Pathway:
Business, Marketing, and Computer Education
Lesson:
BMM C6–4: Financial Statements and Reports
Common Core State Standards for Mathematics:
N.Q.2Domain: Quantities
Cluster: Reason quantitatively and use units to solve problems.
Standard: 2. Define appropriate quantities for the purpose of descriptive modeling.*
Student Objectives:
1. Analyze financial statements.
2. Calculate financial performance ratios.
3. Compare mathematical results with industry standards.
BACKGROUND KNOWLEDGE
for Teachers and Students
Math Concepts:
Arithmetic:Arithmetic is a branch of mathematics in which problems are solved by calculating with numbers, using any one or a combination of the following operations: addition, subtraction, multiplication, division. Two types of problems are solved with arithmetic. Counting, grouping, or regrouping objects solves one type. Measuring or comparing quantities solves the other type.
Logic: Logic is the laws that govern valid thinking patterns and the structure of statements.
Order of operations:Order of operations follows these rules: (1) If grouping symbols are used, perform the operations within the grouping symbols first. (2) Perform all
Percent:Percent is per hundred. It is the ratio of a number to 100 with a percent sign. For
example, 20% means 20 out of 100 or20/
100.
Problem solving: Problem solving is understanding what a problem is asking and applying formulas to complete the calculation.
Ratio: Ratio is a comparison of two quantities by division.
Ratio analysis:Ratio analysis is an evaluation of relationships between elements of
financial statement information used to identify trends over time. Ratio analysis focuses on liquidity (cash), profitability, and solvency (wealth).
Business, Marketing, and Computer Education Concepts:
Accountants and financial analysts review financial statements to assess a company’s strength and performance. One component of this review involves conducting ratio analysis—comparing various line items in a financial statement to a particular item and comparing the calculations from period to period. As a requirement of many loans, certain minimum/maximum levels must be maintained for a financial institution to continue to offer its lending services or to maintain a specific interest rate.
Account: An account is a chronological record of changes to assets, liabilities, or stockholder’s equity. The Cash account is an example; all transactions related to cash would be recorded in the Cash account.
Accounts Payable:Accounts Payable is the amount owed by a company to its vendors/ creditors. It is sometimes referred to as a current liability on a Balance Sheet.
Accounts Payable Turnover:Accounts Payable Turnover is a ratio that determines how long it takes a business, on average, to pay its bills. Turnover Rate = Cost of Goods Sold ÷ Average Accounts Payable. Accounts Payable Turnover = 365 ÷ Turnover Rate.
Accounts Receivable:Accounts Receivable is the amount owed to a company by its creditors (customers).
Accounts Receivable Turnover:Accounts Receivable Turnover is an accounting measure that shows how efficiently a business uses its assets to extend credit and to collect debt. Turnover Rate = Sales ÷ Average Accounts Receivable. Accounts Receivable Turnover = 365 ÷ Turnover Rate. This ratio indicates how long it takes a business, on average, to be paid by its customers.
Asset: An asset is something valuable, such as a resource, owned or controlled by a
business as a result of past events and from which future economic benefits are expected.
Cash: Cash is the amount of ready money residing in a company’s financial accounts, such as petty cash, bank account balances, customer checks, and marketable securities.
Cost of Goods Sold (COGS):Cost of Goods Sold is an Income Statement figure that reflects the cost of obtaining raw materials and producing finished goods sold to consumers. Cost of Goods Sold = Beginning Merchandise Inventory + Net Purchases of Merchandise – Ending Merchandise Inventory. For example:
Beginning Merchandise Inventory = $180,000 Net Purchases of Merchandise = $650,000 Ending Merchandise Inventory = $205,000
COGS = 180,000 + 650,000 – 205,000 = $625,000
Current assets:Current assets are those assets that will be consumed within one year or will be used to pay for the business’s current liabilities.
Current liabilities:Current liabilities are those obligations due to be paid within one year.
