ACTG 212: Principles of Accounting II Financial Analysis Project Michael Masters

Question

ACTG 212: Principles of Accounting II

Financial Analysis Project

Michael Masterson has brought you a set of financial statements of a company that he is considering investing in as a long-term investment. He is asking for your help in determining if the company would be a good investment for him.

Using the attached financial statements, you need to create a vertical analysis as percentage of Total Assets for the Balance Sheet and as a percentage of Sales for the Income Statement, as well as a horizontal analysis of the Balance Sheet and Income Statement. Complete this for both years. In addition to the vertical and horizontal analysis, you need to calculate the following ratios:

Liquidity & Efficiency:

Current Ratio

Acid-Test Ratio

Receivables Turnover & Days’ Sales Uncollected

Inventory Turnover & Days’ sales in Inventory

Solvency

Debt Ratio

Equity Ratio

Debt to Equity Ratio

Profitability

Profit Margin Ratio

Gross Margin Ratio

Return on Total Assets (ROA)

Return on Equity (ROE)

This information then needs to be incorporated into a written memo to Michael Masterson. Be sure to include the following information in your memo.

Introductory Paragraph – This paragraph will be an introduction to your analysis. In this paragraph, explain the importance of analyzing financial statements before investing in a company. Be sure to answer the following questions in your introduction:

1. What is the purpose of creating a vertical analysis and why is it useful in analyzing a potential investment?

2. What is the purpose of creating a horizontal analysis and why is it useful in analyzing a potential investment?

3. Overall, what do each of the three sections of ratios (Profitability, Liquidity & Solvency) tell a person about a company?

Explanation / Answer

Introduction: Long term investments are more linked with fundemental view than technical view. So whenever you are taking any investment call from a long period horizon, you must analyse company Balance sheet and Income statement.

Vertical Analysis: Vertical analysis can be very useful indicator of company efficiency. You can get an estimate of Gross profit percentage, expenes mix and revenue as percentage of cost of goods sold.

Horizontal Analysis: It tells you the incremental improvement in performance of company over the years.

No attachment attached. Writing formulas for Ratio:

Current Ratio= Current Assests/Current Liabilities

Acid-Test Ratio= (Cash+Accounts Receivables+Short Term investments)/Current Liabilities

Receivables Turnover & Days’ Sales Uncollected=

Inventory Turnover & Days’ sales in Inventory= (Ending Inventory/Cost of Goods Sold)*365

Solvency

Debt Ratio= Total Liabilities/Total Assets

Equity Ratio= Total Equity/ Total Assets

Debt to Equity Ratio= Total Liabilities/ Total Shareholders equity

Profitability

Profit Margin Ratio= Net Income/Net Sales

Gross Margin Ratio= Gross Margin/Net Sales

Return on Total Assets (ROA)= Annual Net Income/ Total Assets

Return on Equity (ROE)= Net Income/Shareholders Equity

Profitability, Liquidity and Solvency Ratios are important:

Profitabilty Ratio: It tells you how well the company is performing. A high profitable company will be able to generate high Cash Flows. These sort of companies tend to have high valuations due to cash generation abilities.

Liquidity Ratio: This tells if the company can fulfill its short term obligations. A comfortable liquidity ratio is important for company long term performance.

Solvency Ratio: This tells if the company can fulfill its short term and long term obligations. Companies with high debts and capital intensive industries this ratio is very imporatnt to consider.

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