Finance For The Non Financial Manager II PDF

Finance
for the Non Financial

Manager II
Exercise Book With Solutions
Duncan Williamson
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Duncan Williamson
Finance for the Non Financial Manager

Exercise Book With Solutions
2
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Finance for the Non Financial Manager: Exercise Book With Solutions
1st edition
© 2016 Duncan Williamson & bookboon.com
ISBN 978-87-403-1205-8
3
Finance for the Non Financial Manager:
Exercise Book With Solutions Contents
Contents
1 Introduction 8
2 Building the Accounting Picture 10
3 Building Financial Statements 18

3.1 Case Study: David Tasker 18
4 Business Analysis 23
4.1 Business Activities 26
360°
4.2 Planning Activities 26
4.3 Investing Activities 28
4.4
4.5
Operating Activities
Business Activities
5 Correlation and Correlation Matrices

thinking . 28
34
39
6 Technical and Fundamental Analysis 45
360°
thinking . 360°
thinking .
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7 Financial Statements: basis of analysis 47

7.1 Statement of Comprehensive Income 47
7.1 Statement of Comprehensive Income 56
7.2 The Financial Ratio Analysis of Organisations Some Basic Analysis 66
8 Financial Statements Analysis: in detail 83

8.1 1 Comparative financial statement analysis 83
8.2 2 Common Size Financial Statement Analysis 83
8.3 3 Ratio Analysis 84
8.4 4 Cash Flow Analysis 87
8.5 Analysis of the Statement of Cash Flows 88
8.6 Alternative Cash Flow Measures 89
8.7 Free Cash Flow
TMP PRODUCTION NY026057B 4
89
12/13/2013
8.8 Specialised Cash Flow Ratios 89
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8.9 Cash Reinvestment Ratio 90
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8.9 Valuation 90
8.10 Free Cash Flow to Equity Model 90
8.11 Residual Income Model 91
8.12 Common Size Financial Statement Analysis 92
8.13 Ratio Analysis 95
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8.14 Cash Flow Analysis 98

8.15 Analysis of the Statement of Cash Flows 100
8.16 Alternative Cash Flow Measures 101
8.17 Free Cash Flow 101
8.18 Specialised Cash Flow Ratios 102
8.19 Cash Reinvestment Ratio 102
8.20 Valuation 103
8.21 Valuation Models 103
8.22 Free Cash Flow to Equity Model 104
8.23 Residual Income Model 105
9 Benchmarking of Financial and Non Financial Performance 107

9.1 Key Result Indicators 107
9.2 Seven Characteristics of KPIs 107
9.3 Balanced Scorecard 108
9.4 Beyond Budgeting 108
9.5 Seven Characteristics of KPIs 109
9.6 Balanced Scorecard 110
9.7 Beyond Budgeting 111
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10 Review Annual Report and Accounts 112

10.1 Qualitative analysis of financial and non financial data 112
10.2 2014 Chairman’s letter from the amazon.com 112
10.3 Sensitivity Analysis in Forecasting Financial Statements 115
10.4 Qualitative analysis of financial and non financial data 116
10.5 2014 Chairman’s letter from the amazon.com 116
10.6 Sensitivity Analysis in Forecasting Financial Statements 120

Exercise Book With Solutions Introduction
1 Introduction
Exercises 1–14: what do you know already?
Let’s begin with a quiz: if you don’t know any of the answers, don’t worry; because that will spur you on
when you realise that by the end of this course you WILL know the words, you WILL understand them
and you WILL be able to use and apply them.
1. A bookkeeper is someone who spends their working hours cataloguing the books in the
company library. True or false?
2. A bookkeeper spends his working hours collecting accounting information, classifying it and
recording it in a systematic way. True or false?
3. An accountant is someone who takes the work of a bookkeeper and then prepares financial
statements for the business owners. True or False?
4. An accountant is just a bean counter who doesn’t need to know or understand anything about
business. True or False?
5. This financial statement is an example of a balance sheet. True or false?
Sales/Revenue 100,000
- Cost of goods sold 55,000
= Gross Profit 45,000
- Expenses 20,000
= Net Profit 25,000
6. This financial statement is an example of part of a balance sheet. True or false?
Assets
Fixed Assets/Non Current Assets
land 265,000
buildings 300,000
machinery 75,000
equipment 50,000
Total Fixed Assets 690,000
Current Assets
stocks/inventory 50,000
debtors/accounts receivable 75,000
prepayments 5,000
short term investments 25,000
bank 5,000
cash/cash and cash equivalents 15,000
Total Current Assets 175,000
Total Assets 865,000
8
Exercise Book With Solutions Introduction
7. A fixed asset is an asset we hope to sell within one year. True or false?
8. Liabilities and Shareholders’ funds are the same things because it means money owing to
outsiders. True or false?
9. The relationship between total sales and net profit tells us a great deal about the health of a
business. True or false?
10. The net profit margin is found this way: net profit/total sales * 100. True or false?
11. The asset turnover ratio tells us how many of our assets we have sold. True or false?
12. A KPI is a Kool Performance indicator in text speak. True or false?
13. All of these are part of the features of a valid KPI:
1) Nonfinancial measures (not expressed in dollars, yen, Dollars, euros, etc.)
2) Measured frequently (e.g. daily or 24/7)
3) Acted on by the junior management team only True or false?
14. The Balanced Scorecard is a bookkeeping tool to ensure the ledgers are balanced.
True or false?
How did you do? Here are the answers to exercises 1 to 14:
Question Correct Response Question Correct Response
1 FALSE 8 FALSE
2 TRUE 9 TRUE
3 TRUE 10 TRUE
4 FALSE 11 FALSE
5 FALSE 12 FALSE
6 TRUE 13 FALSE: only 1 and 2 are true
7 FALSE 14 FALSE
9
Exercise Book With Solutions Building the Accounting Picture
2 Building the Accounting Picture

