Unit 2 Financial Statement Analysis Exercises

Complete these exercises and problems and then check your work.


The income statement captures a company’s performance over time while the balance sheet captures its status at a point in time. What does this mean?


A company has $100 million in total assets and $40 million in equity. How much does it have in total liabilities?


How does depreciation create a difference between earnings and cash flows? Are there any other ways/reasons in which accounting earnings can be different from cash flows?


What types of people use ratio analysis? Who might be most interested in liquidity ratios? asset management ratios? debt management ratios? profitability ratios? market value ratios?


Company A has a ROA of 8% and a ROE of 12%. Company B has a ROA of 7% and an ROE of 15%. What does this tell us about the relative levels of debt financing between these two companies? Which company’s approach is better?


Company A tends to have most of its sales in the fourth quarter and does a large percentage of sales on a credit basis. Company B also sells primarily on credit, but most of its sales come in the first and second quarter. An analyst looks at their DSO ratio from the annual balance sheet and income statement and notices that company A has a much higher DSO outstanding. The analyst concludes that Company A is doing a poor job of managing its accounts receivable. Is the analyst correct? Explain? Which company would likely have a higher inventory turnover ratio and why?


Which statements are subject to seasonality?

A) Quarterly Income Statement
B) Annual Income Statement
C) Quarterly Balance Sheet
D) Annual Balance Sheet


Company A has a Profit Margin of 3% while company B has a Profit Margin of 8%. This tells us that company B is outperforming company A. Is this statement true or false and explain your answer?


What do we mean by trend analysis and comparative analysis? Why are these tools more useful than looking at the ratios for a single period in isolation?


Identify at least one potential problem with trend analysis and one potential problem with comparative analysis.


Why might a very low quick ratio be a cause for concern? How about a large quick ratio?


From the perspective of management, what is the primary objective of financial statement analysis? What are some difficulties management might encounter in doing a complete financial statement analysis? Re-examine these two questions from the perspective of the stockholder.


Using the Financial Statements for Joe’s Gadgets in Appendix B, find the following ratios for both 2016 and 2017

1a. Current ratio
1b. Quick ratio (Acid Test)
1c. Inventory Turnover Ratio
1d. Days Sales Outstanding (Average Collection Period)
1e. Fixed Assets Turnover
1f. Total Assets Turnover
1g. Total Debt to Total Assets (Debt Ratio)
1h. Total Debt to Equity
1i. Times Interest Earned
1j. Gross Profit Margin
1k. Net Profit Margin
1l. Return on Assets
1m. Return on Equity
1n. Price Earnings Ratio
1o. Market-to-Book Ratio
1p. Dividend Yield


Using the Financial Statements for Joe’s Gadgets in Appendix B, prepare common size income statements and balance sheets for 2016 & 2017.


Use the following industry average ratios for 2017 and your answers to Problem 1 and Problem 2 to highlight any strengths and weaknesses for Joe’s Gadgets.

3a. Current ratio 1.75
3b. Quick ratio 1.00
3c. Inventory Turnover Ratio 4.75
3d. Days Sales Outstanding 50.0
3e. Fixed Assets Turnover 1.30
3f. Total Assets Turnover 0.50
3g. Total Debt to Total Assets 0.55
3h. Total Debt to Equity 1.22
3i. Times Interest Earned 3.25
3j. Gross Profit Margin 46.53%
3k. Net Profit Margin 4.88%
3l. Return on Assets 4.17%
3m. Return on Equity 12.02%
3n. Price Earnings Ratio 24.15
3o. Market-to-Book Ratio 3.98
3p. Dividend Yield 1.99%


Firm A reports a Profit Margin of 5% and a Total Asset Turnover Ratio of 1.5. Their total asset level is $6,000,000. Assume there are 600,000 shares outstanding and the PE ratio is 13. Also, assume the Return on Equity is 14%. Based on this, calculate the MV/BV ratio. Hint 1: Use (Net Income)/(Shares Outstanding) to get Earnings Per Share. Hint 2: Think of how you can use data provided and ratio formulas to fill in missing values to ultimately get the MV/BV ratio – it will take several steps.

Source: Dr. Kevin Bracker, https://businessfinanceessentials.pressbooks.com/chapter/chapter-2-financial-statement-analysis-2/
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