Current ratio:Current ratio is a financial indicator of a company’s ability to repay its short-term debt (within 12 months). Current Ratio = Current Assets ÷ Current Liabilities.
Debt-to-equity ratio:Debt-to-equity ratio is an indicator of how much of a business’s financing is through debt (borrowing); it is a type of financial ratio found on Balance Sheets, Income Statements, and Statements of Cash Flows. Debt-to-Equity Ratio = Total Debt ÷ Total Stockholders’ Equity.
Financial ratios: Financial ratios evaluate the overall financial condition of an organization. Examples include return on investment (ROI), return on assets (ROA), and debt-to-equity.
Financial statements:Financial statements are records that summarize the monetary activities of a business. The four main financial statements are Balance Sheet, Income Statement, Statement of Cash Flows, and Statement of Retained Earnings.
Gross Margin: Gross Margin is the amount of money generated from selling a product after
the product costs are deducted. The formula is Gross Margin = Sales ! Cost of Goods
Sold.
Gross Margin ratio:Gross Margin ratio (gross profit margin) is a measure of a company’s profitability, specifically the costs related to purchasing a product for resale. It is expressed as a percentage of gross profit. The formula is Gross Margin Ratio = Gross Profit ÷ Sales Revenue.
Income Statement: An Income Statement is a financial document that reports revenue and expenses over a designated period (usually one month or one year).
Long-term assets:Long-term assets are the value of a business’s property, facility, equipment, and other capital assets minus depreciation. Included, also, are long-term investments and other assets the business uses for more than 12 months. Long-term assets provide economic benefit for an extended period.
Long-term liabilities:Long-term liabilities are a category of debt; they are obligations that become due after one year or more.
Net Income/Loss: Net Income/Loss is the overall profit or loss after all expenses are deducted from the Gross Margin.
Guided Practice Exercises:
ANSWER KEY
1. a. $60,000 b. $152,600 c. $39,250 d. $2,000 e. $215,000 f. $221,800 g. $55,000 h. $394,450 i. $572,300 j. $350,5002. a. Current Assets ÷ Current Liabilities 152,600 ÷ 51,500 = 2.96
ANALYSIS: A result >1 suggests the business’s strong ability to repay its current obligations. A 2.96 current ratio means that there are $2.96 of current assets to cover each $1.00 of current liabilities.
b. Gross Margin ÷ Sales
221,800 ÷ 572,300 = 38.76%
ANALYSIS: The result of this performance ratio calculation means that the company has 38.76% of its funds “left over” to cover other non-sales related expenses.
c. Net Income ÷ Sales
18,000 ÷ 572,300 = 3.15%
ANALYSIS: A 3.15% Profit Margin is rather low. This means that only 3.15% of funds are available to reinvest in the business and that the company profited only $3.15 for every $100.00 of sales. Although industry averages may vary, anything below 10% is considered critical.
d. Cost of Goods Sold ÷ Average Inventory
ANALYSIS: The result of this calculation means that the company’s inventory is “turned over,” or sold, every 32 days. This number varies based on the type of business (i.e., fast-food restaurant versus furniture store).
e. Cost of Goods Sold ÷ Average Accounts Payable
350,500 ÷ [(42,500 + 36,000) ÷ 2] = 8.93 = Turnover Rate 365 ÷ 8.93 = 40.87, or 41 days
ANALYSIS: The result means that, on average, this company pays its bills in 41 days.
f. Sales ÷ Average Accounts Receivable
572,300 ÷ [(20,000 + 28,000) ÷ 2] = 23.85 = Turnover Rate 365 ÷ 23.85 = 15.3, or 16 days
ANALYSIS: The result means that, on average, customers pay the company in 16 days. This number—16 days—should be compared with the company’s payment terms (i.e., invoices due in 10 days? 30 days?).
