Question

On Jan 1 ’07 SSS buys 100 US Treasury Bonds (face value $1000 each) for the Trading Portfolio.   The bonds carry an annual interest coupon of 4% paid semiannually Jan 1 and July 1. Journalize the purchase.

On July 1 the bonds pay interest. Journalize the receipt of the interest payment.

On Aug 1, SSS sells 50 of the bonds at 98

On December 31 SSS makes an adjusting entry for accrual of interest to be received January 1 2008. Show the adjustment for the accrual of interest.

On Dec 31, the bonds are trading at 97.   What fair value adjustment, if any, needs to be made?

How will the bonds be shown on the Balance Sheet?

On January 1, 2008 SSS buys 500 shares of Co common stock for $50/share for the stock portfolio as short-term investment.   SSS’s purchase represents 1% of outstanding Co stock and the company exerts no influence on Co. Journalize the purchase by SSS.

On February 1 Co pays a $1/share dividend. Journalize SSS’s receipt of the dividend.

On Feb 15, Co reports $1mm net income. What JE does the company make, if any, to recognize the income?

On March 1 SSS decides to sell 250 shares of its Co stock for $45/share. Journalize SSS’s sale of Co stock.

Fast forward to December 31, 2008: The price of Co shares is $49/share. What fair market adjustment does SSS make, if any?

How will this stock investment be presented on the balance sheet?

Jan 1, SSS buys 60,000 shares of Inc at $20/share as a long-term investment in the stock portfolio. The purchase represents 25% of all outstanding Inc stock and SSS has representation on Inc’s board of directors. Journalize the purchase.

On June 31, 2008 Inc reports net income of $20,000 for its fiscal year ended June 31. Make the journal entry for SSS.

On October 1, Inc pays a $1/share cash dividend. Journalize SSS’s receipt of this dividend.

On Dec 31, Inc shares are trading $18/share. What fair value adjustment, if any, needs to be made?

How will this stock be represented on the SSS balance sheet?

Assume the following asset and liability values represent the average values over the year. Also assume all sales are on credit.

Account                     

Cash                            $125,000                    

Accounts Receivable $175,000                    

Inventory                    $125,000                    

Property, Plant

   & Equipment           $200,000                    

Current Liabilities      $325,000                    

Long-term Liabilities $275,000                   

Stockholders’ Equity $25,000                                

Total Sales Revenue   $800,000                 

Total Expense             $600,000 (includes $250,000 COGS)    

Outstanding Shares       100,000

Price per Share              $50/shr        

What is the Current Ratio?

What is the Acid Test or Quick Ratio?

When would Acid Test Ratio be a better measure of liquidity compared to Current Ratio?

How is Vertical Analysis calculated and what does it communicate

What is the company’s AR Turnover

Inventory Turnover?

Days in Inventory?

what is the company’s profit margin?

what is the company’s Return on Assets?

Return on EQ?

           

            What is another way to calculate ROE?

            What is the stock’s P/E ratio?

            Why would one company have a higher P/E ratio than another?

What is the company’s Debt Ratio?

What is most important to a Short Term Creditor?

What is most important to Owners?

What the basic types of Financial Analysis?

Answer 1

(A) CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES

= (cash + accounts receivable + inventory ) / current liabilities

= ( $125,000 + $175,000 + $125,000) / $ 325,000

= $425,000/ $325,000

= 1.3 times

It means that for every 1 dollar that the firm owes its creditors, it is owed 1.3 by its debtors. Current ratio is a liquidity ratio that shows a firms ability to pay off its short term obligations(that are due within a year).

(B) QUICK RATIO OR ACID TEST RATIO = QUICK ASSETS / CURRENT LIABILITIES

= (cash + accounts receivable) / current liablities

= ( $125,000 + $175,000 ) / $325,000

= $300,000 / $325,000

= 0.92 times

This liquidity ratio measures if the firm has the ability to immediately pay off its short term liabilities. Ideally a ratio of 1:1 or higher is acceptable.

