Financial Accounting 6.0: Analyzing Financial Statements | HBS CORe
inventory turnover
cost of goods sold/average inventory A higher inventory turnover represents more efficient inventory management.
days purchases outstanding
Again this simply shows the AP turnover measured in average days outstanding. A days purchases outstanding that is longer than the allowed terms from the vendor could indicate that the business is struggling to pay its obligations.
debt to equity ratio
Another very common indicator of leverage is the debt to equity ratio. This number is very similar to the equity multiplier, but we use total liabilities in the numerator rather than assets.
Suppose the profit margin for Cardullo's Gourmet Shoppe, Inc for Q1 was 4.99% and Q2 was 10.57%. Which of the following statements can you conclude regarding Cardullo's? Cardullo's is more efficient in utilizing its assets in Q2 than in Q1. Cardullo's does a better job in cost control in Q2 than in Q1. Cardullo's is more effective in extending credit and collecting debts in Q2 than in Q1.
Cardullo's does a better job in cost control in Q2 than in Q1. This is the correct answer! Profit margin is the percentage of selling price that turned into profit. Cardullo's could increase its profit by reducing costs, thus increase its profit margin.
Which of the following companies would likely have the LEAST difficulty making the interest payments on its debts? Company A with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $15,000 Company B with Net Income of $100,000, Interest Expense of $30,000, and Tax Expense of $10,000 Company C with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $20,000
Company C will likely have the least difficulty making interest payments on its debt, because it has the highest Interest Coverage Ratio. The Interest Coverage Ratio can be calculated as ( EBIT / Interest Expense ) Company A has an EBIT of $140,000 ( $100,000 + $25,000 + $15,000 ) Company A's Interest Coverage Ratio is 5.6 ( $140,000 / $25,000 ) Company B has an EBIT of $140,000 ( $100,000 + $30,000 + $10,000 ) Company B's Interest Coverage Ratio is 4.7 ( $140,000 / $30,000 ) Company C has an EBIT of $145,000 ( $100,000 + $25,000 + $20,000 ) Company C's Interest Coverage Ratio is 5.8 ( $145,000 / $25,000 )
Notice how overall Amazon's gross profit % trend is increasing while the profit margin trend is decreasing. 2009 2010 2011 2012 Gross Profit Margin 22.57% 22.35% 22.44% 24.75% Profit Margin 3.68% 3.37% 1.31% (0.06)% Which of the following is a reasonable explanation for the inverse trends? Higher demand has allowed Amazon to increase their prices, while higher overhead expenses have been hurting overall profits. Amazon issued new stock during the year to raise additional capital. Inventory prices have increased resulting in increased COGS.
Higher demand has allowed Amazon to increase their prices, while higher overhead expenses have been hurting overall profits. This is the correct answer! Higher selling prices would result in a higher gross profit margin, but increasing operating expenses could eat away the profits before they hit the bottom line.
Consider the following selected accounts from the balance sheet (in millions) for Apple Inc. What is the leverage ratio that would be used in the DuPont Framework for 2013? Use average balances for the ratio.
In the DuPont Framework, the leverage ratio is calculated by dividing the average total assets by the average equity. Average Total Assets / Average Equity = 191,532 / 120,879.50 = 1.58 The suggested correct answer formula is: =AVERAGE(B6:C6)/AVERAGE(SUM(B12:B14),SUM(C12:C14))
Consider the following summarized balance sheet (in millions) for Apple Inc. for 2013. What is the current ratio observed in 2013?
The Current Ratio is calculated by dividing Current Assets by Current Liabilities at a point in time. For this ratio, we do not use the average amounts. Current Assets include Cash, Equivalents, Marketable Securities, Accounts Receivable, Inventory, and Other Current Assets. Current Liabilities include Accounts Payable, Accrued Expenses, and Other Current Liabilities. Current Assets / Current Liabilities = 73,286 / 43,658 = 1.68 The suggested correct answer formula is: =SUM(B2:B5)/SUM(B12:B14)
Calculate the Gross Profit Margin for Chrissie's Cooking Supply based on its Income Statement.
