Financial Management: Vertical, Horizontal, and Ratio Analysis - Assignment Example

November 9, of of Table of Contents Cover page Table of Contents…………………………………………………………. 2 Part I ……………………………………………..……………………….. 3-6 Vertical Analysis ………………………………………..............................6-10 Horizontal Analysis…………………………………………………….….10-13 Ratio Analysis……………………………………………………………...13 References………………………………………………………………….14 Part I 1 Cash 60000 Common Stocks 60000 2 Cash 32000 Bank Loan 32000 3 Truck 12000 Notes payables 2000 Loan payables - truck 10000 4 Office equipment 6000 Cash 6000 5 Office equipment 400 Cash 400 6 Office equipment 3600 Cash 3600 7 Inventory 60000 Cash 60000 8 Cash 340000 Account Receivables 60000 Sales 400000 CGS 240000 Inventory 240000 9 Inventory 200000 Cash 200000 10 Advertising expenses 20000 Cash 20000 11 Rent expense 7200 Utilities expense 4800 Telephone expense 1200 Employee salaries 112000 Cash 125200 12 Loan 3333 Interest expense 699 Cash 4032 13 Loan 8000 Interest expense 4160 Cash 12160 Cash Common Stocks 60000 60000 32000 6000 Bank Loan 400 32000 3600 8000 60000 Bal. 24000 340000 200000 Loan payable – Truck 20000 10000 125200 3333 4032 Bal. 6667 12160 Truck Bal. 608 12000 Office Equipment Notes Payable 6000 2000 400 3600 Bal. 10000 Inventory 60000 Account receivables 240000 60000 200000 Bal. 20000 Advertising expenses 20000 Sales Utilities expense 400000 4800 Rent expense Employee salaries 7200 112000 Telephone expense Interest expense 1200 699 4160 Cost of goods sold Bal. 4859 240000 Projected Income Statement Revenues 400000 Cost of goods sold 240000 Gross Profit 160000 Expenses Interest expense 4859 Telephone expense 1200 Employee salaries 112000 Utilities expense 4800 Rent expense 7200 Advertising expense 20000 Total expenses 150059 Net Income 9941 Projected Balance Sheet Current Assets Cash 608 Account receivables 60000 Inventory 20000 Total current assets 80608 Equipment, machinery Truck 12000 Office equipment 10000 Total equipment, machinery 22000 Total Assets 102608 Liabilities & Stockholders equity Current liabilities Notes payable 2000 Long-term liability Bank Loan 24000 Loan payable – Truck 6667 Total liabilities 32667 Common stocks 60000 Retained earnings 9941 Total equity 102608 The projected income statement of Garden Place showed the company is going to have good profitability during the upcoming year. The projected net income of the company is $9,941. The gross profit of the company is $160,000, while its gross margin is 40%. Gross margin is calculated dividing gross income by total sales. The gross margin is a measure of broad profitability (Garrison & Noreen, 2003). The net margin of the company is 2.48%. Net margin is a measure of the absolute profitability of the company. The net margin ratio is calculated dividing net income by total sales. The return on assets of Garden Place is projected to be 9.68%. Return on assets measures how profitable is a firm in relation to its assets (Investopedia, 2012). The return on equity of Garden Place is projected by be 14.21%. “Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet” (Kennon, 2012). The total assets of the firm are projected to reach $102,608, while its total equity is projected to be $69,941. The current ratio of the company is projected to be 40.34. The firm’s current ratio is outstanding considering the fact that a good current ratio is one that is above the 1.0 threshold. The purpose of the current ratio is to demonstrate the ability of the company to pay off its short term debt (Investorwords, 2012). The formula to calculate current ratio is current assets divided by current liabilities. The debt to equity ratio of the company is 0.47. This financial ratio is used to determine the level of risk and stability of the company (Scott, 2012). The formula to calculate the debt to equity ratio is total debt divided by total equity. The inventory turnover ratio measures how many times the company