Exercise 15
Choose the answer you believe to be correct:
The bookkeeping and accounting cycle comprises
a) Invoices, returns notes, petty cash vouchers, journals vouchers

b) A logical time frame and a Gantt Chart is an ideal way of showing it
c) Comprised rather technical ideas best left to the accountant and his team
Exercise 16
In the section we call the Paper Trail there are three statements named, which of the following could
we also have added?
a) Statement of Comprehensive Balances and Statement of Changes in Equity

b) Statement of Comprehensive Income and Statement of Changes in Equity
c) Statement of Comprehensive Equity and Statement of Changes in Income
Exercise 17
a) The Income Statement is a period statement while the Balance Sheet is a Flow Statement
b) The Income Statement is a period statement while the Balance Sheet is a Position Statement
c) The Income Statement is a position statement while the Balance Sheet is a period Statement
Exercise 18
a) Total Assets = Total Liabilities – Capital

b) Total Assets = Total Liabilities / Capital
c) Total Assets = Total Liabilities + Capital
10
Exercise 19
In a balance sheet, the word current means
a) Something will be received/paid within one year from the balance sheet date
b) Something will be received/paid more than one year from the balance sheet date
c) Something will be received/paid whenever time permits
Exercise 20
What do you think is meant by the winding up basis in the context of the going concern concept?
Exercise 21
Imagine two expenses that a business might incur today but only pay for in a week’s time or even later.
Exercise 22
The idea of prepayments are important here too: where we pay for something before we use it. Give an
example of when a business might prepay an expense.
Exercise 23
a) Try to find the names of two methods of calculating depreciation.

b) Show how the two depreciation methods you have found in your answer to part a) of this
question might work for, for example, a motor vehicle that costs $25,000, has a useful, working,
life of 10 years might be sold for $5,000 after the ten years of use.
Exercise 24
Give an example of how the prudence concept might work in reality.
Exercise 25
Give an example of an objective decision being taken by an accountant by first thinking about a subjective
decision he might take.
11
Exercise 26
Suggest what the dual effects of buying an asset by a business would be if the business bought the asset
• for cash
• from a creditor
Suggest what might be the dual effects of a sale of goods by a business for cash.
Exercise 27
Suggest an example of why the entity concept is so important for a business.
Exercise 28
If assets and expenses are not included at cost value, what could they be included as?
Exercise 29
What are the implications of the money measurement concept for the bookkeeper and accountant?
Exercise 30
Try to find an example of how bookkeepers and accountants use the concept of materiality.
Exercise 31
Give an example of when a newspaper seller realises a sale and an example of when a car dealership
realises a sale if that business receives cars from the manufacturer on a sale or return basis.
How did you do? Here are the answers:
Exercise 15 a
Exercise 16 b
Exercise 17 b
Exercise 18 c
Exercise 19 a
Exercise 20
The winding up basis means that we value our assets and liabilities according to what we can get for
them, assets; and what we can negotiate with, liabilities. For example, in the non current asset section
we might have a building valued at $100,000 but on the winding up basis, because everyone knows
our business is in trouble, we might only be able to sell it for, say, $55,000. With a current liability, for
example, we might owe $17,500 to a supplier but when they understand our problem they might accept,
say $5,000 on the basis that it’s the best we can do!
12
Exercise 21
Imagine two expenses that a business might incur today but only pay for in a week’s time or even later.
• Electricity costs: typically we use electricity which is recorded on a meter and pay for it a
month or two later.
• Salaries are usually earned in one month and then paid for in the following month.
The purpose of the accruals concept is that it allows the bookkeeper to match the costs to the activities
when they were carried out. That is, we need to know the cost of electricity when it was used, not when
it was paid. Expenses paid in arrears must be shown in the current period’s profit statement.
Exercise 22
The idea of prepayments are important here too: where we pay for something before we use it. Give an
example of when a business might prepay an expense.
A good example of an expense that is prepaid is rent of buildings and equipment, which is often paid in
advance. Such costs relate to a future period must be carried forward as a prepayment for that period
and not charged in the current profit statement.
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Exercise 23
c) Try to find the names of two methods of calculating depreciation.

