FINANCIAL ANALYSIS

Exercise

1. Indicate the effects of the transactions listed in the following table on total current assets,
current ratio, and net income. Use ( + ) to indicate an increase, ( - ) to indicate a
decrease, and ( 0 ) to indicate either no effect or an indeterminate effect. Be prepared to
state any necessary assumptions, and assume an initial current ratio of more than 1.0.
(Note: A good accounting background is necessary to answer some of these questions;
if yours is not strong, just answer the questions you can handle.)

Total Effect on
Current Current Net
Assets Ratio Income
Cash is acquired through issuance of additional
common stock.
Merchandise is sold for cash.
Federal income tax due for the previous year is paid.
A fixed asset is sold for less than book value.
A fixed asset is sold for more than book value.
Merchandise is sold on credit.
Payment is made to trade creditors for previous
purchases.
A cash dividend is declared and paid.
Cash is obtained through short-term bank loans.
Short-term notes receivable are sold at a discount.
Marketable securities are sold below cost.
Advances are made to employees.
Current operating expenses are paid.
Short-term promissory notes are issued to trade
creditors in exchange for past due accounts payable.
10-year notes are issued to pay off accounts payable.
A fully depreciated asset is retired.
Accounts receivable are collected.
Equipment is purchased with short-term notes.
Merchandise is purchased on credit.
The estimated taxes payable are increased.
 2. Balance sheet analysis Complete the balance sheet and sales information that follows
using the following financial data:

Debt ratio: 50%

Current ratio: 1.8
Total assets turnover: 1.5
Days sales outstanding: 36.5 days
Gross profit margin on sales: (Sales - Cost of goods sold)/Sales = 25% )
Inventory turnover ratio: 5 x
Calculation is based on a 365-day year.

3. Ratio analysis:
Data for Barry Computer Co. and its industry averages follow.
a. Calculate the indicated ratios for Barry.
b. Construct the extended Du Pont equation for both Barry and the industry.
c. Outline Barry’s strengths and weaknesses as revealed by your analysis.
d. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and
common equity during 2005. How would that information affect the validity of your ratio
analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages
are not used. No calculations are needed.)