sold its inventory during a year. Garden Palace has a projected inventory turnover ratio of 12.0 which implies that the company sold its inventory 12 times during the year. The formula to calculate the inventory turnover ratio is cost of good sold divided by average inventory (Kennon, 2012). Part II A vertical analysis of the income statement, balance sheet, and statement of cash flow of company A and company B is illustrated below: Vertical Analysis Net Income Company A Percent of sales 2011 2010 2011 2010 Net sales 514633 465013 100.00% 100.00% Cost of goods sold 490102 434785 95.23% 93.50% Gross profit 24531 30228 4.77% 6.50% Selling, general and administrative expenses 13336 12031 2.59% 2.59% Operating income before impairment 11195 18197 2.18% 3.91% Impairment recovery 0 346 0.00% 0.07% Operating income 11195 18543 2.18% 3.99% Other Income / expenses Change in value derivative liability 896 0 0.17% 0.00% Interest expense -4039 -3997 -0.78% -0.86% Income before income taxes 8052 14546 1.56% 3.13% Income taxes 3091 5401 0.60% 1.16% Net income 4961 9145 0.96% 1.97% Vertical Analysis Balance Sheet Company A 2011 2010 2011 2010 Assets Current assets Cash 4274 1270 0.47% 0.67% Trade account receivables 56504 41174 20.95% 21.66% Inventory 184113 132196 68.26% 69.53% Deferred taxes 3384 2611 1.25% 1.37% Other current assets 11053 8795 4.10% 4.63% Total current assets 259328 186046 96.14% 97.86% Advance to supplier 4479 0 1.66% 0.00% Preferential supply agreement 521 0 0.19% 0.00% Long term financing costs 1360 0 0.50% 0.00% Property and equipment, net 4040 4078 1.50% 2.14% Total assets 269728 190124 100.00% 100.00% Current liabilities Notes payable – bank 154424 100447 57.25% 52.83% Current maturities of mortgage payable 160 151 0.06% 0.08% Trade account payable 50054 31482 18.56% 16.56% Income taxes payable 4060 6143 1.51% 3.23% Accrued expenses and derivative liabilities 4089 10537 1.52% 5.54% Dividend payable 231 0 0.09% 0.00% Total current liabilities 213018 148760 78.98% 78.24% Mortgage payable 1461 1621 0.54% 0.85% Subordinate convertible debt 9501 0 3.52% 0.00% Derivative liability 1934 0 0.72% 0.00% Deferred taxes payable 212 0 0.08% 0.00% Stockholders Equity Common stock 117 117 0.04% 0.06% Additional paid-in capital 11937 11937 4.43% 6.28% Retained earnings 35271 31235 13.08% 16.43% Accumulated other comprehensive loss -214 -96 -0.08% -0.05% Treasury stock -3509 -3450 -1.30% -1.81% Total stockholders equity 43602 39743 16.17% 20.90% Total liabilities and stockholders equity 269728 190124 100.00% 100.00% Vertical analysis Statement of Cash Flow Company A 2011 2010 2011 2010 Cash flow from operating activities Net income 4961 9145 116.07% 720.08% Adjustments to reconcile net income to net cash Depreciation and amortization 434 374 10.15% 29.45% Change in the value of derivative liability -896 0 -20.96% 0.00% Amortization of convertible note discount 330 0 7.72% 0.00% Impairment recovery 0 -346 0.00% -27.24% Provision for doubtful accounts 207 0 4.84% 0.00% Deferred income taxes -564 -32 -13.20% -2.52% Foreign exchange loss -11 155 -0.26% 12.20% Changes in: Restricted cash 0 2149 0.00% 169.21% Trade account receivables -5584 -13245 -130.65% -1042.91% Inventories -52268 -17564 -1222.93% -1382.99% Other current assets -2332 -6240 -54.56% -491.34% Trade accounts payable 8569 -1542 200.49% -121.42% Income taxes payable -2083 4440 -48.74% 349.61% Accrued expenses and derivative liabilities -6451 -21283 -150.94% -1675.83% Net cash used in operating activities -55788 -44579 -1305.29% -3510.16% Cash flow used in investing activities Advance related to supply agreement -5000 0 -116.99% 0.00% Net proceed sale of property and equipment 0 346 0.00% 27.24% Purchases property and equipment -84 -27 -1.97% -2.13% Net cash provided in investing activities -5084 319 -118.95% 25.12% Cash flow provided by financing activities Proceeds from subordinated convertible debt 12000 0 280.77% 0.00% Proceeds from