EXERCISE
Tutorial Two: Working with Financial Statements
Name IRN
1 Đào Thị Minh Phương 2032300161
2 Đặng Minh Sang 2032300175
3 Vũ Hà Quang 2132309002
4 Nguyễn Thị Kim Oanh 1932300379
5 Lê Thị Ngọc Linh 1932300479
I. Concept Questions
1. What is a source of cash? Give three examples.
A source of cash is any activity that brings cash into the company. Example:
○ Sales: Money from selling goods or services.
○ Borrowing: Loans from banks or issuing bonds.
○ Selling stock: Raising money by offering shares of the company.
2. What is a use, or application, of cash? Give three examples.
A use of cash is anything that takes cash out of the company. Examples:
○ Paying bills: Such as rent or utilities.
○ Buying equipment: For operations.
○ Repaying debt: Paying off loans or bonds.
3. Why is it often necessary to standardize financial statements?
Standardizing financial statements makes it easier to compare companies of different
sizes or to see how a company is doing over time by removing size differences.
4. Name two types of standardized statements and describe how each is formed.
○ Common-size income statement: Each item is shown as a percentage of total
sales.
○ Common-size balance sheet: Each item is shown as a percentage of total
assets.
5. What are the five groups of ratios? Give two or three examples of each kind.
○ Liquidity ratios: Measure if a company can pay its short-term bills (Current
Ratio, Quick Ratio).
○ Debt ratios: Show how much debt a company has ( Debt-to-Equity, Total
Debt Ratio).
○ Turnover ratios: Show how well a company uses its assets (Inventory
Turnover, Asset Turnover).
○ Profitability ratios: Show how much profit a company makes (Profit Margin,
Return on Assets).
○ Market value ratios: Show how the stock market values the company
(Price-to-Earnings, Market-to-Book Ratio).
6. Given the total debt ratio, what other two ratios can be computed? Explain how.
From the total debt ratio, we can calculate:
○ Debt-equity ratio: Compares total debt to shareholders’ equity.
○ Equity multiplier: Shows how much of the assets are financed by equity.
7. Turnover ratios all have one of two figures as the numerator. What are these two
figures? What do these ratios measure? How do you interpret the results?
The two figures are sales or cost of goods sold. These ratios measure how efficiently
a company uses its assets. Higher turnover means the company is using its assets
effectively.
8. Profitability ratios all have the same figure in the numerator. What is it? What
do these ratios measure? How do you interpret the results?
The numerator is net income. These ratios measure how much profit the company
makes. Higher ratios mean the company is more profitable.
9. Return on assets (ROA) can be expressed as the product of two ratios. Which
two?
ROA is Profit Margin × Asset Turnover. This shows how well the company is
turning sales into profits and how efficiently it uses its assets.
10. Return on equity (ROE) can be expressed as the product of three ratios. Which
three?
ROE is Profit Margin × Asset Turnover × Equity Multiplier. This shows how well
the company generates profit from its equity.
11. What are some uses for financial statement analysis?
It helps investors, managers, and lenders understand a company’s performance and
financial health. It’s used for making decisions about investing, managing, or lending.
12. Why do we say that financial statement analysis is management by exception?
Because managers focus on significant changes or unusual results, rather than
spending time on areas where performance is as expected.
13. What are SIC codes and how might they be useful?
SIC codes classify companies by industry. They are useful for comparing a company’s
performance to others in the same industry.
14. What are some problems that can arise with financial statement analysis?
○ Different accounting methods: Companies may use different ways of
recording finances, making comparisons harder.
○ Inflation: Over time, inflation can distort financial data.
○ One-time events: Unusual events may affect results and not reflect long-term
performance.
I. Concepts review and critical thinking questions
1. Current Ratio [LO2] What effect would the following actions have on a firm’s
current ratio? Assume that net working capital is positive.
a. Inventory is purchased.
b. A supplier is paid.
c. A short-term bank loan is repaid.
d. A long-term debt is paid off early.
e. A customer pays off a credit account.
f. Inventory is sold at cost.
g. Inventory is sold for a profit.
Solution:
(a) NWC is unchanged. If inventory is purchased with cash, then there is no change
in the current ratio. If inventory is purchased on credit, then there is a decrease
in the current ratio if it was initially greater than 1.0.
(b) NWC is unchanged. Reducing accounts payable with cash increases the current
ratio if it was initially greater than 1.0.
(c) NWC is unchanged. Reducing short-term debt with cash increases the current
ratio if it was initially greater than 1.0.
(d) NWC and current ratio decrease.
(e) NWC and current ratio are unchanged.
(f) NWC and current ratio are unchanged.
(g) NWC and current ratio increase.
2. Current Ratio and quick ratio [LO2] In recent years, Dixie Co. greatly increased its
current ratio. At the same time, the quick ratio has fallen. What has happened? Has the
liquidity of the company improved?
Solution
The firm has increased its inventory relative to other current assets, assuming that level of
current liabilities mostly remained unchanged. As a result, liquidity has potentially decreased
because inventory is considered the least liquid among current assets.
IV. Questions and problems
1. Calculating Liquidity Ratios [LO2] SDJ, Inc., has net working capital of $2,170,
current liabilities of $4,590, and inventory of $3,860. What is the current ratio?
What is the quick ratio?
Solution
NWC = CA – CL = 2,710
CA = NWC + CL = 2,710 + 4,950 = 7,660
Current ratio = CA/CL = 7,660/4,950 = 1.55
Quick ratio = (CA – Inventory)/CL = (7,660 – 3,860)/4,950 = 0.76
2. Calculating Profitability Ratios [LO2] DTO, Inc., has sales of $16.7 million, total
assets of $12.9 million, and total debt of $5.7 million. If the profit margin is 5
percent, what is net income? What is ROA? What is ROE?
Sales = $16.7 million
Total equity= Total assets - Total debt = 12.9-5.7 =7.2 $
Profit margin = Net Income/Sales = 5%
Net Income (NI) = 5% x 16.7 = $ 0.835 million
ROA = NI/TA =
ROE = NI/TE =
