Finance & Accounting for Nonfinancial Managers (2011) by Finkler Steven

Author:Finkler, Steven [Finkler, Steven]
Language: eng
Format: azw3
Publisher: CCH Inc.
Published: 2011-03-24T16:00:00+00:00

stockholders’ equity account as compared to the total equities. For the income statement, all numbers are compared to total sales. Once we have calculated the common size ratios, we can use them to compare our firm to itself over time, to specific competitors, and to industrywide statistics.

The common size ratios for PW’s balance sheet and income statement are presented in Exhibits 24-1 and 24-3. Exhibit 24-2 also provides common size balance sheet and income statement ratios.

EXHIBIT 24-3

Pacioli Wholesale Corporation

Income Statement

For the Years Ending June 30, 2012 and June 30, 2011

2012 2011 Sales 100.0% $297,000 100.0% $246,000 Less Cost of Good Sold 54.5% 162,000 58.1% 143,000

Gross Profit 45.5% $135,000 41.9% $103,000

Operating Expenses

Selling Expenses 10.1% $ 30,000 10.2% $ 25,000

General Expenses 4.0% 12,000 4.1% 10,000

Administrative Expenses 16.5% 49,000 16.3% 40,000

Total Operating Expenses 30.6% $ 91,000 30.5% $ 75,000

Operating Income 14.8% $ 44,000 11.4% $ 28,000

Interest Expense 4.0% 12,000 4.1% 10,000

Income before Taxes 10.8% $ 32,000 7.3% $ 18,000

Income Taxes 4.4% 13,000 2.8% 7,000

Net Income 6.4% $ 19,000 4.5% $ 11,000

The Balance Sheet: Assets Looking at the balance sheet (Exhibit 24-1), we can begin to get a general feeling about PW by comparing the common size ratios for two years. Note that there will typically be some rounding errors in ratio analysis. We could eliminate them by being more precise. For example, in 2012 the ratio of cash to total assets really is 2.6756 percent. We generally don’t bother with such precision. Ratios can’t give their users a precise picture of the firm. They are meant to serve as general conveyors of broad information. Our concern is if a number is particularly out of line—either unusually high or low. It is virtually impossible to interpret minor changes.

For PW, current assets have remained relatively stable, falling from 31.7 percent to 31.4 percent of total assets. Note, however, that accounts receivable have fallen while inventory has risen. Is this good or bad? If accounts receivable have fallen because sales are down this year or because there are more bad debts, and inventory has risen because PW is left with a lot of unsold goods, then this is bad. On the other hand, if accounts receivable are down because the firm has been successful in its efforts to collect more promptly, and inventory is up because it is needed to support growing sales, then this is a good sign.

Clearly, ratios can’t be interpreted in a vacuum. The ratio merely points out what needs to be investigated. The ratio doesn’t provide answers in and of itself. In the case of PW, the income statement (Exhibit 24-3) shows us that sales did indeed rise during the fiscal year ending June 30, 2012. It would appear that the changes in accounts receivable and inventory represent a favorable trend.

Fixed assets (Exhibit 24-1) for PW have increased, not only in absolute terms, but also as a percentage of total assets. After accounting for depreciation that has accumulated on buildings and equipment over their lifetime, we see a rise in net buildings and equipment from 32.

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