The Gross Profit Margin is calculated by dividing Gross Profit by Revenue. Gross Profit / Revenue = Gross Profit Margin 81,477 / 152,633 = 53.38% The suggested correct answer formula is: =B7/B5
days purchases outstanding (where credit purchases data is not available)
average accounts payable/ (COGS/365)
Days Purchases Outstanding (wher credit purchases data is available)
average accounts payable/(annual credit pruchases/365)
Accounts Receivable Turnover
credit sales/average accounts receivable often called AR turnover, is similar to the inventory turnover, but provides an indication of a business' efficiency in collecting receivables from customers. AR turnover represents the number of times per year a company is collecting its outstanding accounts receivable. Uncollected receivables represent cash that is tied up and can't be used for other purposes. An AR turnover that is too low could indicate that the business' customers are having trouble paying. Inefficient cash collections could lead to eventual cash flow problems. AR turnover is calculated as follows:
current ratio =
current assets/ current liabilities
Cash Conversion Cycle
days inventory + average collection period - days purchases outstanding
EBIT
earnings before interest and taxes net income + interest expense+ income tax expense
Asset turnover
efficiency in the dupont framework sales/assets
As a result of continued demand growth, Company A's revenue was growing from 2011 to 2013. However, the company's gross profit margin decreased from 2011 to 2013: 2011: 39.51% 2012: 37.84% 2013: 36.28% Which of the following is a reasonable explanation for the inverse trends? Although the market was growing with the demand, competition was driving the prices down. The company changed its pricing strategy according to a recent study of consumer behavior, which resulted in an increase in the selling price of its products. The company adopted a more effective marketing channel and reduced the overall marketing cost.
Although the market was growing with the demand, competition was driving the prices down. This is the correct answer! This is not an unusual situation and it would explain the inverse trends.
DuPont Framework
An expanded formula of the return of equity. Profitability x Efficiency x Leverage
days purchases outstanding (another way)
365/accounts payable turnover
accounts payable turnover (where credit purchases data is not available)
COGS/average accounts payable
Company A has a higher Accounts Payable Turnover Ratio than Company B. Which of the following statements is true regarding these two companies? Company A has a longer Average Collection Period than Company B. Company A has a lower percentage of credit purchases than Company B. Company A is paying suppliers at a faster rate than Company B.
Accounts Payable Turnover = Credit Purchases / Average Accounts Payable Balance Accounts Payable Turnover measures the number of times a company can pay off its average account payable balance during a time period.
What is the best explanation for the increase in the current ratio in 2013? Long term marketable securities increased significantly Current liabilities increased by over $5 million. Current assets continued to grow without a proportionate increase to its liabilities.
Current assets continued to grow without a proportionate increase to its liabilities. There has been some increase in working capital coming from increases in cash, accounts receivable, and other current assets, and the biggest increase in short term marketable securities.
gross profit margin
gross profit/sales
Leverage
leverage assets/equity
A higher AR turnover represents
more efficient cash collections. Note that in the absence of information about credit sales, we will often simply use sales as a substitute. There are some limitations to simply using sales, especially if a company does have a large discrepancy between total sales and credit sales.
Profitability
profit margin net income/sales
Which of the following companies is most likely to have a negative Cash Conversion Cycle? A discount retailer A farmer who grows corn and sells to a distributor A manufacturer who makes high-quality steam evaporators for nuclear power plants A car dealership that provides their own in-house financing
A discount retailer A discount retailer sells most of its inventory quickly and for cash, while delaying payments to suppliers.
Which of the following measures does not reflect a company's profitability? Gross Profit Margin Days Sales in Accounts Receivable EBIAT Profit Margin
Days Sales in Accounts Receivable Days Sales in Accounts Receivable is the average number of days a company takes to collect payments on goods sold. It is not related to profitability.
Average in spreadsheet
For example, when you need to find an average of two values in cells A1 and A2, you could either use: =AVERAGE(A1,A2) Or you could use: =SUM(A1,A2)/2 Or you could also use: =(A1+A2)/2
How would you assess its liquidity and working capital management from year to year? No real change; good liquidity and good ability to pay current obligations Slight improvement and move in the right direction Looks the same on the surface but underlying changes are resulting in higher cash.
Looks the same on the surface but underlying changes are resulting in higher cash. Although the change in the current ratio is very small, there are significant underlying movements. Increases in accounts receivable have been offset by increases in accounts payable & accrued expenses. The biggest change could be the reduced investment in inventory which could be a reason cash has increased.
How do you calculate the profit margin ratio within the DuPont Framework? Operating income/Sales COGS/Sales Net income/Sales EBIT/Sales
Net income/Sales This is the correct answer! This ratio shows the % of each dollar of sales that ends up as net profit.
Why is it important to consider seasonality of industries when analyzing financial statements of companies? Management applies different policies in accordance with the different seasons. Outcomes of the analysis would depend on when you are looking at the statements. Analysts need to apply US GAAP in all quarters. Valuation and forecasts rely on the worst season for most companies.
Outcomes of the analysis would depend on when you are looking at the statements. Ratio analysis could differ significantly by looking at peak times as opposed to the entire fiscal year.