d) Show how the two depreciation methods you have found in your answer to part a) of this question
might work for, for example, a motor vehicle that costs $25,000, has a useful, working, life of 10
years might be sold for $5,000 after the ten years of use.
Depreciation is the writing down of the cost of a motor vehicle and it might be calculated using. If we
buy a motor vehicle for $25,000, for example, and we think that this vehicle has a useful life of 10 years
after which we think we might sell it for $5,000, we could charge ($25,000 – $5,000)/10 years = $2,000
per year for depreciation: that is, we can use the straight line method.
Alternatively, we might depreciation the motor vehicle by using the reducing balance method and for that
we would depreciate the motor vehicle at the rate of 14.866% per year. That would be $25,000 * 14.866%
for year one = $3,716.50 and for year two is would be ($25,000 – $3,716.50) * 14.866% = 3,164.01…
The point here, consistency, is that if we used the straight line method for year one, we would calculate
$2,000 for year one and ($25,000 – $2,000) * 14.866% = $3,419.18 for year two: that is not consistent
and is not allowed.
Exercise 24
Give an example of how the prudence concept might work in reality.
There are many possible answers to this question. If we imagine that our medium to large sized business
sells goods or services on credit, it would not be prudent to pretend that pretend that all of our debtors
will pay everything they owe us.
The prudent accountant will create an account for possible doubtful debts. This means that are ready to
cancel some of those debts and profits and the balance sheet will reflect that.
Exercise 25
Give an example of an objective decision being taken by an accountant by first thinking about a subjective
decision he might take.
A subjective decision might be that the accountant says, I think that motor vehicle will be sold for $10,000
in three years’ time…he THINKS…on what basis?
An objective decision might be that the accountant says, I have gone through Parker’s Car Price Guide
and checked with our auditors and we agree, that motor vehicle should be shown as having a resale
value of $7,500 three years from now.
14
Exercise 26
Suggest what the dual effects of buying an asset by a business would be if the business bought the asset
• for cash
• from a creditor
Suggest what might be the dual effects of a sale of goods by a business for cash
When an asset is bought, another asset cash (or bank) is also and simultaneously decreased OR a liability
such as creditors is also and simultaneously increased.
When a sale is made the asset of stock is reduced as goods leave the business and the asset of cash is
increased (or the asset of debtors is increased) as cash comes into the business.
Exercise 27
Suggest an example of why the entity concept is so important for a business.
The best example here concerns that of the sole trader or one man business. The sole trader will often take
money out of the business for his personal expenses by way of drawings. Even though it’s his business and
apparently his money, there are still two bookkeeping aspects to the transaction: the business is ‘giving’
money and the individual is ‘receiving’ money. So, the affairs of the individuals behind a business must
be kept separate from the affairs of the business itself.
Exercise 28
If assets and expenses are not included at cost value, what could they be included as?
Modern accounting uses the phrase fair value. Until relatively recently, every company in the world, with
exceptions, used the cost or historic cost concept. Fair value really means that assets might be shown at
their current market value rather than their historic cost.
Exercise 29
What are the implications of the money measurement concept for the bookkeeper and accountant?
Let’s think of an extreme example: imagine that we are trying to do business together. You want to sell
me some fuel for my motor vehicle but I don’t have any money. I do have 100 kilogrammes of rice. If
we agree that I can have 100 litres of fuel in exchange for 100 Kg of rice, that’s one thing.
15
How will your bookkeeper enter this sale in the books? At what value? How will he find that value?
Suppose there is no one else on earth who wants or needs that rice?
If we cannot value the rice then there can be no bookkeeping transaction to record.
Exercise 30
Try to find an example of how bookkeepers and accountants use the concept of materiality.
One simple way to see how bookkeepers and accountants use the concept of materiality is to look at, for
example, a balance sheet of a medium sized to large business. You will see something like this:
DW plc Balance Sheet as at 31st December 2014

Fixed Assets $’000 $’000
Land 1,500
Buildings 7,650
Total Fixed Assets 9,150
The Wake
the only emission we want to leave behind
.QYURGGF'PIKPGU/GFKWOURGGF'PIKPGU6WTDQEJCTIGTU2TQRGNNGTU2TQRWNUKQP2CEMCIGU2TKOG5GTX
6JGFGUKIPQHGEQHTKGPFN[OCTKPGRQYGTCPFRTQRWNUKQPUQNWVKQPUKUETWEKCNHQT/#0&KGUGN6WTDQ
2QYGTEQORGVGPEKGUCTGQHHGTGFYKVJVJGYQTNFoUNCTIGUVGPIKPGRTQITCOOGsJCXKPIQWVRWVUURCPPKPI
HTQOVQM9RGTGPIKPG)GVWRHTQPV
(KPFQWVOQTGCVYYYOCPFKGUGNVWTDQEQO