Independent Practice Exercises:
ANSWER KEY
1. a. Current Assets ÷ Current Liabilities 140,500 ÷ 27,500 = 5.11
ANALYSIS: A result >1 suggests a strong ability of a business to repay its current obligations. A 5.11 current ratio means that there are $5.11 of current assets to cover each $1.00 of current liabilities.
b. Gross Margin ÷ Sales
152,000 ÷ 400,000 = 38%
ANALYSIS: The result of this performance ratio calculation means that the company has 38% of its funds “left over” to cover other non-sales related expenses.
c. Net Income ÷ Sales
27,500 ÷ 400,000 = 6.88%
ANALYSIS: A 6.88% Profit Margin is rather low. This means that only 6.88% of funds are available to reinvest in the business and that the company profited only $6.88 for every $100.00 of sales. Although industry averages may vary, anything below 10% is considered critical.
d. Cost of Goods Sold ÷ Average Inventory
ANALYSIS: The result of this calculation means that the company’s inventory is “turned over,” or sold, every 100 days. This number varies based on the type of business (i.e., fast-food restaurant versus furniture store). This number—100 days—is considered high.
e. Cost of Goods Sold ÷ Average Accounts Payable
248,000 ÷ [(24,000 + 37,000) ÷ 2] = 8.13 = Turnover Rate 365 ÷ 8.13 = 44.90, or 45 days
ANALYSIS: The result means that, on average, this company pays its bills in 45 days.
f. Sales ÷ Average Accounts Receivable
400,000 ÷ [(41,500 + 39,000) ÷ 2] = 9.94 = Turnover Rate 365 ÷ 9.94 = 36.72, or 37 days
Guided Practice
Exercises:
1. Use the information on the West Company, Inc., Balance Sheet and Income Statement dated December 31, (Current Year), to locate and/or calculate the following account balances.
a. Land
b. Total Current Assets
c. Advertising Expense
d. Interest Payable
e. Total Stockholders’ Equity
f. Gross Margin
g. Retained Earnings
h. Average Total Assets [HINT: Compare last year and this year.]
i. Sales
j. Cost of Goods Sold
West Company, Inc. Comparative Balance Sheet December 31, (Current Year)
Current Year Last Year
Assets
Cash 98,000.00 76,000.00
Accounts Receivable 20,000.00 28,000.00
Inventory 32,000.00 28,800.00
Supplies 2,600.00 3,500.00
Total Current Assets 152,600.00 136,300.00
Buildings 155,000.00 155,000.00 Vehicles 35,000.00 35,000.00 Land 60,000.00 60,000.00 Total Assets 402,600.00 386,300.00 Liabilities Accounts Payable 42,500.00 36,000.00 Interest Payable 2,000.00 3,000.00 Salaries Payable 7,000.00 6,200.00
Total Current Liabilities 51,500.00 45,200.00
Long-Term Debt 130,000.00 136,000.00
Interest on Long-Term Debt 6,100.00 8,100.00
Total Liabilities 187,600.00 189,300.00
Stockholders’ Equity
Common Stock 100,000.00 100,000.00
Preferred Stock 60,000.00 60,000.00
Retained Earnings 55,000.00 37,000.00
Total Stockholders’ Equity 215,000.00 197,000.00
West Company, Inc. Income Statement
For the year ended December 31, (Current Year) Current Year Revenue
Sales 572,300.00
Cost of Goods Sold 350,500.00
Gross Margin 221,800.00 Expenses Advertising Expense 39,250.00 Communications Expense 6,800.00 Interest Expense 2,000.00 Miscellaneous Expense 1,150.00 Salaries Expense 135,200.00 Utilities Expense 19,400.00 Total Expenses 203,800.00 Net Income 18,000.00
2. Use the information on the West Company, Inc., Balance Sheet and Income Statement dated December 31, (Current Year), presented in Exercise 1, to calculate the following performance ratios. Then, analyze the results.
a. Current Ratio (Find these line items on the Balance Sheet. Round your answer to two decimal places.)
b. Gross Margin Ratio (Find these line items on the Income Statement. Round your answer to two decimal places.)
