than Pelican Paper? What are the risks that Timberla
when they choose to purchase its stock instead of Pe

Solution:

Req a: Debt Ratio and times interest earned ra

Pelican Paper, Inc

Debt Ratio:

Debt Ratio = Total Debt / Total Assets

=1,000,000/10,000,000

0.10
Times interest earned ratio:
mpany that measures its current Times interest earned ratio = Earnings before
s ratio is also sometimes known
=6250000/100000

62.5 times
Req b: Operating Profit margin, Net Profit mar
$43 a share and its earnings over
stock could then be calculated Operating Profit: Operating Profit (EBIT) /Sale

=6250000/25000000

how much investors are willing 25%

ng at a multiple (P/E) of 20, the
current earnings. Net profit margin = Earnings available for com

gher earnings growth in the future =3690000/25000000

te either that a company may
onally well relative to its past 14.76%
n both cases P/E will be
e P/E, this is not the Return on Total Assets:

Return on Total Assets (ROA) = Earnings available fo

=3690000/10000000

36.90%

Return on Common Equity:

Return on Equity (ROE) = Earnings available for com

=3690000/9000000

41.00%

Req c : Profitability and risk

The larger debt of the Timberland Forest causes the

This will reduce the earnigns available for the equity
of the Timberland Forest is lesser than Pelican Paper
of the Timberland Forest.

Investors of Timberland might face a the time of liqu

debt and debt holders will be paid first. And also the
will be lesser. Larger debt increases the interest amo
before interest and taxes.

Practice Exercise 05

DuPont system of analysis Use the following ratio inf

International and the industry averages for Johnson’
a. Construct the DuPont system of analysis for both
b. Evaluate Johnson (and the industry) over the 3-ye
c. Indicate in which areas Johnson requires further a

Johnson
Financial Leverage Multiplier
Net Profit Margin
Total Assets turnover

Industry average
Financial Leverage Multiplier
Net Profit Margin
Total Assets turnover
 MRE
ed earnings Philagem, Inc., ended 2012 with a net
00. The company is subject to a 40% tax rate and must
k dividends before distributing any earnings on the
ck currently outstanding.

earnings per share (EPS).

ock dividends of $0.80 per share, how many dollars

218000
(87,200)
130,800
32000
for Shareholders 98,800

= $98,800/85,000 = 1.1623529

erred to the retained earnings will be the amount left after

ds to the common stockholders. The dividend paid to the
ers is $.80 per share. It means total dividend paid is Calcu-
g $0.80 with total number of shares (85 000 shares)

to common stockholders = .80*85000 shares = 68000

d to retained earnings = $98,800-68,000 = 30800

………………………………………………………………….
MRE
year ended December 31, 2012, the balance sheets for December 31, 2012 and 2011,
d earnings for the year ended December 31, 2012, for Technica, Inc., are given below:

me Statement Balance Sheet

December 31, 2012 December 31, 2012
600,000 2012
460,000 Assets
 140,000 Cash 15000
Marketable securities 7200
30,000 Accounts receivable 34100
30,000 Inventories 82000
60,000 Total current assets 138300
80,000 Land and buildings 150000
(10,000) Machinery and equipment 200000
70,000 Furniture and fixtures 54000
27,100 Other 11000
stockholders 42,900 Total gross fixed assets 415000
2.15 Less: Accum depreciation 145000
Net fixed assets 270000
f Retained Earnings Total assets 408300
ded December 31, 2012 Liabilities and Stockholders’ Equity
Accounts payable $57,000
50,200 Notes payable 13000
42,900 Accruals 5000
(20,000) Total current liabilities $75,000
73,100 Long-term debt 150000
Common stock equity (shares outstanding:
19,500 in 2012 and 20,000 in 2011) 110200
12.75 Retained earnings 73100
Total stockholders’ equity 183300
Total liabilities and Equity $408,300
the following ratios:

X Gross Profit Margin

XI Operating profit Margin
turnover XII Net Profit margin
ge of Inventory XIII Earnings per share
ollection period XIV Return on Assets (ROA)
ayment period XV Return on Equity (ROE)
ts turnover XVI Price / Earnings (P/E) Ratio
XVIIMarket / Book (M/B) Ratio
erest earned XVIIDuPont Identity
……………………………………………………………………

gement: An evaluation of the books of Blair Supply,

of-year accounts receivable balance, which is believed
ing in the months indicated. The company had annual
extends 30-day credit terms.

ounts receivable
$3,875
$2,000
$34,025
$15,100
$52,000
$300,000
receivable $407,000

valuate the firm’s collection system.

occur between July and December, would this affect the
part a? Explain.

ncial leverage and profitability Pelican Paper, Inc.,

are rivals in the manufacture of craft papers. Some
each company follow. Use them in a ratio analysis that
leverage and profitability.

Pelican Paper, Inc Timberland Forest, Inc.

10,000,000 10,000,000
9,000,000 5,000,000
1,000,000 5,000,000
100,000 500,000
25,000,000 25,000,000
6,250,000 6,250,000
3,690,000 3,450,000

t and coverage ratios for the two companies. Discuss

to cover the costs in relation to each other.

fitability ratios for the two companies. Discuss their

 debt of Timberland Forest made it more profitable
the risks that Timberland’s investors undertake
e its stock instead of Pelican’s?

es interest earned ratio

Timberland Forest, Inc.

Total Assets

0/10,000,000 =5,000,000/10,000,000

0.50

o = Earnings before interest and taxes / Interest

=6250000/500000

12.5 times
argin, Net Profit margin, ROA and ROE

g Profit (EBIT) /Sales

/25000000 =6250000/25000000

25%

ngs available for common stockholders / Sales

/25000000 =3450000/25000000

13.80%
 = Earnings available for common stockholders / Total assets

/10000000 =3450000/10000000

34.50%

rnings available for common stockholders / Common stock equity

/9000000 =3450000/5000000

69.00%

land Forest causes the larger interest than the Pelican Paper.
available for the equity shareholders. But the common stock
sser than Pelican Paper. This will increase the earnings per share

t face a the time of liquidation. Timberland Foret has larger

paid first. And also the earnings left for the common stockholders
reases the interest amount to be deducted from earnings

e the following ratio information for Johnson

y averages for Johnson’s line of business to:
em of analysis for both Johnson and the industry.
industry) over the 3-year period.
nson requires further analysis. Why?

2010### 2012
Multiplier 1.75 1.8 1.85
 0.059 0.1 0.049
2.11 2.2 2.34

Multiplier 1.67 1.7 1.64

0.059 0 0.041
2.05 2.1 2.15
12
2011
 16000
8000
42200
50000
116200
150000
190000
50000
10000
400000
115000
285000
401200

49000
16000
6000
$71,000
160000

120000
50200
170200
$401,200
5.0796812749