Notice the column headings…$’000: here we see that this company has rounded off its balance sheet
values to the nearest thousand Dollars. For example, $1,468 might have been rounded up to $1,500
and $7,652 might have been rounded down to $7,650. The company believes it is only material to show
thousands of Dollars. Larger businesses might round off to the nearest million Dollars…
Exercise 31
Give an example of when a newspaper seller realises a sale and an example of when a car dealership realises
a sale if that business receives cars from the manufacturer on a sale or return basis.
Selling a newspaper for cash means that the sale is realised as soon as you or I walk up to the seller, give
him the money and take away the newspaper. Most retail sales are like this.
As far as the car dealership is concerned, this might be complicated. However, the dealership realises a
sale when a customer buys a car. On the other hand, the car manufacturer cannot realise all sales of all
cars until the time when all of the cars have been sold, or the sale or return period has expired when it
can realise the sales or take back the cars from the dealership.
17
Exercise Book With Solutions Building Financial Statements
3 Building Financial Statements

3.1 Case Study: David Tasker
For the rest of this section we will work through the David Tasker Case Study. The purpose of this case
study is to walk through a whole series of events in the life of an imaginary business. As we work through
the events we will determine whether a transaction is a bookkeeping transaction. We will also apply the
basic accounting concepts and conventions to each transaction.
By the end of this case study we will have a good grasp of how and why a transaction should or should
not enter the world of the bookkeeper!
David Tasker operates a wholesale operation. The company employs (among others) Jack Smith as a
Sales Manager. By filling in the templates that follow, draw up the final accounts of the business after
each of the following transactions: where necessary.
Jan 1 Tasker starts the business with $7,000 in a bank account for the business
Jan 2 the company buys fixtures and fittings by cheque $3,000
Jan 3 Smith resigns
Jan 4 Tasker withdraws $1,000 from the bank for his personal use
Jan 5 the company buys land for $7,000: $2,000 is paid by cheque immediately and $5,000 is paid for
by means of taking out a mortgage secured on the property
Jan 6 the company buys goods on credit for $1,000
Jan 7 Tasker is offered $7,000 for his business but refuses to sell
Jan 8 the company sells for cash for $600, goods which had cost $500
Jan 9 Tasker is told that land similar to his was sold recently for $8,000: whilst Tasker is interested in
this news, he takes no action on it.
Jan 10 goods are sold on credit for $600, which had cost $500
Jan 11 debtors pay their debts in cash $600
Jan 12 a customer, Sandy Bedds, pays $1,200 cash for goods to be supplied after 10 days
Jan 13 the company pays $2,100 cash into the bank and draws a cheque for $1,000 to pay for goods
bought on the 6th
Jan 14 goods are bought on credit for $2,000
Jan 15 goods costing $1,000 were delivered to Sandy Bedds in full settlement of the outstanding advance
of the 12th
Jan 15 Tasker decides to calculate his profit so far. He reads the electricity meter and finds the business
has used $10 worth of electricity. The electricity bill will not be received until the end of January
Jan 15 salaries to date paid in cash $50
18
Jan 15 the rate of interest on the mortgage is 12% pa, payable on 31st December. Tasker calculates the
appropriate charge for the month to be $25: charge this amount in full
Jan 15 Tasker assesses the value of the use of the fixtures and fittings to be $25
Exercise 32 Indicate in which of the principal financial statements each item appears
Item Balance Income Statement of

Sheet Statement Cash Flows
Accounts Payable
Accumulated Depreciation
Capital Expenditures
Change Cash and Equivalents
Ordinary Shares Issued
Current Debt: Changes
Direct Operating Activities
Financing Activities: Net Cash Flow
Gross Plant, Property and Equipment
Income before Extraordinary Items
Indirect Operating Activities
Interest Paid: Net
Investing Activities
Long Term Debt Due In One Year
Receivables
Operating Activities: Net Cash Flow
Preference Shares: Non redeemable
Pre tax Income
Retained Earnings
Disposal of Property, Plant and Equipment
Selling, General and Administrative Expense
Stock Equivalents
Total Current Assets
Total Income Taxes
Total Preference Shares
19

Accrued Expenses
Cash and Equivalents
Ordinary Shareholders ’Equity
Cost of Goods Sold
Dividends per Share
Earnings per Share
Financing Activities
Funds from Operations: Other
Income Taxes Paid
Interest Expense
Inventories
Investing Activities: Other
Long Term Debt
Net Plant, Property and Equipment
Other Assets
Other Current Liabilities
Preference Share Dividends
Prepaid Expenses
Total Assets
Total Equity
Total Liabilities and Equity


Accounts Payable X
Accumulated Depreciation X
Capital Expenditures X
Change Cash and Equivalents X
Ordinary Shares Issued X
Current Debt: Changes X
Direct Operating Activities X
Financing Activities: Net Cash Flow X
Gross Plant, Property and Equipment X
Income before Extraordinary Items X
Indirect Operating Activities X
Interest Paid: Net X
Investing Activities X
Long Term Debt Due in One Year X
Receivables X
Operating Activities: Net Cash Flow X
Preference Shares: Non redeemable X
Pre tax Income X
Retained Earnings X X
Disposal of Property, Plant and Equipment X
Selling, General and Administrative Expense X
Stock Equivalents X
Total Current Assets X
Total Income Taxes X
Total Preference Shares X
21

