Chapter 4 Inter-Company Evaluation of Financial Statements Copyright © Houghton Mifflin Company. All rights reserved.

5–2Copyright © Houghton Mifflin Company. All rights reserved. Using Classified Financial Statements Information in financial statements may be used to evaluate two important goals of management –Maintaining adequate liquidity –Achieving satisfactory profitability A series of ratios are used to evaluate these two goals

5–3Copyright © Houghton Mifflin Company. All rights reserved. Working Capital (cont’d) Working capital is used to buy inventory, obtain credit, and finance expanded sales Lack of working capital can lead to a company's failure Compute working capital for Shafer Auto Parts Corporation

5–4Copyright © Houghton Mifflin Company. All rights reserved. Average Current Ratio for Selected Industries

5–5Copyright © Houghton Mifflin Company. All rights reserved. Average Profit Margin for Selected Industries

5–6Copyright © Houghton Mifflin Company. All rights reserved. Asset Turnover (cont’d) Compute asset turnover for Shafer Auto Parts Corporation Average total assets is computed by adding total assets at the beginning of the year to total assets at the end of the year and dividing by 2 This means that Shafer produces $1.90 in sales for each $1.00 invested in average total assets

5–7Copyright © Houghton Mifflin Company. All rights reserved. Asset Turnover for Selected Industries

5–8Copyright © Houghton Mifflin Company. All rights reserved. Return on Assets … measures how efficiently a company uses its assets to produce income

5–9Copyright © Houghton Mifflin Company. All rights reserved. Indicates how efficiently the company is using all its assets Indicates income- generating strength of the company’s resources Return on Assets (cont’d) Combines profit margin and asset turnover Return on assets overcomes the limitations of profit margin and asset turnover ratios –Profit margin does not consider the assets necessary to produce income –Asset turnover ratio does not take into account the amount of net income produced

5–10Copyright © Houghton Mifflin Company. All rights reserved. Return on Assets (cont’d) Compute return on assets for Shafer Auto Parts Corporation Average total assets is computed by adding total assets at the beginning of the year to total assets at the end of the year and dividing by 2 This means that for each dollar invested by the owner, Shafer’s assets generate 9.4 cents of net income Or, Difference between 9.4 and 9.5 due to rounding

5–11Copyright © Houghton Mifflin Company. All rights reserved. Return on Assets for Selected Industries

5–12Copyright © Houghton Mifflin Company. All rights reserved. Debt to Equity (cont.) Compute debt to equity for Shafer Auto Parts Corporation A ratio less than 1.0 (or 100%) means that less than half of the company’s assets are financed by creditors and more than half are financed by investors For every 61.4 cents of financing from creditors, $1.00 of financing came from investors

5–13Copyright © Houghton Mifflin Company. All rights reserved. Average Debt to Equity Ratio for Selected Industries

5–14Copyright © Houghton Mifflin Company. All rights reserved. Average stockholders’ equity is computed by adding total stockholders’ equity at the beginning of the year to total stockholders’ equity at the end of the year and dividing by 2 This means that Shafer earned 14.6 cents on every dollar invested by stockholders Return on Equity (cont’d) Compute return on equity for Shafer Auto Parts Corporation

5–15Copyright © Houghton Mifflin Company. All rights reserved. Average Return on Equity for Selected Industries