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Analysis of Financial Statements and Efficiency

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1) Draw a scratch-work Balance Sheet for a company with Assets = 100, and describe the leverage of a company where you decide how much leverage the company has. (For example, 90% borrowing, 10% equity---you choose the leverage.)
If your company makes three (dollars) on the assets of 100 ($3 on $100, etc.); and has to pay out 2% on its liabilities, please tell me what the return on equity is. (Use your equity figure for "average equity".).

2) Give me several reasons why a market might not be "efficient". Are markets perfectly efficient? Why or why not?

3) Why is the analysis that a creditor would do different than one that a stock investor might do?

4) Accounting has traditionally relied on assets being valued at historical cost. More and more, though, "fair value accounting" has come to be accepted. In what ways is fair value accounting an improvement on the historical cost method? What are the pitfalls of employing fair value accounting?

5) Considering DR expenses, CR revenues, and the various asset and liability/equity accounts, discuss three ways that a company might try to boost its earnings by treating expenses or revenues as balance sheet items(or vice versa).

6) Whose responsibility is it to produce the financial reports for a company? What does the auditor actually do? Does the controller have any involvement in certifying to the accuracy of the 10-K? What happens if the controller does not agree with the financials? Do auditors attest to the soundness of internal controls of a company?

7) Why is the distinction between operating income and non-operating income important? What is Comprehensive Income? What is Other Comprehensive Income?

8) If a company constantly reports the same kind of extraordinary items on its financial statement, what impression should that give to the user of the company's financial statements?

9) Why is it important to account for Employee Stock Option programs? What do we call it when we try to figure out what earnings per share would be if all the stock options were exercised?

10) Why are there deferred income taxes? If a company has a deferred tax liability on its books, what does that mean happened? Can a company have both a deferred tax asset and a deferred tax liability?

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Solution Preview


Please see explanations below and the attached Excel chart for calculations.

1) Here we have:

Asset Amount in $ Liabilities and Shareholders' equity Amount in $
Current Asset 20 Current Liabilities 10
Fixed Asset 80 Long term Debt 40
Equity 50
Total 100 Total 100

Here, I used 50% debt and 50% equity. Therefore the debt to equity ratio is 1:1.

The six Ratios:
(i) Quick Ratio: It's a liquidity ratio that helps to find out company's ability to repay its current debt obligation, is calculated by subtracting inventories from the current assets and then dividing by the current liabilities.
(ii) Inventory turnover ratio: It is an asset management ratio that helps to find out whether company is holding excess amount of unproductive inventory or not, is calculated by dividing sales by inventories.
(iii) Debt Ratio: It is a debt management ratio that helps to find out the weight of debt used in the capital structure of the company, is calculated by dividing total debt by total asset.
(iv) Profit Margin on Sales: It's a profitability ratio that helps to find out the cost efficiency of the company by finding out income per dollar of sales generated, is calculated by dividing net income available to shareholders by sales.
(v) Return on Equity: It's a ratio that helps to find out the amount of return generated by using the equity capital, is ...

Solution Summary

The following posting helps with an analysis of financial statements and efficiency.