Accrued Expenses X
Cash and Equivalents X
Ordinary Shareholders ’Equity X
Cost of Goods Sold X
Dividends per Share X
Earnings per Share X
Financing Activities X
Funds from Operations: Other X
Income Taxes Paid X
Interest Expense X X
Inventories X
Investing Activities: Other X
Long Term Debt X
Net Plant, Property and Equipment X
Other Assets X
Other Current Liabilities X
Preference Share Dividends X X
Prepaid Expenses X
Total Assets X
Total Equity X
Total Liabilities and Equity X
22
Exercise Book With Solutions Business Analysis
4 Business Analysis
Credit Analysis
Exercise 34 Complete the following table of ratios:
The creditors’ turnover ratio tells us on average how many days it takes amazon.com to pay its accounts
payables: in 2014, an average of 95.73 days or by the 96th day. What are the results for 2012 and 2013?

Exercise 35 The table below shows the new payables figure for amazon.com and then the revised ratio
table showing creditors’ turnover and trade creditors’ turnover for you to complete:
Note: these are not amazon.com’s true trade creditors figures, they are for illustration only.
Exercise 36 Here is the table of fully worked payables turnover data for ten years for amazon.com: what
comments do you have?
Accounts Receivable
We can look at accounts receivable, debtors, in a similar way to the accounts payable and here are the
debtors’ turnover results we need to look at amazon.com’s position:
Exercise 37 What do you make of those results?
Analysis of Shares
Exercise 38 Summarise the equity section of Apple Inc’s balance sheet from the following:
24
Exercise 39 Find examples of companies that have treasury stock and how that came about. Give
real examples of unrealised gains and losses that might appear in the line item accumulated other
comprehensive income.
Exercise 40 Trends in Equity Shares?
Consider the following graph, showing share premium and total shareholders’ equity for amazon.com:
Note: at an almost constant $5 million, it is hardly worth showing the par value on that graph.
Create the stockholders’ equity graph for Apple Inc that you see above for amazon.com and comment on
what you have found. In addition, create a graph of issued ordinary shares of Apple Inc and comment
on what you have found.
Exercise 41 In the last ten years Apple Inc has generated total sales of $647,391 million and its closing
balance on retained earnings at the start of those ten years was $4,005 million and at the end of those
10 years it is $87,152 million. Prepare your analysis of Apple Inc’s profit retention policy by creating a
graph of sales, net income and retained earnings for the ten years for which you have full data:
Financial period Net sales ($ million) Net profits ($ million) Retained Earnings
2005 13,931 1,328 4,005
2006 19,315 1,989 5,607
2007 24,578 3,495 9,101
2008 37,491 6,119 13,845
2009 42,905 8,235 23,353
2010 65,225 14,013 37,169
2011 108,249 25,922 62,841
2012 156,508 41,733 101,289
2013 170,910 37,037 104,256
2014 182,795 39,510 87,152
Exercise 42 Think of at least three other possible users of business analysis or financial data: name them
or their position and suggest what it is that they might want to know.
25
4.1 Business Activities

A company carries out many activities as it tries to provide a saleable product or service and to yield a
satisfactory return on investment. Its financial statements and related disclosures tell us about the four
major activities of the company:
• Planning
• Financing
• Investing and
• Operating
It is important to understand each of these major business activities before we can effectively analyse a
company’s financial statements in detail.
Exercise 43 Suggest two activities you can find under each of these four headings
4.2 Planning Activities

Also for amazon.com, additional discussion appears in the section in their annual report entitled
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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These two sources are excellent starting points in constructing a company’s business plan and in
performing a business environment and strategy analysis.
Important questions here are, can amazon.com be
• certain of the future of consumer and business computing needs?

• certain its input costs will not increase?
• sure how competitors will react?
These and other questions add risk to our analysis. While all actions involve risk, some actions involve
more risk than others. Financial statement analysis helps us estimate the degree of risk, or uncertainty
and helps us to be better informed and to take better decisions.
While information taken from financial statements does not provide perfect answers, it does help us to
gauge the soundness of a company’s business opportunities and strategies and to better understand its
financing, investing and operating activities.
Exercise 44 Explore the various sources we have just mentioned for amazon.com and highlight what
you consider are the main points for us to focus on.
Exercise 45 Create a graph or other illustration that tells us the sources of finance of our two companies,
amazon.com and Apple Inc. Keep your illustrations simple but consider the message you are trying to
convey as you construct them. Include current liabilities, non current liabilities and total equity in your
illustrations and take just the final year’s data from your database.
Here is my suggestion: a panel chart for amazon.com
27
Alternatively, also for 2014:
Exercise 46 Fill in the gaps in the following sentences:
Looking at the results of exercise 45 we can see that amazon.com’s balance sheet shows total creditor
financing of $____ billion, which is about __% of its total financing. Of this amount, around $____
billion is long term liability financing, while the remaining $____ billion is operating creditor financing.
Exercise 47 We already know a great deal about amazon.com and Apple Inc so let’s explore the relationship
between loan coupons and the success or otherwise of the business. Compare coupon rates for amazon.
com and Apple Inc and make any comments you think are appropriate.
4.3 Investing Activities

