Question

After investigating the different forms of business organization, Natalie Koebel decides to operate her business as a corporation, Cookie Creations Inc., and she begins the process of getting her business running.

While at a trade show, Natalie is introduced to Gerry Richards, operations manager of “Biscuits,” a national food retailer. After much discussion, Gerry asks Natalie to consider being Biscuits’ major supplier of oatmeal chocolate chip cookies. He provides Natalie with the most recent copy of the financial statements of Biscuits. He expects that Natalie will need to supply Biscuits’ Watertown warehouse with approximately 1,500 dozen cookies a week. Natalie is to send Biscuits a monthly invoice, and she will be paid approximately 30 days from the date the invoice is received in Biscuits’ Chicago office.

Natalie is thrilled with the offer. However, she has recently read in the newspaper that Biscuits has a reputation for selling cookies and donuts with high amounts of sugar and fat, and as a result, consumer demand for the company’s products has decreased.

Instructions

Natalie has several questions. Answer the following questions for Natalie.

(a) What type of information does each financial statement provide?

(b) What financial statements would Natalie need in order to evaluate whether Biscuits will have enough cash to meet its current liabilities? Explain what to look for.

(c) What financial statements would Natalie need in order to evaluate whether Biscuits will be able to survive over a long period of time? Explain what to look for.

(d) What financial statement would Natalie need in order to evaluate Biscuits’ profitability? Explain what to look for.

(e) Where can Natalie find out whether Biscuits has outstanding debt? How can Natalie determine whether Biscuits would be able to meet its interest and debt payments on any debts it has?

(f)   How could Natalie determine whether Biscuits pays a dividend?

(g) In deciding whether to go ahead with this opportunity, are there other areas of concern that Natalie should be aware of?

Answer 1

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(a) What type of information does each financial statement provide?

The different types of statements are; income statement, balance sheet, retained earnings statement, and a statement of cash flow. An income statement measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year. A balance sheet summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. A statement of earnings retained is a financial statement outlining the changes in retained earnings for a specified period. The statement of retained earnings is prepared in accordance with generally accepted accounting principles. The statement of retained earnings reconciles the beginning and ending retained earnings for the period, using information such as net income from the other financial statements. A cash flow statement is one of the quarterly financial reports any publicly traded company is required to disclose to the SEC and the public. The document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter

(b) What financial statements would Natalie need in order to evaluate whether Biscuits will have enough cash to meet its current liabilities? Explain what to look for.

Natalie would need to study the balance sheet of “Biscuits” to see if their income will meet or exceed their liabilities. A balance sheet allows you to do a side-by-side comparison of the revenue and liabilities of a company. It's called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has (assets) by either borrowing money (liabilities) or getting it from shareholders (shareholders' equity). Each of the three segments of the balance sheet will have many accounts within it that document the value of each. Accounts such as cash, inventory and property are on the asset side of the balance sheet, while on the liability side there are accounts such as accounts payable or long-term debt. The exact accounts on a balance sheet will differ by company and by industry, as there is no one set template that accurately accommodates for the differences between different types of businesses.

(c) What financial statement would Natalie need in order to evaluate whether Biscuits will be able to survive over a long period of time? Explain what to look for.

Natalie could look at a cash flow statement to determine the longevity possibilities of Biscuits. This statement would give her a view of the companies operating activities along with its investing and financing activities. If the company does not have a negative operating cost and has properly invested then Natalie could surmise that Biscuits could remain profitable for a time to come.

(d) What financial statement would Natalie need in order to evaluate Biscuits’ profitability? Explain what to look for.

To analyze Biscuits profitability Natalie would need to look at the balance sheet and specifically focus on the ratio analysis that can be performed with the balance sheet. The main types of ratios that use information from the balance sheet are financial strength ratios and activity ratios. Financial strength ratios, such as the working capital and debt-to-equity ratios, provide information on how well the company can meet its obligations and how they are leveraged. This can give investors an idea of how financially stable the company is and how the company finances itself. Activity ratios focus mainly on current accounts to show how well the company manages its operating cycle; which include receivables, inventory and payables. These ratios can provide insight into the company's operational efficiency.

(e) Where can Natalie find out whether Biscuits has outstanding debt? How can Natalie determine whether Biscuit would be able to meet its interest and debt payments on any debts it has?

Natalie would need to look at the cash flow statement to find out if Biscuits has outstanding debts. Because public companies tend to use accrual accounting, the income statements they release each quarter may not necessarily reflect changes in their cash positions. For example, if a company lands a major contract, this contract would be recognized as revenue and therefore income, but the company may not yet actually receive the cash from the contract until a later date. While the company may be earning a profit in the eyes of accountants and paying income taxes on it, the company may, during the quarter, actually end up with less cash than when it started the quarter. Even profitable companies can fail to adequately manage their cash flow, which is why the cash flow statement is important: it helps investors see if a company is having trouble with cash.

(f) How could Natalie determine whether Biscuits pays a dividend?

Natalie could look at Biscuits retained income statement to determine if dividends are paid out and how much is paid out or retained for the company to reinvest. In most cases, companies retain their earnings in order to invest them into areas where the company can create growth opportunities, such as buying new machinery or spending the money on more research and development. Should a net loss be greater than beginning retained earnings, retained earnings can become negative, creating a deficit. The retained earnings general ledger account is adjusted every time a journal entry is made to an income or expenses account.

(g) In deciding whether to go ahead with this opportunity, are there other areas of concern that she should be aware of?

If Natalie fully reviews Biscuits complete operating performance, financial position, and cash flows she should be able to make an informed decision about joining the company.