Question

What would you say about a business that had the following Balance Sheet and Income Statement:

Balance Sheet

Cash $2000

Inventory $2500

Accounts Receivable $8000

Property, Plant, Equipment $30,000

Land $30,000

Total Assets $72,500

Liabilities

Accounts Payable $1,000

Notes Payable $9,000

Long-Term Debt $45,000

Total Liabilities $55,000

Equity $17,500

Income Statement

Revenues $11000

Cost of Goods Sold $2000

Selling Expenses $1000

Other Expenses $2000

Be sure to mention at least one important element of the Balance Sheet, one important element of the Income Statement, and one important element for how the two interact both now and in the future if the Income Statement is repeated again in the next time period.

Answer 1

From the following points i can make the following conclusions about the business

1) The busness is making a net profit. Also the business is making strong operating profit suggesting that the company is doing well in its operations. With restrictions on cost the company is doing well on EPs parameter. (EPS=earning per share) . Here Net income is $6000. While operating profit is $8000. Net profit margin is 54.54% and operating profit margin is 72.72%.

The business would command high PE because of its strong performance. If listed the price would shoot up.

2) Assuming dividends is $0 and entire amount is reinvested into business the reserves and surplus will be $6000. So total equity is $23,500

The business is leveraged with D/E more than 1. It has high financial leverage. The business carries a high rate of default risk if not serviced its loan in timely manner. The long term liability is huge and total shareholder equity is less. When the business would want to refinance its existing loan it might have to pay higher interest rate as the business does not have sufficient reserves and surplus and also there is no long term investments in securities like equities or bonds which they sell and clear the dues. If not paid the debt holders will have a claim on the assets of the business.

3) The current ratio and quick ratio is more than 1 indicating the business does not have liquidity problems in short run. The working capital is positive. Hence there are no short term liabilities.

4) The account receivalbe as a percentage of sales is more than 50% indicating aggressive selling by the company. Whether that account receivables will be recovered or not the company has to estimate that. In future there could be some provisions on doubtful assets.

5) The cash flow from operations is quite less because of aggressive selling practices.

6) The business has less COGS, selling expenses and other expenses because the ending invesntory is high indicating that the business has done aggressive selling to some of its related parties.

PART B

Let me take an example of Depreciation and Plant, Property & Equipment (PP&E). Every year the asset (PP&E) value is reduced by an amount shown as depreciation expense in Income statement. Depreciation expense is non cash charge but it relates to wear & tear of the asset. The asset value will be depreciated over the useful life and at the end of its useful life the asset will be sold at salvalge value. This happens bacause the asset value wiill not work efficiently every year. The output from the asset in the first year will be high. Slowly & slowly the efficiencies reduces. The depreciation amount accumulated is shown as accumulated depreciation in Balance Sheet.

Depreciation= (Value of asset- Salvage value)/Number of useful years

Depreciation will be there in every income statement till the time the PP&E is there in balance sheet.