Exercise 48 Fill in the gaps in the following text by referring to amazon.com’s 2014 financial statements.
Amazon.com invested $____ billion in current assets (___% of total assets) and $____ billion in property,
plant and equipment (___% of total assets). Its remaining assets include other long term assets and
intangibles and they amount to $ ____ billion.
4.4 Operating Activities

Exercise 49 Fill in the gaps for 2014 for amazon.com. amazon.com earned net income of $_______
billion in 2014. This number by itself is not very meaningful. Instead, it must be compared with the
level of investment used to generate these earnings. amazon.com’s return on start of year total assets of
$_____ billion is ____% (that is, $_______ billion/$_______ billion): which is a superior/inferior return.
28

Exercise 34 Complete the following table of ratios:
The creditors’ turnover ratio tells us on average how many days it takes amazon.com to pay its accounts
payables: in 2014, an average of 95.73 days or by the 96th day. What are the results for 2012 and 2013?
Ratio Name Ratio Formula 2014-12 2013-12 2012-12
Creditors Turnover accounts payable/average daily cost of sales 95.73 101.95 105.74
Exercise 35 The table below shows the new payables figure for amazon.com and then the revised ratio
table showing creditors’ turnover and trade creditors’ turnover for you to complete:
Creditors Turnover accounts payable/average daily cost of sales 95.73 101.95 105.74
Trade Creditors Turnover trade accounts payable/average daily cost of sales 86.16 90.73 90.94
2014-12 2013-12 2012-12
Trade Creditors 14,813 13,468 11,453
Note: these are not amazon.com’s true trade creditors figures, they are for illustration only
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Exercise 36 Here is the table of fully worked payables turnover data for ten years for amazon.com: what
comments do you have?
Overall the situation seems to be fine in that the company is taking quite a while to pay its creditors and
whilst 96 days is a long time, it was 111 days in 2010 so their suppliers must be happier now.
The trade creditors figure gives us a better picture of supplier payment days and that is about 10 days
quicker than creditors’ turnover, again with a peak in 2010.
Accounts Receivable
We can look at accounts receivable, debtors, in a similar way to the accounts payable and here are the
debtors’ turnover results we need to look at amazon.com’s position:
Ratio Name Ratio Formula 2014-12 2013-12 2012-12 2011-12 2010-12 2009-12 2008-12 2007-12 2006-12 2005-12
Debtors Turnover
accounts receivable/average daily credit sales 32.64 32.11 26.71 25.17 21.81 19.00 20.26 22.41 17.64 15.50
Trade Debtorstrade
Turnover
accounts receivable/average daily credit sales 16.13 23.99 24.57 38.79 63.71 55.64 20.42 17.49 41.44 47.47
Exercise 37 What do you make of those results?
Retail customers rarely get credit from a retailer and there is no reason to think amazon.com is any
different. So, all debtors here will be corporate debtors: that is, companies buying on credit terms from
amazon.com. Since we have not looked for the segmental information here, the overall averages here
are almost certainly wrong but they give us an idea of what is happening. Contrast the overall 33 days
with the equivalent 96 days for creditors.
Analysis of Shares
Exercise 38 Summarise the equity section of Apple Inc’s balance sheet from the following:
30
I created graphs for this exercise:
To help with the third graph, I prepared this summary table:
Year Revenue Net income Retained earnings

2014-12 88,988 -241 1,949
2013-12 74,452 274 2,190
2012-12 61,093 -39 1,916
2011-12 48,077 631 1,955
2010-12 34,204 1152 1,324
2009-12 24,509 902 172
2008-12 19,166 645 -730
2007-12 14,835 476 -1,375
2006-12 10,711 190 -1,837
2005-12 8,490 359 -2,027
By the way, I know that amazon.com is a break even company so I have left the graph so that the profit
lines are right at the bottom of the graph: that makes them difficult to see. As an alternative, then, you
might put the revenue line on the secondary axis, like this:
Is that new graph better? You decide!
Exercise 39 Find examples of companies that have treasury stock and how that came about. Give real examples
of unrealised gains and losses that might appear in the line item accumulated other comprehensive income.
31
There are many companies with treasury shares or stock: they often come about when a company has a
lot of cash on its balance sheet but with no idea of how to spend it. In this case, some companies return
the cash to their shareholders and treasury shares come about at that time.
Trends in Equity Shares?
Consider the following graph, showing share premium and total shareholders’ equity for amazon.com:
Note: at an almost constant $5 million, it is hardly worth showing the par value on that graph.