notes payable – bank 54395 46691 1272.70% 3676.46% Repayment – mortgage payments -151 -141 -3.53% -11.10% Dividends paid -694 -2085 -16.24% -164.17% Deferred financing costs -1596 0 -37.34% 0.00% Treasury stock purchased -59 -83 -1.38% -6.54% Stock options exercised 0 18 0.00% 1.42% Tax benefit from stock option exercised 0 11 0.00% 0.87% Net cash provided by financing activities 63895 44411 1494.97% 3496.93% Net increase in cash 3023 151 70.73% 11.89% Effect of exchange rate -19 -23 -0.44% -1.81% Cash at beginning of year 1270 1142 29.71% 89.92% Cash at end of year 4274 1270 100.00% 100.00% Vertical Analysis Income Statement Company B 2012 2011 2012 2011 Net sales 222505 215429 100.00% 100.00% Cost of goods sold 173642 168047 78.04% 78.01% Causality loss 0 2208 0.00% 1.02% Insurance recovery 0 -1708 0.00% -0.79% Total cost of sales 173642 168547 78.04% 78.24% Gross profit 48863 46882 21.96% 21.76% Selling and administrative expenses 40375 41022 18.15% 19.04% Restructuring charges 0 1403 0.00% 0.65% Intangible assets impairment charges 1815 396 0.82% 0.18% Operating income 6673 4061 3.00% 1.89% Other income (expense), net 272 108 0.12% 0.05% Income before income taxes 6945 4169 3.12% 1.94% Income taxes 1888 929 0.85% 0.43% Net income 5057 3240 2.27% 1.50% Vertical Analysis Balance Sheet Company B 2012 2011 2012 2011 Assets Current assets Cash 40355 16623 27.05% 11.05% Trade account receivables 25807 27670 17.30% 18.40% Inventories 34136 57438 22.88% 38.19% Prepaid expenses 4194 4965 2.81% 3.30% Total current assets 104492 106696 70.05% 70.94% Property, plant, and equipment, net 21669 20663 14.53% 13.74% Intangible assets 1257 3072 0.84% 2.04% Cash surrender life insurance policies 16217 15026 10.87% 9.99% Other assets 5536 4954 3.71% 3.29% Total assets 149171 150411 100.00% 100.00% Liabilities and stockholders equity Current liabilities Trade account payable 9233 11785 6.19% 7.84% Accrued salaries 3855 3426 2.58% 2.28% Other accrued expenses 792 1111 0.53% 0.74% Accrued dividends 1078 1077 0.72% 0.72% Total current liabilities 14958 17399 10.03% 11.57% Deferred compensation 7100 6242 4.76% 4.15% Total liabilities 22058 23641 14.79% 15.72% Stockholders equity Common stock 17262 17161 11.57% 11.41% Retained earnings 109742 109000 73.57% 72.47% Accumulated other comprehensive income 109 609 0.07% 0.40% Total shareholders equity 127113 1297701 85.21% 862.77% Total liabilities and stockholders equity 149171 150411 100.00% 100.00% Vertical Analysis Statement of Cash Flow Company B 2012 2011 2012 2011 Cash flow from operating activities Cash received from customers 224577 213850 556.50% 1286.47% Cash paid to suppliers and employees -190365 -226986 -471.73% -1365.49% Insurance proceed received on casualty loss 0 1708 0.00% 10.27% Income taxes paid, net -1987 -3938 -4.92% -23.69% Interest received (paid), net 51 -93 0.13% -0.56% Net cash provided by operating activities 32276 -15459 79.98% -93.00% Cash inflows from investing activities Purchases of property, plant, equipment -3805 -2010 -9.43% -12.09% Proceeds received on notes receivable 35 31 0.09% 0.19% Proceeds sale of property and equipment 125 0 0.31% 0.00% Premium paid on life insurance policies -1144 -1346 -2.83% -8.10% Proceeds received on life insurance policies 560 1724 1.39% 10.37% Net cash used in investing activities -4429 -1601 -10.98% -9.63% Cash flows from financing activity Proceeds short term borrowing 0 0 0.00% 0.00% Payment of short term debt 0 0 0.00% 0.00% Cash dividends paid -4315 -4312 -10.69% -25.94% Payment of long term debt 0 0 0.00% 0.00% Net cash used in financing activities -4315 -4312 -10.69% -25.94% Net increase (decrease) in cash 23732 -21372 58.81% -128.57% Cash at beginning of year 16223 37995 40.20% 228.57% Cash at end of year 40355 16623 100.00% 100.00% The vertical analysis of Company A and Company B showed various discrepancies in the results. The income statement of Company A reflected that cost of good