Which ratio measures the ability of a company to make a profit relative to revenue generated during a period? Gross Profit Margin Days Sales in Receivable Profit Margin Days Purchases Outstanding
Profit Margin Profit Margin (Net Income/Sales) measures the ability of a company to make a profit relative to revenue generated during a period.
Which of the following ratios measures the ability of a company to make a profit relative to the revenue generated during the period? ROA Profit Margin ROE ROI
Profit Margin This is the correct answer! Profit margin shows the % of each dollar of sales that ends up as net profit.
Calculate the Profit Margin for Chrissie's Cooking Supply based on its Income Statement.
The Profit Margin is calculated by dividing the Net Income by the Revenue. Net Income / Revenue = 11,216 / 152,633 = 7.35% The suggested correct answer formula is: =B19/B5
Consider the following financial data (in thousands) for Green Mountain Coffee Roasters. What is the profit margin reported in 2013?
The Profitability or Profit Margin is calculated by dividing the Net Income by the Revenue. In this case, the calculation is as follows: Net Income / Revenue = 483,232 / 4,358,100 = 11.09% The suggested correct answer formula is: =C9/C4
current ratio
The current ratio helps us understand the business' ability to pay its short term obligations, and is measured as current assets divided by current liabilities. The ratio focuses on the business' more liquid assets and liabilities, or those that are convertible to cash or coming due, within a year. Remember that short term assets are things like cash, inventory, or accounts receivable. Essentially these are the assets that a business has in cash or will turn into cash to help pay approaching obligations. Current liabilities include accounts payable and wages payable, and are items that must be paid, in cash, in the short term. If current assets aren't larger than current liabilities, which would lead to a ratio less than 1, it could indicate that a business may have trouble meeting its obligations in the near term. Generally, the higher the current ratio the better position the business is in to meet its approaching liabilities. But if the current ratio is too high, it might indicate that the business is not managing its working capital efficiently.
average collection period
365/accounts receivable turnover The average collection period is very useful because it can be compared to the cash collection policy of the firm. If payment is expected from customers within 30 days, but the average collection period is 40 days, it may be a sign of concern. Businesses can influence their collection period by altering the payment terms they offer, but will have to balance the desire for greater cash collection efficiency with the impact that it will have on sales, as customers generally find value in receiving credit terms from a supplier.
Consider the following portions of summarized financial statements (in millions) for Apple Inc. What is the accounts payable turnover and the days purchases outstanding observed in 2013?
Accounts Payable Turnover is calculated by dividing the annual credit purchases by the average accounts payable balance. In this case, we do not have access to Apple's credit purchases so we are using Cost of Sales as a proxy. Again we will use a 2-point average of beginning and end of year accounts payable balances. Cost of Sales / Average Accounts Payable = 106,606 / 21,771 = 4.90 Days Purchases Outstanding is calculated by dividing Average Accounts Payable by the average daily Cost of Sales, which is Cost of Sales divided by 365. Average Accounts Payable / Average Daily Cost of Sales = 21,771 / 292 = 74.54 There are several formulas that could help you arrive at the correct answer, but one solution is presented below: Accounts Payable Turnover: =C17/AVERAGE(B7:C7) Days Payable Outstanding: =AVERAGE(B7:C7)/(C17/365)
Consider the following summarized financial statements (in millions) for Apple Inc. What is the accounts receivable turnover and the average collection period observed in 2013? Assume all sales are on credit.
Accounts Receivable Turnover is calculated by dividing the annual credit sales by the average accounts receivable balance. In this case, we assume that all of Apple's revenue is from sales made on credit terms. Again we will use a 2-point average of beginning and end of year accounts receivable balances. Credit Sales / Average Accounts Receivable = 170,910 / 12,016 = 14.22 Average Collection Period is calculated by dividing Average A/R by the average daily Credit Sales, which is Credit Sales divided by 365. Average Accounts Receivable / Average Daily Credit Sales = 12,016 / 468 = 25.66 There are several formulas that could help you arrive at the correct answer, but one solution is presented below: Accounts Receivable Turnover: =C14/AVERAGE(B3:C3) Average Collection Period: =AVERAGE(B3:C3)/(C14/365)
Suppose the following were the gross profit margins for Green Mountain Coffee Roasters (GMCR) from 2011 through 2013. 2011: 34.13% 2012: 32.89% 2013: 37.16% What could be an explanation of the fluctuations in gross profit margins for GMCR from 2011 through 2013? Selling & Operating expenses went from 13.15% to 12.48% to 12.86% from 2011 to 2013. Labor and Overhead costs were lower as a percentage of Sales in 2012. An increase in manufacturing capacity at the beginning of 2012 caused overhead to increase but allowed for greater efficiency and significant sales growth later.
