CHAPTER ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS – PART I I Questions The objective of financial statements analysis is to determine the extent of a firm’s success in attaining its financial goals, namely: a To earn maximum profit b To maintain solvency c To attain stability Some of the indications of satisfactory short-term solvency or working capital position of a business firm: Favorable credit position Satisfactory proportion of cash to the requirements of the current volume Ability to pay current debts in the regular course of business Ability to extend more credit to customers Ability to replenish inventory promptly These tests are: Improvement in the financial position Well-balanced financial structure between borrowed funds and owners’ equity Effective employment of borrowed funds and owners’ equity Ability to declare satisfactory amount of dividends to stockholders Ability to withstand adverse business conditions Ability to engage in research and development in an attempt to provide new products or improve old products, method or processes Some indicators of managerial efficiency are: Ability to earn a reasonable return on its investment of borrowed funds and owners’ equity Ability to control operating costs within reasonable limits No overinvestment in fixed assets, receivables and inventories The techniques used in Financial Statement Analysis are: I Vertical analysis which shows the relationships of the items in the same year: also referred to as “static measure.” 3-2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations a b Financial ratios Common-size statements II Horizontal analysis which shows the changes or tendencies of an item for or more years; also referred to as “dynamic measure.” a Comparative statements - showing changes in absolute amount and percentages b Trend percentages III Use of special reports or statements a Statements of Changes in Financial Position b Gross Profit / Net Income Variation Analysis Horizontal analysis involves the comparison of items on financial statements between years Analysis of comparative financial statements or the increase/decrease method of analysis and trend percentages are the two techniques that may be applied under horizontal analysis Vertical analysis involves the study of items on a single statement for a single year, such as the analysis of an income statement for some given year Common-size statement and financial ratios are techniques used in vertical analysis II Practical Problems PROBLEM Total Current Working Assets Capital Food is sold for cash Equipment is sold at less than its net book value Beverages are sold on account A cash dividend is declared Accrued payroll is paid Treasury stock is purchased A fully depreciated fixed asset is retired Current Ratio + + + + + + + + + – – – + – – – 0 Comments Food is assumed to have been sold at a profit Cash is increased Assumption: Beverage sold at a profit Assumption: No payment yet but liability is set up Analysis and Interpretation of Financial Statements – Part I Equipment is purchased with longterm notes Utility expenses are paid (they were not previously accrued) 10 A cash dividend is paid 0 – – – – + 3-3 Assumption: Current liability was set up when dividends were declared PROBLEM Requirement 1: XYZ Corporation Balance Sheet As of December 31 Change Peso 2000 Assets Cash and equivalents Receivables Inventories Prepayments and others Total Current Assets Property, Plant & Equipment - net of depreciation Total Assets % 2001 14,000 28,800 54,000 4,800 101,600 16,000 55,600 85,600 7,400 164,600 2,000 26,800 31,600 2,600 63,000 14.29% 93.06% 58.52% 54.17% 62.01% 30,200 131,800 73,400 238,000 43,200 106,200 143.05% 80.58% 54,000 55,400 6,800 7,000 123,200 44,600 70,200 44,000 23,800 2,600 1,200 71,600 34,600 440.00% 73.32% 61.90% 20.69% 138.76% 0.00% 97.19% 114,800 34,600 43.14% 238,000 106,200 80.58% Liabilities and Stockholders’ Equity Notes payable to banks 10,000 Accounts payable 31,600 Accrued liabilities 4,200 Income taxes payable 5,800 Total current liabilities 51,600 Capital stock 44,600 Retained earnings 35,600 Total shareholders’ equity 80,200 Total liabilities and shareholders’ equity 131,800 3-4 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations XYZ Corporation Income