sold accounted for 95.23% of the costs in 2011, while Company B had cost of goods sold of 78.04% of sales during fiscal year 2012. These numbers imply that Company B had greater gross profitability. The net margin of Company A was 0.96% and Company B had a net margin of 2.27%. The total cash of Company A accounted for 0.47% of sales in 2011 and 0.67% of sales in 2010. In contrast the cash account of Company B accounted for 27.05% and 11.05% of sales in fiscal years 2012 and 2011. Company B has better cash reserves than Company A. The total equity of Company A in relations to total assets was 16.17% in 2011, while company B had a total equity to total assets relation of 85.21%. Company B finances most of its operation through the sale of equity. The total debt in relation to sales of Company A in 2011 was 83.83%. Company B had a debt to sales ratio of 14.79%. The operations of Company A are mostly financed through debt. The cash from operating activities of Company A in relation to cash at the end of the year was -1305.29%. In comparison the cash from operating activities in relation to cash at the end of the year of Company B was 79.28%. Company A relied more in cash from operating activities than Company B. A horizontal analysis of Company A is illustrated below: Horizontal Analysis Net Income Company A Change % Change 2011 2010 Net sales 514633 465013 49620 10.67% Cost of goods sold 490102 434785 55317 12.72% Gross profit 24531 30228 -5697 -18.85% Selling, general and administrative expenses 13336 12031 1305 10.85% Operating income before impairment 11195 18197 -7002 -38.48% Impairment recovery 0 346 -346 -100.00% Operating income 11195 18543 -7348 -39.63% Other Income / expenses Change in value derivative liability 896 0 896 und. Interest expense -4039 -3997 -42 1.05% Income before income taxes 8052 14546 -6494 -44.64% Income taxes 3091 5401 -2310 -42.77% Net income 4961 9145 -4184 -45.75% Horizontal analysis Balance Sheet Company A 2011 2010 Change % Change Assets Current assets Cash 4274 1270 3004 236.54% Trade account receivables 56504 41174 15330 37.23% Inventory 184113 132196 51917 39.27% Deferred taxes 3384 2611 773 29.61% Other current assets 11053 8795 2258 25.67% Total current assets 259328 186046 73282 39.39% Advance to supplier 4479 0 4479 und. Preferential supply agreement 521 0 521 und. Long term financing costs 1360 0 1360 und. Property and equipment, net 4040 4078 -38 -0.93% Total assets 269728 190124 79604 41.87% Current liabilities Notes payable – bank 154424 100447 53977 53.74% Current maturities of mortgage payable 160 151 9 5.96% Trade account payable 50054 31482 18572 58.99% Income taxes payable 4060 6143 -2083 -33.91% Accrued expenses and derivative liabilities 4089 10537 -6448 -61.19% Dividend payable 231 0 231 und. Total current liabilities 213018 148760 64258 43.20% Mortgage payable 1461 1621 -160 -9.87% Subordinate convertible debt 9501 0 9501 und.. Derivative liability 1934 0 1934 und. Deferred taxes payable 212 0 212 und. Stockholders Equity Common stock 117 117 0 0.00% Additional paid-in capital 11937 11937 0 0.00% Retained earnings 35271 31235 4036 12.92% Accumulated other comprehensive loss -214 -96 -118 122.92% Treasury stock -3509 -3450 -59 1.71% Total stockholders equity 43602 39743 3859 9.71% Total liabilities and stockholders equity 269728 190124 79604 41.87% Horizontal Analysis Statement of Cash Flow Company A 2011 2010 Change % Change Cash flow from operating activities Net income 4961 9145 -4184 -45.75% Adjustments to reconcile net income to net cash 16.04% Depreciation and amortization 434 374 60 16.04% Change in the value of derivative liability -896 0 -896 und. Amortization of convertible note discount 330 0 330 und. Impairment recovery 0 -346 346 -100.00% Provision for doubtful accounts 207 0 207 und. Deferred income taxes -564 -32 -532 1662.50% Foreign exchange loss -11 155 -166 -107.10% Changes in: Restricted cash 0 2149 -2149 -100.00% Trade