An increase in manufacturing capacity at the beginning of 2012 caused overhead to increase but allowed for greater efficiency and significant sales growth later. This is the correct answer! The increase in overhead costs could hurt 2012 margins but pave the way for more profitable operations in 2013.
Consider the following summarized financial statements (in millions) for Apple Inc. What is the asset turnover observed in 2013? Use the average assets from the beginning and ending of the year for your calculation. Remember to use the AVERAGE of assets for 2012 and 2013 in your calculation.
Asset Turnover is calculated by dividing the annual revenue by the average asset value for the year. In this case, we are using a two-point average of beginning and end of year asset values so the calculation is as follows: Revenue / Average Assets = 170,910 / 191,532 = 0.89 To calculate average assets, you are given the beginning total of $176,064 but you must calculate the ending total by summing all asset accounts as of Sept 28, 2013 (a shortcut would be to add the Liabilities and Equity at September 28, 2013, since we know A = L + OE). The ending total is $207,000 making the average $191,532. There are several formulas that could help you arrive at the correct answer, but one solution is presented below: =B17/AVERAGE(B14,SUM(B2:B9))
Calculate the Asset Turnover for Chrissie's Cooking Supply based on its Balance Sheet and Income Statement. Use average balances in your calculation where applicable. (On 12/31/2014, Chrissie's Cooking Supply had total assets of $65,173.)
Asset Turnover is calculated by dividing the annual revenue by the average asset value for the year. In this case, we are using the average of beginning and end of year asset values. Revenue / Average Assets = 152,633 / 82,925 = 1.84 The suggested correct answer formula is: =B24/AVERAGE(B11,D5)
The current ratios of 2012 and 2013 for Cardullo's Gourmet Shoppe are listed as follows. 2012: 1.39 2013: 1.69 What does the upward trend in the ratio mean for Cardullo's? Cardullo's has better ability to pay off its short-term liabilities in 2013 than in 2012. In 2013, a larger portion of asset financing is being done through equity. Cardullo's Accounts Payable Turnover is higher in 2013 than in 2012.
Cardullo's has better ability to pay off its short-term liabilities in 2013 than in 2012. Current ratio indicates a company's liquidity. A higher current ratio means a higher proportion of current assets available to cover current liabilities.
Suppose the gross profit margin for Cardullo's Gourmet Shoppe, Inc for Q1 was 47.25% and Q2 was 47.70%. Which of the following is a reasonable explanation for the change in the ratio? Cardullo's offered a volume discount in Q2. Cardullo's negotiated with vendors and successfully reduced overall inventory prices. Cardullo's sold a truck and realized a gain on the sale in Q2.
Cardullo's negotiated with vendors and successfully reduced overall inventory prices. This is the correct answer! If the cost of inventory decreased, Cardullo's could make more money off of each item it sold.
Company A has a higher Days Purchases Outstanding than Company B. Which of the following statements is true regarding these two companies? Company A is paying suppliers at a faster rate than Company B. Company A has a lower Accounts Payable Turnover than Company B. Company A has a better ability to pay off its short-term liabilities than Company B.
Company A has a lower Accounts Payable Turnover than Company B. Days Purchases Outstanding = 365 / (Credit Purchases / Average Accounts Payable Balance) Days Purchases Outstanding is inversely related to Accounts Payable Turnover. A company with a higher Days Purchases Outstanding would have a lower Accounts Payable Turnover.
Company A has a higher Days Inventory than Company B. Which of the following statements is true regarding these two companies? Company A has a lower Inventory Turnover than Company B. Company A has a higher average inventory than Company B. Company A is more efficient in using its inventory to generate revenue.
Company A has a lower Inventory Turnover than Company B. Days Inventory = Average Inventory / (COGS / 365) Days Inventory is inversely related to Inventory Turnover. A company with a lower Inventory Turnover would have a higher Days Inventory.
Company A has a shorter Average Collection Period than Company B. Which of the following statements is true regarding these two companies? Company A has a lower Accounts Receivable Turnover than Company B. Company A is more efficient in collecting receivables from customers than Company B. Company A is more efficient in generating revenue than Company B.
Company A is more efficient in collecting receivables from customers than Company B. Average Collection Period = 365 / (Credit Sales / Average AR Balance) A lower Average Collection Period means the company is more efficient in collecting from their customers.
Company A has a shorter Average Collection Period than Company B using the formula 365 / (Credit Sales / Average AR Balance). Which of the following statements is true regarding these two companies? Company A has a lower percentage of credit sales than Company B. Company A is more efficient in collecting receivables from customers than Company B. Company A is more efficient in generating revenue than Company B.