Exercise 40 Create the stockholders’ equity graph for Apple Inc that you see above for amazon.com and
comment on what you have found. In addition, create a graph of issued ordinary shares of Apple Inc
and comment on what you have found.
Here are the graphs I have prepared for this exercise:
We can see with amazon.com that most of its equity capital is in the form of share premium whereas it
sees fair to say that Apple Inc’s share premium is much less than equity capital and that is much better
for the company.
Notice that Apple Inc has reduced the number of shares it has issued over the last two years of so as it
is returning cash to shareholders.
Exercise 41 In the last ten years Apple Inc has generated total sales of $647,391 million and its closing
balance on retained earnings at the start of those ten years was $4,005 million and at the end of those
10 years it is $87,152 million. Prepare your analysis of Apple Inc’s profit retention policy by creating a
graph of sales, net income and retained earnings for the ten years for which you have full data:
Financial Net sales Net profits Retained

period ($ million) ($ million) Earnings
2005 13,931 1,328 4,005
2006 19,315 1,989 5,607
2007 24,578 3,495 9,101
2008 37,491 6,119 13,845
2009 42,905 8,235 23,353
2010 65,225 14,013 37,169
2011 108,249 25,922 62,841
2012 156,508 41,733 101,289
2013 170,910 37,037 104,256
2014 182,795 39,510 87,152
33
Here is the graph I have prepared for this exercise:
Exercise 42 Think of at least three other possible users of business analysis or financial data: name them
or their position and suggest what it is that they might want to know.
• The business community

• Regulatory authorities such as the stock exchange
• Legal authorities
4.5 Business Activities

A company carries out many activities as it tries to provide a saleable product or service and to yield a
satisfactory return on investment. Its financial statements and related disclosures tell us about the four
major activities of the company:
• Planning
• Financing
• Investing and
• Operating
It is important to understand each of these major business activities before we can effectively analyse a
company’s financial statements in detail.
Exercise 43 Suggest two activities you can find under each of these four headings
Planning
Planning for production

Planning for cash requirements
34
Financing
Considering the amounts of cash to raise by means of a share issue

Setting the selling price of shares and therefore the share premium
Investing
How and when to finance the paying off of the long term debt
Working out the amount of dividend to pay
Operating
Planning to buy more equipment to help with production

Reviewing whether to dispose of the fleet of cars being used by the sales team
Exercise 44 Explore the various sources we have just mentioned for amazon.com and highlight what
you consider are the main points for us to focus on.

You must read the chairman’s letter to appreciate the answer to this question. I have included this letter
in the materials for this course and you need to concentrate on what the chairman says under the four
headings I have already given:
• Marketplace
• Amazon Prime
• Amazon Web Services
• Career Choice
Exercise 45 Create a graph or other illustration that tells us the sources of finance of our two companies,
amazon.com and Apple Inc. Keep your illustrations simple but consider the message you are trying to
convey as you construct them. Include current liabilities, non current liabilities and total equity in your
illustrations and take just the final year’s data from your database.
Here is my suggestion: a panel chart for amazon.com
Alternatively, also for 2014:
36
For Apple,the same examples, albeit with different formatting for one of them:
Exercise 46 Fill in the gaps in the following sentences:
financing of $____ billion, which is about __% of its total financing. Of this amount, around $____
billion is long term liability financing, while the remaining $____ billion is operating creditor financing.
Suggested solution:
financing of $43.764 billion, which is about 80.29% of its total financing. Of this amount, around $15.675
billion is long term liability financing, while the remaining $28.089 billion is operating creditor financing.
Exercise 47 We already know a great deal about amazon.com and Apple Inc so let’s explore the relationship
between loan coupons and the success or otherwise of the business. Compare coupon rates for amazon.
com and Apple Inc and make any comments you think are appropriate.
By combining the amazon.com and Apple Inc coupon and maturity dates I prepared this graph.
37
What you should notice is that the coupons for amazon.com are generally higher than the coupons for
Apple Inc. What this suggests is that the bond market sees Apple Inc as a safer company to lend money
to that amazon.com. Remember the idea: the greater the risk, the greater return.
Exercise 48 Fill in the gaps in the following text by referring to amazon.com’s 2014 financial statements.
Amazon.com invested $____ billion in current assets (___% of total assets) and $____ billion in property,
plant and equipment (___% of total assets). Its remaining assets include other long term assets and
intangibles and they amount to $ ____ billion.
Suggested Solution*
Amazon.com invested $31.327 billion in current assets (57.48% of total assets) and $7.150 billion in
property, plant and equipment (13.12% of total assets). Its remaining assets include other long term
assets and intangibles and they amount to $16.028 billion.
*Note: I have taken the question to refer to end of year figures and not increases from the previous year.
Exercise 49 Fill in the gaps for 2014 for amazon.com. amazon.com earned net income of $_______
billion in 2014. This number by itself is not very meaningful. Instead, it must be compared with the
level of investment used to generate these earnings. amazon.com’s return on start of year total assets of
$_____ billion is ____% (that is, $_______ billion/$_______ billion): which is a superior/inferior return.
Suggested Solution
amazon.com earned net income of $(0.241) billion in 2014. This number by itself is not very meaningful.
Instead, it must be compared with the level of investment used to generate these earnings. amazon.com’s
return on start of year total assets of $54,505 billion is (0.44)% (that is, $(0.241) billion/$54.505 billion):
which is a seriously inferior return.
38
Exercise Book With Solutions Correlation and Correlation Matrices
5 Correlation and Correlation