Statement Years ended December 31 (P thousands) Change Peso Net sales Cost of goods sold Gross profit Selling, general and administrative expenses Income before income taxes Income taxes Net Income % 2000 266,400 191,400 75,000 2001 424,000 314,600 109,400 157,600 123,200 34,400 59.16% 64.37% 45.87% 35,500 39,500 12,300 27,200 58,400 51,000 16,400 34,600 22,900 11,500 4,100 7,400 64.51% 29.11% 33.33% 27.21% Requirement 2: Short-term financial position Current Assets  62.01%  Current Liabilities  138.76%  Unfavorable Quick Assets  62.40%  Current Liabilities  138.76%  Unfavorable Net Sales  59.16%  Accounts Receivable  93.06%  Unfavorable Cost of Goods Sold  64.37%  Inventories  58.52%  Total Liabilities  138.76%  Total Stockholders’ Equity  43.14%  Cost of Goods Sold  64.37%  Favorable Leverage Total Assets  80.58%  Unfavorable Total Liabilities  138.76%  Unfavorable Profitability Net Sales  59.16%  Unfavorable Analysis and Interpretation of Financial Statements – Part I 3-5  Selling, general & administrative expenses  64.51%  Net Income  27.21%  Total Assets  80.58% STATEMENT OF INCOME Revenues Cost of goods sold Other expenses Income before income taxes Income taxes (36.95% in 20x3) Net income 20x3 20x2 (Thousands) P94,749 (k) P 88,412 74,564 65,586 (a) 15,839 13,564 4,346 9,262 1,606 (l) 1,581 P 2,740 P 7,681 (b) (m) Net Sales Net Sales  59.16%  Unfavorable  59.16%  Unfavorable 10 Net Income  27.21%  Unfavorable PROBLEM Requirement STATEMENT OF RETAINED EARNINGS Beginning balance P 1,851 (n) Net income 2,740 (o) Dividends (559) Ending balance P 4,032 (p) BALANCE SHEET Assets: Cash Property, plant, and equipment Other assets Total assets Liabilities: Current liabilities Long-term debt and other liabilities Total liabilities Shareholders’ Equity: Common stock Retained earnings Other shareholders’ equity P 9,987 7,681 (c) (455) P 17,213 (d) P 45 (q) 23,894 3,240 (r) P 27,179 (s) P P 11,454 (t) 11,331 22,785 P 9,973 10,120 20,093 (f) P P 229 4,032 (u) 133 45 (e) 20,874 16,900 P 37,819 230 17,213 (g) 283 3-6 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations Total shareholders’ equity Total liabilities and shareholders’ equity STATEMENT OF CASH FLOWS Net cash provided by operating activities Net cash used in investing activities Net cash provided by financing activities Increase (decrease) in cash Cash at beginning of year Cash at end of year 4,394 (v) P 27,179 (w) 17,726 P 37,819 (h) P 2,383 (x) (3,332) 987 38 45 (y) P 83 (z) P 2,906 (3,792) 911 25 (i) 20 P 45 (j) Requirement a Operations deteriorated in 20x3 as indicated by the following: Higher percentage of cost of sales to sales (20x2 – 74.18%) (20x3 – 78.70%) Other expenses likewise increased as a percentage of sales in 20x3 Tax rate significantly increased from 17.07% in 20x2 to 36.95% in 20x3 Decline in total assets Increase in liabilities as a percentage of total assets (20x2 – 53.13%) (20x3 – 83.83%) b The company had increased dividend payment despite the decline in profit c Total resources or assets, end of 20x3 – P27,179 Total resources or assets, end of 20x2 – P37,819 d Total liabilities, end of 20x2 – P20,093 Total liabilities, end of 20x3 – P22,785 e Major sources of cash in both 20x3 and 20x2 were from operations and financing Cash from operations had declined while cash from financing activities increased This is not favorable The company had been using most its cash in investing activities, particularly for the purchase of property and equipment PROBLEM Requirement (1) Paid rooms occupied Rooms available * = No of guest rooms Out-of-order Comped for valid business reasons Comped to friends of management 5,000 5,820* = 200 (2) (2) (2) 85.9% Analysis and Interpretation of Financial Statements – Part I 194 Requirement (2) Rooms occupied by or more guests Rooms occupied by guests = 3,200 5,000 + = 3,200 5,004 3-7 rooms x 30 days = 5,820 rooms available = 63.95% PROBLEM Beginning food inventory Add: Food purchases P 4,500 20,500 P25,000 4,000 P21,000 Less: Ending food inventory Less: Employee Meals Cost Food transfers to the beverage dept Net Food Cost Net Food Cost Sales = P20,500 P60,000 P 400 100 = 500 P20,500 34.17% PROBLEM Requirement (1) Current Assets Cash Credit card receivables Accounts receivable Food inventories Beverage inventories