Company A is more efficient in collecting receivables from customers than Company B. Average Collection Period = 365 / AR Turnover = 365 / (Credit Sales / Average AR Balance) Accounts Receivable Turnover is an indicator of a business' ability and efficiency in collecting receivables from customers.
Company A has a higher Inventory Turnover Ratio than Company B. Which of the following statements is true regarding these two companies? Company A has a lower average inventory level than Company B. Company A has more inventory than Company B. Company A is more efficient in using its inventory to generate revenue.
Company A is more efficient in using its inventory to generate revenue. Inventory Turnover = Cost of goods sold / Average inventory Inventory Turnover measures the number of times inventory is sold or used in a time period. It is an indicator of operating efficiency.
Based on the breakdown of the DuPont framework for two companies below, which of the following might explain why Company A has a higher ROE than Company B? Company A is more efficient in utilizing its assets than Company B. The manufacturing cost of Company A is lower than Company B. Company A has better ability to pay off its debts than Company B.
Company A is more efficient in utilizing its assets than Company B. Company A has a higher ROE than Company B because it has a higher Asset Turnover Ratio, which means Company A is more efficient in utilizing its assets.
Company X's DuPont analyses of 2012 and 2013 are as follows: Based on the breakdown of the DuPont framework, which of the following statements is true regarding Company X? Company X is more profitable in 2013 than in 2012. Company X has more assets in 2013 than in 2012 Company X has a lower assets to equity ratio in 2013 than in 2012.
Company X has a lower assets to equity ratio in 2013 than in 2012. The Equity Multiplier decreased from 2012 to 2013.
Bob's Burgers has an Inventory Turnover of 6.0, an Accounts Receivable Turnover of 8.5, and an Accounts Payable Turnover of 10.1. What is the length of their Cash Conversion Cycle? 4.4 139.8 67.6 54.0
Days Inventory + Average Collection Period - Days Purchases Outstanding = Cash Conversion Cycle Days Inventory = 365 / Inventory Turnover Average Collection Period = 365 / Accounts Receivable Turnover Days Purchases Outstanding = 365 / Accounts Payable Turnover ( 365 / 6.0 + 365 / 8.5 - 365 / 10.1 ) = 67.6
Which of the following items is NOT related to a company's ability to pay off its debts? Current Ratio Quick Ratio Debt to Equity Ratio
Debt to Equity Ratio Debt to Equity Ratio measures a company's leverage, not ability to pay off debts.
EBIAT
EBIAT is an acronym for Earnings Before Interest After Taxes. It is a measure of how much income the business has generated while ignoring the effect of financing and capital structure of the business. It is calculated by adding back interest and taxes to net income, and then calculating and subtracting income tax expense based on the earnings before interest and taxes.
Interest Coverage Ratio or Times Interest Earned
EBIT/interest expense
The profit margin for East Corp. for each year from 2011 to 2013 is listed as follows. 2011: 7.13% 2012: 7.68% 2013: 8.14% Which of the following is NOT a reasonable explanation for the trend in the ratio? The variable costs decreased due to an improvement in technology. An increase in the sales price due to higher demand resulting from a successful marketing campaign. East Corp. declared a cash dividend to shareholders.
East Corp. declared a cash dividend to shareholders. This is the correct answer! This situation wouldn't directly impact a company's profit margin.
You have just reviewed the financial statements of Penelope's Candy Store (PCS). You have determined that PCS has a Profit Margin of 19%. How do you explain this to owner Penelope Hassey? For every $19 in sales, $100 ended up in Net Income. For every $100 in sales, $19 ended up in Net Income. 19% of Net Income was generated by Profit Margin. 19% of sales were generated by Net Income.
For every $100 in sales, $19 ended up in Net Income. Profit Margin (Net Income/Sales) measures the ability of a company to make a profit relative to revenue generated during a period. A Profit Margin of 19% tells us that for every $100 in sales, $19 ended up in Net Income.
Consider the following financial data (in millions) for Apple Inc. What is the gross profit margin reported in 2013?
Gross Profit Margin is calculated by dividing the Gross Profit (Revenue less Cost of Sales) by the Revenue. In this case, the calculation is as follows: (Revenue - Cost of Sales) / Revenue = Gross Profit Margin (170,910 - 106,606) / 170,910 = 37.62% The suggested correct answer formula is: =(B1-B4)/B1
Consider the following financial data (in thousands) for Green Mountain Coffee Roasters. What's the gross profit margin reported in 2013?