account receivables -5584 -13245 7661 -57.84% Inventories -52268 -17564 -34704 197.59% Other current assets -2332 -6240 3908 -62.63% Trade accounts payable 8569 -1542 10111 -655.71% Income taxes payable -2083 4440 -6523 -146.91% Accrued expenses and derivative liabilities -6451 -21283 14832 -69.69% Net cash used in operating activities -55788 -44579 -11209 25.14% Cash flows from investing activity Advance related to supply agreement -5000 0 -5000 und. Net proceeds property plant and equipment 0 346 -346 -100.00% Purchases of property and equipment -84 -27 -57 211.11% Net cash provided by investing activities -5084 319 -5403 -1693.73% Cash flow provided by financing activities Proceeds from subordinate convertible debt 12000 0 12000 und. Proceeds from notes payable – bank 54395 46691 7704 16.50% Repayments - mortgage payable -151 -141 -10 7.09% Dividends paid -694 -2085 1391 -66.71% Deferred financing costs -1596 0 -1596 und. Treasury stock purchased -59 -83 24 -28.92% Stock options exercised 0 18 -18 -100.00% Tax benefit from stock option exercised 0 11 -11 -100.00% Net cash provided by financing activities 63895 44411 19484 43.87% Net increase in cash 3023 151 2872 1901.99% Effect of exchange rate -19 -23 4 -17.39% Cash at beginning of year 1270 1142 128 11.21% Cash at end of year 4274 1270 3004 236.54% The horizontal analysis of Company A showed differences in the accounts of the company from 2011 to 2010. The total sales of Company A increased by 10.67%. An increase in total sales is a desirable outcome. Despite the company having an increase in sales the profitability of the company decreased due to the fact the net income of the firm decreased by 45.75%. The cash position of the firm increased by 236.54%. The cash spend in operating activities increased by 25.04%. The current assets and total assets of Company A increased by 39.39% and 41.87% respectively. The firm’s total equity went up by 9.71%. The table below shows a ratio analysis of Company A for 2011 and Company B for fiscal year 2012. Ratio Analysis Company A Company B Gross margin 4.77% 21.96% Net margin 0.96% 2.27% Return on Assets 1.84% 3.39% Return on Equity 11.38% 3.98% Working capital 46310 89534 Current ratio 1.22 6.99 Quick acid ratio 0.35 4.70 Inventory turnover 2.66 5.09 Average sale period 137.12 71.75 Debt to equity ratio 5.19 0.17 The gross margin of Company B of 21.96% was superior to the gross margin of Company A of 4.77%. The net margin ratio of Company B was superior to Company A by 1.29%. The return on assets and the return on equity of Company B were also better than Company A. These two ratios imply that Company B had a superior profitability. The working capital of company A at $46,310 was lower than the working capital of Company B of $89,534. The current ratio of both companies implies that the firms are in a good position to pay off its short term debt, but Company B had a much higher current ratio at 6.99. The quick acid ratio of Company B was also superior. The liquidity position of Company B is better than Company A. Company B had a higher inventory turnover than Company A by 2.43. Company B is selling its inventory more times during the year than Company A. The debt to equity ratio shows that Company A is mostly financed through debt, while company B is financed through equity. Overall if I was to invest in either of these two companies the financial analysis shows that Company B has superior financial performance. References Garrison, R., Noreen, E. (2003). Managerial Accounting (10th ed.). Boston: McGraw-Hill Irwin. Investopedia.com (2012). Return on Assets – (ROA). [Accessed 9 November 2012] Investorwords.com (2012). Current ratio. [Accessed 9 November 2012] Kennon, J. (2012). Inventory Turns / Inventory Turnover. [Accessed 9 November 2012] Kennon, J. (2012). Return on Equity (ROE). [Accessed 9 November 2012] Scott, R. (2012). Typical Debt to Equity Ratios. [Accessed 9 November 2012] Read More