Prepaid expenses Total Current Assets Year P12,800 2,800 420 4,280 1,850 1,400 P23,550 Year P14,720 3,360 100 4,366 1,702 1,610 P25,858 Change Peso Percentage P1,920 15.00% 560 20.00% (320) (76.20%) 86 2.00% (148) ( 8.00%) 210 15.00% P2,308 9.80% Requirement (2) Except for Food inventories and Beverage inventories, all other current assets changed by more than 10%, the most notable of which is accounts receivable which decreased by 76.20% The decrease in accounts receivable accompanied by increase 3-8 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations in Cash and Credit card receivables could indicate the change in company’s policy of reducing sales open account which may result to a more favorable liquidity position PROBLEM Foxtail Hotel Comparative Income Statement Years Ended December 31, 2002 and 2003 Total revenue Expenses: Cost of goods sold Selling and general expenses Interest expense Income tax expense Total expenses Net income Change Peso Percentage P(37,000) ( 9.00)% 2002 P410,000 2003 P373,000 P202,000 P188,000 (14,000) ( 6.90)% 98,000 7,000 42,000 349,000 P 61,000 93,000 4,000 37,000 322,000 P 51,000 (5,000) (3,000) (5,000) (27,000) P(10,000) ( 5.10)% (42.90)% (11.90)% (7.70)% (16.40)% Net income decreased by a higher percentage than total revenues in 2003 because cost of goods sold and selling and general expenses decreased by a lower percentage than revenues, thus, decreasing the profit margin Favorable change could be observed in interest expense which decreased by 42.9% and income tax expense by 11.9% PROBLEM Rainee Restaurant Common-size Balance Sheet December 31, 2003 Common-size Percentages Assets Total current assets Long-term investments Property, plant and equipment, net Total assets P 72,000 35,000 217,000 P324,000 22.22% 10.80% 66.98% 100.00% Liabilities Total current liabilities Long-term debt Total liabilities P 58,000 118,000 P176,000 17.90% 36.42% 54.32% Analysis and Interpretation of Financial Statements – Part I Stockholders’ Equity Total stockholders’ equity Total liabilities and stockholders’ equity PROBLEM 148,000 P324,000 3-9 45.68% 100.00% Requirement (1) Common-size Income Statement Year Ended December 31, 2003 Net Sales Cost of goods sold Gross profit Operating expenses Operating income Other expenses Net income Francisco Hotel 100.0% 63.6 36.4 20.9 15.5 0.6 14.9% Industry Average 100.0% 65.8 34.2 19.7 14.5 0.4 14.1% Common-size Balance Sheet December 31, 2003 Current assets Fixed assets, net Intangible assets, net Other assets Total Francisco Hotel 77.8% 16.4 0.9 4.9 100.0% Current liabilities Long-term liabilities Stockholders’ equity Total Industry Average 70.9% 23.6 0.8 4.7 100.0% 46.0% 13.8 40.2 100.0% 48.1% 16.6 35.3 100.0% Requirement (2) (a) Ratio of gross profit to net sales (b) Ratio of operating income to net sales (c) Ratio of net income to net sales = = = 36.4% 15.5% 14.9% > > > 34.2% 14.5% 14.1% Francisco’s profit performance is better than the industry average in year 2003 Requirement (3) (a) Ratio of current assets to total assets = (b) Ratio of stockholders’ equity to total assets = 77.8% 40.2% > > 70.9% 35.3% 3-10 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations Francisco’s financial position is better than the industry averages PROBLEM 10 Cash Credit card receivables Food inventories Beverage inventories Total current assets July P 8,880 1,240 4,480 2,220 P16,820 August P 7,104 1,984 6,272 1,887 P17,247 Change Peso Percentage P(1,776) (20.00%) 744 60.00% 1,792 40.00% (333) (15.00%) P 427 2.50% August P 7,104 1,984 6,272 1,887 P17,247 Common-size Percentages July August 52.80% 41.19% 7.37% 11.50% 26.63% 36.37% 13.20% 10.94% 100.00% 100.00% PROBLEM 11 Cash Credit card receivables Food inventories Beverage inventories Total current assets July P 8,880 1,240 4,480 2,220 P16,820 PROBLEM 12 Year Ave Rm Rate P480 440 530 Index 100.00 91.69 110.42 PROBLEM 13 Dining Room Bar-Lounge Sales Revenue P128,880 P 66,586 Guests 9,206 5,202 Ave Check P14.00 P12.80 PROBLEM 14 Sales revenue Cost of sales revenue Gross margin Direct costs Contributory income Indirect costs Operating income Year 2003 P 23,502 9,208 P 14,294 10,202 P 4,092 2,477 P 1,615 Year 2004 P 24,612 9,438 P 15,174 11,622 P 3,552 2,403 P 1,149 Changes  Pesos + 1,110 + + 230 + + 880 + + 1,420 + – 540 – – 74 – – 466 – % 4.7% 2.5% 6.0% 13.9% 13.2% 3.0% 28.9% Analysis and Interpretation of Financial Statements – Part I 3-11 Operating income decreased inspite of the increase in sales because of the substantial increase in direct costs PROBLEM 15 Sales revenue Cost of sales Gross margin Operating expenses Operating income Condensed Income Statement P480,000 201,600 P278,400 206,400 P 72,000 100% 42% 58% 43% 15% PROBLEM 16 ASSETS Current Assets Cash Credit card receivables Accounts receivable Vending inventories Prepaid expenses Total Current Assets Property, Plant & Equipment Land Building Furnishings Equipment Accumulated depreciation Glassware, linen inventories Total Property & Equipment (net) Total Assets Year 2003 Year 2004 Peso Changes Percent P 11,300 3,900 11,700 7,800 3,900 P 38,600 P 15,400 6,300 18,900 8,400 4,100 P 53,100 P 4,100 2,400 7,200 600 200 P 14,500 36.28% 61.54% 61.54% 7.69% 5.13% 37.56% P 81,200 758,100 83,712 90,688 (315,500) P 81,200 795,300 93,412 90,688 (335,800) 37,200 9,700 20,300 4.91% 11.59% 6.43% 12,200 15,300 3,100 25.41% P710,400 P749,000 P740,100 P793,200 29,700 P 44,200 4.18% 5.90% P 9,100 4,200 12,400 P 12,200 4,900 15,500 3,100 700 3,100 34.07% 16.67% 25.00% 13,600 11,200 (2,400) (17.65%) LIABILITIES & STOCKHOLDERS’ EQUITY Current Liabilities Accounts Payable Accrued Expenses Payable Taxes Payable Current Portion, Mortgage Payable 3-12 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations Total Current Liabilities Long-term Liabilities Mortgage Payable Total Liabilities Stockholders’ Equity Capital Stock Retained Earnings Total Stockholders’ Equity Total Liabilities & Stockholders’ Equity P 39,300 P 43,800 4,500 11.45% 423,500 P462,800 412,300 P456,100 (11,200) (6,700) (2.64%) (1.45%) P125,200 161,000 P145,200 191,900 20,000 30,900 15.97% 19.19% P286,200 P337,100 50,900 17.78% P749,000 P793,200 P 44,200 5.90% Significant increases could be observed in Cash, Credit card receivables and Accounts receivable The increase in receivable could be due to the company’s change in policy in granting credit and an indication of inefficiency in the collection of receivables Furnishings and glassware, linen inventories likewise showed significant increases This can be viewed favorably because restaurants should keep up with the demands of new atmosphere as well as provide for the normal wear and tear of their supplies Total liabilities declined a little but with significant increases in accounts payable, accrued expenses payable and taxes payable The company should exercise care in increasing more liabilities that it can handle The increase in stockholders’ equity accompanied by a decrease in total liabilities can be viewed favorably because it indicates strengthening of the company’s financial position This could also mean a) lesser reliance on borrowed capital, b) infusion of equity capital, and c) profitable operations as reflected in the increase in retained earnings PROBLEM 17 “A” Sales Revenue Cost of Sales Gross margin Direct Costs Wages Expense Supplies Expense Other Direct Costs Contributory Income Indirect Costs “B” 100% 39% 61% 30% 8% 3% 41% 20% 100% 38% 62% 34% 8% 3% 45% 17% Analysis and Interpretation of Financial Statements – Part I Rent Expense Insurance Expense Other Indirect Expenses Operating Income 4% 1% 2% 7% 13% 3-13 4% 2% 2% 8% 9% While “B” reports higher revenue, “A” has been more profitable for two main reasons: Direct costs as a percentage of revenue is only 41% as against 45% of B Indirect costs is also lower by 1% in A as compared with B “B” however has an advantage over “A” as far as cost of sales is concerned In conclusion, “B” should try to control their operating expenses, direct and indirect, to realize higher profit  ... liabilities and shareholders’ equity 131,800 3-4 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations XYZ Corporation Income Statement Years ended December 31 (P thousands)... 9,973 10,120 20,093 (f) P P 229 4 ,032 (u) 133 45 (e) 20,874 16,900 P 37,819 230 17,213 (g) 283 3-6 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations Total shareholders’... in accounts receivable accompanied by increase 3-8 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations in Cash and Credit card receivables could indicate the change