Gross Profit Margin is calculated by dividing the Gross Profit by the Revenue. In this case, the calculation is as follows: Gross Profit / Revenue = 1,619,386 / 4,358,100 = 37.16% The suggested correct answer formula is: =B6/B4
The current ratios for Cardullo's and H&M are listed as follows. Cardullo's: 1.69 H&M: 2.25 Which of the following statements is true regarding the two companies? H&M has more current assets than Cardullo's. H&M likely has better ability to pay off its short-term liabilities than Cardullo's. H&M manages its working capital better than Cardullo's.
H&M likely has better ability to pay off its short-term liabilities than Cardullo's. Current ratio indicates a company's liquidity. A higher current ratio means a higher proportion of current assets available to cover current liabilities.
Calculate the Leverage used in the DuPont Framework for H&M based on its Balance Sheet and Income Statement. Use average balances in your calculation where applicable. (On 11/30/2012, H&M had total assets of $60,173 and total equity of $43,835.)
In the DuPont Framework, the leverage ratio is calculated by dividing the average total assets by the average equity. Average Total Assets / Average Equity = 62,925 / 44,542 = 1.41 The suggested correct answer formula is: =AVERAGE(B11,D5)/AVERAGE(SUM(B16:B18),D8)
Which of the following changes will cause a company's Asset Turnover to decrease? Increase in Sales Revenue Fixed Asset Write off Increase in inventory ending balance
Increase in inventory ending balance Asset Turnover = Sales / Average Assets An increase in the inventory ending balance will cause Average Assets, the denominator, to increase, and thus will decrease Asset Turnover.
Company X reported the following information on its 2015 income statement: Interest Expense: $10,000 Income Tax: $50,000 Net Income: $140,000 What is Company X's Interest Coverage Ratio for 2015? 8.5 17.5 21.0 20.0
Interest Coverage Ratio = EBIT / Interest Expense = (Net Income + Income Tax + Interest Expense) (140,000 +50,000 + 10,000) / 10,000) = 20.0
A company's Inventory Turnover decreased during the year. Which of the following is a reasonable explanation to this trend? Inventories were less marketable compared with last year. 3% of inventories were written off by the end of the year. Cost of Goods Sold of current year increased by 5%.
Inventories were less marketable compared with last year. Inventory Turnover = Cost of goods sold / Average inventory As the inventories became less marketable, the company would be less efficient in operating its inventories, and thus the Inventory Turnover would decrease.
Consider the following summarized financial statements (in millions) for Apple Inc. What is the inventory turnover and days inventory observed in 2013?
Inventory Turnover is calculated by dividing the annual Cost of Goods Sold (or Cost of Sales in this case) by the average inventory value for the year. In this case, we are using a two-point average of beginning and end of year asset values so the calculation is as follows: Cost of Sales / Average Inventory = 106,606 / 1,278 = 83.45 Days Inventory is calculated by dividing Average Inventory by the average daily Cost of Sales which is Cost of Sales divided by 365. Average Inventory / Average Daily Cost of Sales = 1,278 / 292 = 4.37 There are several formulas that could help you arrive at the correct answer, but one solution is presented below: Inventory Turnover: =C15/AVERAGE(B4:C4) Days Inventory: =AVERAGE(B4:C4)/(C15/365)
The gross profit margin for Amazon for each year from 2010 to 2012 is listed as follows. 2010: 22.35% 2011: 22.44% 2012: 24.75% Which of the following statements is a reasonable explanation for the trend in the ratio? Increased competition is forcing Amazon to lower its prices. Amazon issued new stock during the year to raise additional capital. Inventory prices have fallen resulting in decreased COGS.
Inventory prices have fallen resulting in decreased COGS. This is the correct answer! If the cost of inventory decreased, Amazon could make more money off of each item it sold.
The Peach Pit, a restaurant, has Net Income of $25,000, Sales of $55,000, Assets of $115,000, and no debt. What is their ROE? 21.7% 4.29% 2.17% 42.9%
ROE = (Net Income / Sales) X (Sales / Assets) X (Assets / Equity) If a company has no debt, then their equity multiplier is 1. (25,000/55,000) * (55,000/115,000) * 1 = 21.7%
At the end of the third quarter, a department store is showing lower cash flows and lower sales on its financial statements compared to the average of the previous four quarters. It also shows an increase in inventory compared to the second quarter. Which of the following options is MOST likely to be the cause? Seasonality Depreciation In Decline Stage Efficiency
Seasonality Seasonality is causing the department store to build up its inventory for the holiday season and would anticipate a lower inventory and increased sales and cash flows for the 4th quarter financial statement.
Consider the following selected accounts from the balance sheet (in millions) for Apple Inc. First, calculate the debt to equity ratio observed in both 2012 and 2013 (hint: do NOT use averages). Then, calculate the debt to equity ratio using the average liabilities and average equity.