ANALYSIS: What does the calculated Gross Margin ratio mean?
c. Profit Margin (Find these line items on the Income Statement. Round your answer to two decimal places.)
ANALYSIS: What does the calculated Profit Margin mean?
d. Inventory Turnover (Find these line items on the Income Statement and Balance Sheet. [HINT: For an Inventory Turnover ratio, the Income Statement account is always in the numerator position.] Round the turnover rate to two decimal places and your final answer up to the nearest full day.)
e. Accounts Payable Turnover (Find these line items on the Income Statement and Balance Sheet. Round the turnover rate to two decimal places and your final answer up to the nearest full day.)
ANALYSIS: What does the calculated Accounts Payable Turnover rate mean?
f. Accounts Receivable Turnover (Find these line items on the Income Statement and Balance Sheet. Round the turnover rate to two decimal places and your final answer up to the nearest full day.)
Independent Practice
Exercises:
1. Use the information on the East Company, Inc., Balance Sheet and Income Statement dated December 31, (Current Year) to calculate the following performance ratios. Then, analyze the results.
East Company, Inc. Comparative Balance Sheet December 31, (Current Year)
Current Year Last Year
Assets
Cash 22,000.00 20,000.00
Accounts Receivable 41,500.00 39,000.00
Inventory 72,000.00 64,000.00
Supplies 5,000.00 4,000.00
Total Current Assets 140,500.00 127,000.00
Buildings 160,000.00 140,000.00 Vehicles 43,000.00 49,000.00 Total Assets 343,500.00 316,000.00 Liabilities Accounts Payable 24,000.00 37,000.00 Salaries Payable 3,500.00 4,000.00
Total Current Liabilities 27,500.00 41,000.00
Long-Term Debt 100,000.00 102,000.00
Interest on Long-Term Debt 6,750.00 6,500.00
Total Liabilities 134,250.00 149,500.00
Stockholders’ Equity:
Common Stock 60,000.00 60,000.00
Preferred Stock 20,000.00 20,000.00
Retained Earnings 129,250.00 86,500.00
Total Stockholders’ Equity 209,250.00 166,500.00
Total Liabilities and Stockholders’ Equity 343,500.00 316,000.00
East Company, Inc. Income Statement
For the year ended December 31, (Current Year) Current Year Revenue
Sales 400,000.00
Cost of Goods Sold 248,000.00
Gross Margin 152,000.00 Expenses Advertising Expense 39,000.00 Communications Expense 2,595.00 Interest Expense 15,000.00 Miscellaneous Expense 1,150.00 Salaries Expense 40,000.00 Rent Expense 15,755.00 Utilities Expense 11,000.00 Total Expenses 124,500.00 Net Income 27,500.00
a. Current Ratio (Find these line items on the Balance Sheet. Round your answer to two decimal places.)
b. Gross Margin Ratio (Find these line items on the Income Statement.)
ANALYSIS: What does the calculated Gross Margin ratio mean?
c. Profit Margin (Find these line items on the Income Statement. Round your answer to two decimal places.)
ANALYSIS: What does the calculated Profit Margin mean?
d. Inventory Turnover (Find these line items on the Income Statement and Balance Sheet. [HINT: For an Inventory Turnover ratio, the Income Statement account is always in the numerator position.] Round the turnover rate to two decimal places.)
e. Accounts Payable Turnover (Find these line items on the Income Statement and Balance Sheet. Round the turnover rate to two decimal places and your final answer up to the nearest full day.)
ANALYSIS: What does the calculated Account Payable Turnover rate mean?
f. Accounts Receivable Turnover (Find these line items on the Income Statement and Balance Sheet. Round the turnover rate to two decimal places and your final answer up to the nearest full day.)