(C) Quick ratio only considers the most liquid assets, It tells us how well the firm can actually meet its short-term obligations even when there is no sales or that without having to sell any of its inventories. It reflects how profitable the firm is. The quick pace at which the cash flows to a firm is also identified.

(D) Vertical analysis is a method by which the financial statements of a firm are analysed in which the item in every line is written as a percentage of a base amount/figure; total figure in case of a balance sheet and sales figure in case of a profit and loss account. It communicates the trends in the data. For example, what % of cost of goods sold is the sales, or what % of current assets are there. Analysis of trend is an important aspect to track the progress of business and implement control wherever necessary.

(E) ACCOUNTS RECEIVABLES TURNOVER RATIO

= NET CREDIT SALES / AVERAGE ACCOUNTS RECEIVABLE

= $800,000 / $175,000

= 4.5 times

It is an efficiency ratio telling you how quickly the company is collecting or turning over its accounts receivable into cash over a period.

365 / AR RATIO = TURNOVER IN DAYS

365 / 4.5 = 81.11 days

It means customers on average take 81 days to pay their receivables.

(F) INVENTORY TURNOVER RATIO = COST OF GOODS SOLD / AVERAGE INVENTORY

= $250,000 / $125,000

= 2 times

It shows how many times the company has sold or replaced inventory during a period of time. Higher the ratio, the better it is. Low inventory turnover means low sales,overstocking or poor liquidity of its inventory.

(G) INVENTORY TURNOVER IN DAYS = DAYS IN YEAR / INVENTORY TURNOVER RATIO

= 365 / 2

= 182.5 days

It shows that the firm needs 183 days to convert its inventory into sales.

(H) PROFIT MARGIN = GROSS PROFIT / NET SALES * 100

= (NET SALES - COST OF GOODS SOLD ) / NET SALES * 100

= ( $800,000 - $250,000 ) / $800,000 * 100

= $550,000 / $800,000 * 100

= 68.75 %

(I) RETURN ON ASSETS = NET INCOME / TOTAL ASSETS

= ( sales revenue - total expense) / ( cash + accounts receivable + inventory + plant)* 100

= ( $800,000 - $600,000) / ( $125,000 + $175,000 + $125,000 + $200,000) * 100

= $200,000 / $625,000 * 100

= 32%

It shows how the management is using its resources to generate income. ROAs of 5% are generally considered good.

(J) ROE = NET INCOME / SHAREHOLDERS' EQUITY

= $200,000 / $25,000

= 8

(K) ROE can also be calculated by dividing net profits by shareholders average equity. Shareholders' equity can also be calculated as the company's assets minus its debt.

(L) PRICE EARNINGS RATIO = CURRENT STOCK PRICE / EPS(earnings per share)

= $ 50 / (COMPANY'S PROFIT / OUTSTANDING SHARES OF COMMON STOCK)

= $50 / ( $200,000 / 100,000)

= $50 / 2

= 25

It  indicates the amount of dollar that an investor can expect to invest in a company in order to receive one dollar of that company's earnings.

(M) A company with a higher amount of leverage is likely to have a lower P/E value when compared to a firm with fewer debt. But, if they are efficient, the highly leveraged firm will earn higher profits if it is able to manage the risks it had taken.

(N) DEBT RATIO = TOTAL DEBT / TOTAL ASSETS * 100

= $275,000 / $ 625,000 * 100

= 44%

(O) Short term creditors are more interested in liquidity ratios because its shows a company's ability to pay its creditors or short term liabilities. The most common types of liquidity ratios are current ratio, quick ratio and operating cashflow ratio.

(P) From the owner perspective, all the ratios will be important to them with a special attention on financial ratios as these measure the relative magnitude of two selected numerical values taken from the final accounts. The various types of financial ratios are liquidity,leverage,operating/efficiency and returns ratio

(Q) The types of financial analysis are :

• Trend Analysis
• Vertical Analysis
• Hortizontal Analysis
• Solvency Analysis
• Liquidity Analysis
• Varience Analysis
• Sensitivity Analysis