The Debt to Equity Ratio is calculated by dividing the total liabilities by the total equity. In this case, total liabilities includes Accounts Payable, Accrued Expenses, Other Current Liabilities, Long Term Debt, and Other Long Term Liabilities. Total equity includes Common Stock, Retained Earnings, and AOCI & Other Equity. For 2012, total liabilities are $57,854 and total equity is $118,210. Total liabilities / total equity = $57,854 / $118,210 = 0.49 The suggested correct answer formula is: =SUM(B7:B11)/SUM(B12:B14) For 2013, total liabilities are $83,451 and total equity is $123,549. Total liabilities / total equity = $83,451 / $123,549 = 0.68 The suggested correct answer formula is: =SUM(C7:C11)/SUM(C12:C14) For the average, average total liabilities are $70,653 and average total equity is $120,880. Total liabilities / total equity = $70,653 / $120,880 = 0.58 The suggested correct answer formula is: =AVERAGE(SUM(B7:B11),SUM(C7:C11))/AVERAGE(SUM(B12:B14),SUM(C12:C14)) Note that there is no requirement to calculate ratios using beginning and ending balances before calculating a ratio using average balances, but some managers may find it useful to see how the ratio differs under these different calculation methods.
Consider the following financial data (in millions) for Apple Inc. What is the profit margin reported in 2013?
The Profitability or Profit Margin is calculated by dividing the Net Income by the Revenue. In this case, the calculation is as follows: Net Income / Revenue = 37,037 / 170,910 = 21.67% The trick is to recognize that the Revenue is equal to the Cost of Sales plus the Gross Profit (170,910 = 106,606 + 64,304). As we have learned, Revenue minus Cost of Sales equals Gross Profit so it follows that Cost of Sales plus Gross Profit equals Revenue. The suggested correct answer formula is: =C12/(C6+C7)
Consider the following summarized balance sheet (in millions) for Apple Inc. for 2013. What is the quick ratio observed in 2013?
The Quick Ratio is calculated by dividing the most liquid Current Assets by Current Liabilities at a point in time. One way to calculate Quick assets removes inventories from current assets. At September 28, 2013: (Current Assets - Inventory) / Current Liabilities = 71,522 / 43,658 = 1.64 The suggested correct answer formula is: =(SUM(B2:B5)-B4)/SUM(B12:B14)
Consider the following portions of summarized financial statements (in millions) and ratios for Apple Inc. What is the cash conversion cycle observed in 2013?
The correct answer is -44.50. The correct answer formula is: =F6+F7-F8 The Cash Conversion Cycle is the number of days between when your company pays for inventory purchases and when your company collects from customers. It is calculated by subtracting the Days Purchases Outstanding from the total of the Days Inventory and the Average Collection Period. For the year ending June 30, 2013 it was: Days Inventory + Average Collection Period - Days Purchases Outstanding = 4.37 + 25.66 - 74.54 = -44.50
Initech finances their business using a combination of equity and liabilities. Which of the following numbers is most likely Initech's equity multiplier? -1 0 1 1.5
The correct answer is 1.5. A company that finances using only equity will have an equity multiplier of 1. Any amount over 1 shows the proportion financed using liabilities. Since Initech uses a combination of equity and liabilities to finance operations, the only option that would most likely be their equity multiplier is option 4, 1.5.
Based on the breakdown of the DuPont framework for the two companies listed in the preceding image, which company is more likely to be a high volume retailer? Company A Company B
The correct answer is Company B. Company B is likely a high volume retailer because its low profit margin indicates that it isn't adding a lot of value to products, and the high asset turnover means that it is selling through a lot of inventory.
How does the equity multiplier measure the impact of debt for a company if the formula does not include debt at all under the DuPont Framework? ROE calculation does not consider the amount of leverage DuPont Framework allows us to use Debt/Equity instead The debt is implied in the numerator (total assets) It includes the impact of convertible bonds that are usually relevant
The debt is implied in the numerator (total assets) As liabilities (including debt) increase, the equity multiplier will be higher than one. Increasing leverage has the potential of higher returns but the investment become riskier too.
What does the asset turnover represent in the DuPont formula? The efficiency with which assets are used to generate revenue Management use assessment of the working capital How important intangible assets are overall The margins generated by total assets
The efficiency with which assets are used to generate revenue DuPont framework measures a business' operating efficiency using Asset Turnover, which indicates how well a business is using its assets to produce sales. A business that can create more revenue with fewer assets is considered to be more efficient.
Gross profit and profit margins followed similar patterns in years 2011, 2012 and 2013 for Apple Inc. 2011 2012 2013 Gross Profit Margin 40.5% 43.9% 37.6% Profit Margin 23.9% 26.7% 21.7% What could explain the increase of ratios in 2012? Reducing operating expenses relative to sales The introduction of new products or versions of a product with temporarily higher margins The acquisition of small tech companies
The introduction of new products or versions of a product with temporarily higher margins This is the correct answer! Changes in product mix can have a significant impact on profitability from year to year for a consumer technology company like Apple.
Ratios
The ratios we discuss and the ways that we calculate them are typical of the way companies or analysts may use ratios to analyze a business but they are not necessarily "the correct way" and other ratios and methods are not necessarily incorrect. The key things that you want to do when you use ratios are to try to use amounts that can give an insight into the business (such as EBIT per square foot, as we will hear mentioned by Geoff Ruddell from Morgan Stanley as a meaningful ratio in the retail industry) and to be consistent in the way that the ratios are calculated when comparing them between periods for a company or when comparing them for different companies.
Which of the following is measured by the DuPont Framework? The return that a business generates during a period on equity invested in the business by the owners of the business. The return or profit received as a result of investing funds. The number of days between when a company pays for inventory purchases and when a company collects from customers. The number of times a company can cover its interest expense only using its earnings before interest and tax.
The return that a business generates during a period on equity invested in the business by the owners of the business. This is the definition of ROE (Return on Equity), which is measured by the DuPont Framework.
Consider the following summarized income statement (in millions) for Apple Inc. What is the interest coverage ratio observed in 2013? Calculate EBIT first, then use that to calculate the interest coverage ratio.
To calculate Earnings Before Interest and Taxes (EBIT), we start with Net Income and then add back Interest Expense and Income Tax Expense. Net Income + Interest Expense + Income Tax Expense = 37,037 + 136 + 13,118 = 50,291 The suggested correct answer formula is: =B16+B11+B15 To calculate the Interest Coverage Ratio, we divide EBIT by Interest Expense. EBIT / Interest Expense = 50,291 / 136 = 370 The suggested correct answer formula is: =E6/B11
Which of the following companies would potentially be most affected by seasonality while reporting its interim financial statements? Toy retailer Gold extraction Consulting firm Car leasing company
Toy retailer The correct answer is a toy retailer, because a toy retailer is usually highly affected by seasonality as most of its sales are earned during the end of a calendar year because of the holiday season.
The interest coverage ratio, also known as times interest earned
is a good way to gauge how capable a business is of making the interest payments on its debt. For this, we use a common income number called EBIT (Earnings Before Interest and Taxes). This number has to be calculated from the income statement by adding back interest expense and tax expense for the period to net income. We then divide by interest expense for the period. This ratio tells us the number of times a company can cover its interest expense using its earnings before interest and taxes.
The quick ratio
is similar to the current ratio except only highly liquid current assets are used in the numerator. One way to calculate this is to use current assets less inventory (because inventory tends to be less liquid than other current assets). The quick ratio is an even more stringent test than the current ratio to see if a business can meet its current obligations because it depends only on the most readily available current assets. Some businesses may have trouble turning their inventory into cash, so this gives us an idea of their ability to meet current obligations even if their inventory can't be sold immediately. This ratio is also sometimes called an acid test ratio.
average collection period, sometimes referred to as Days Sales Outstanding or Days Sales in Receivables
is the average number of days it took for a business to collect payment from a customer. It is closely tied to the AR turnover. The AR turnover and average collection period ratios are parallel to Inventory turnover and days inventory ratios. Both reveal information about the efficiency of managing a specific account in terms of number of times per year the account is turned over or the number of days values remain in the account.
Accounts Payable Turnover, or AP turnover
is very similar to both inventory turnover and AR turnover. The same process is followed but for the accounts payable account. We are looking at how long it takes us to pay our vendors. Vendors include suppliers of inventory and also suppliers of services or other non-inventory items
A smaller AP turnover
meaning it is taking longer to pay suppliers, isn't necessarily a bad thing as long as payment is being made within the terms or expectations of the supplier. Generous payment terms from a supplier can be a huge benefit to a business because it acts as free short term financing. However, companies are often offered a discount for paying quickly, so there is a trade off between discounts for paying early and taking advantage of free short term financing.
quick ratio =
(current assets - inventory)/current liabilities
Efficiency
asset turnover sales/assets
Leverage
assets/equity
average collection period
average accounts receivable/credit sales per day Assuming all sales were made on credit, Credit Sales per Day can be calculated as Sales / 365. Again, in the absence of information about credit sales, we will often simply use sales as a substitute anyway.
days inventory
average inventory/(COGS/365) 365/inventory turnover
debt to equity
average total liabilities/average total equity
accounts payable turnover (where credit purchases data is available)
credit purchases/average accounts payable