Matrices
Exercise 50 Take the table that follows and use Excel to find the coefficient of correlation, r, for X1 v Y1
and X1 v Y2. Plot the data on one or two graphs and interpret your results.
X Y1 Y2
2 22.9 -22.9
10 45.78 -45.78
7 33.49 -33.49
17 49.77 -49.77
14 40.94 -40.94
16 36.18 -36.18
3 21.05 -21.05
12 50.57 -50.57
11 31.32 -31.32
15 53.76 -53.76
18 55.66 -55.66
3 27.61 -27.61
4 11.15 -11.15
1 10.11 -10.11
6 37.90 -37.9
5 31.08 -31.08
13 45.48 -45.48
19 63.83 -63.83
20 63.60 -63.6
9 27.01 -27.01
Exercise 51 Take the table that follows and use Excel to find the coefficient of correlation, r, for X v
Y1 and X v Y2. Plot the data on two graphs and interpret your results as we are trying to find the best
relationship between Machine (X1) and Labour Hours (X2) and Indirect Labour Costs (Y).
39
Week Machine Direct Labour Indirect Factory

Hours (X1) Hours (X2) Labour Costs (Y)
1 68 30 1,190
2 88 35 1,211
3 62 36 1,004
4 72 20 917
5 60 47 770
6 96 45 1,456
7 78 44 1,180
8 46 38 710
9 82 70 1,316
10 94 30 1,320
11 68 29 752
12 48 38 963
Exercise 52, Find the values of r for the three variables in exercise 51.
Exercise 53 Here are the correlation matrices of our two companies, amazon.com and Apple Inc insofar
as they relate to sales, net income and retained earnings. Explain what these two correlation matrices
might be telling us about those two companies.
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amazon.com Revenue Net Retained Apple Inc Revenue Net Retained

income earnings income earnings
Revenue 1 Revenue 1
Net income -0.5053 1 Net income 0.9894 1
Retained 0.8879 -0.1187 1 Retained 0.9815 0.9902 1

earnings earnings
Here are the solutions!
Exercise 50 Take the table that follows and use Excel to find the coefficient of correlation, r, for X1 v Y1
and X1 v Y2. Plot the data on one or two graphs and interpret your results.
X Y1 Y2
2 22.9 -22.9
10 45.78 -45.78
7 33.49 -33.49
17 49.77 -49.77
14 40.94 -40.94
16 36.18 -36.18
3 21.05 -21.05
12 50.57 -50.57
11 31.32 -31.32
15 53.76 -53.76
18 55.66 -55.66
3 27.61 -27.61
4 11.15 -11.15
1 10.11 -10.11
6 37.9 -37.9
5 31.08 -31.08
13 45.48 -45.48
19 63.83 -63.83
20 63.6 -63.6
9 27.01 -27.01
41
Your graphs could look like this, with Y1 nd Y2 both on the same graph:
Exercise 51 Take the table that follows and use Excel to find the coefficient of correlation, r, for X v
Y1 and X v Y2. Plot the data on two graphs and interpret your results as we are trying to find the best
relationship between Machine (X1) and Labour Hours (X2) and Indirect Labour Costs (Y).
Week Machine Direct Labour Indirect Factory

Hours (X1) Hours (X2) Labour Costs (Y)
1 68 30 1,190
2 88 35 1,211
3 62 36 1,004
4 72 20 917
5 60 47 770
6 96 45 1,456
7 78 44 1,180
8 46 38 710
9 82 70 1,316
10 94 30 1,320
11 68 29 752
12 48 38 963
42
Exercise 52
We can put the answer to this exercise in the form of a correlation matrix:
Correlation Matrix
Machine Hours Direct Labour Indirect Factory
(X1) Hours (X2) Labour Costs (Y)
Machine Hours (X1) 1
Direct Labour Hours (X2) 0.1237 1
Indirect Factory Labour Costs (Y) 0.8256 0.3187 1
You need to use the Data Analysis ToolPak for this and your first task is to install that add in and then
use it! You will see the instructions on how to install the ToolPak starting on page 4 of the notes for
section Correlation and Correlation Matrices.
Exercise 53 Here are the correlation matrices of our two companies, amazon.com and Apple Inc insofar
as they relate to sales, net income and retained earnings. Explain what these two correlation matrices
might be telling us about those two companies.
amazon.com Revenue Net Retained Apple Inc Revenue Net Retained

income earnings income earnings
Revenue 1 Revenue 1
Net income -0.5053 1 Net income 0.9894 1
Retained earnings 0.8879 -0.1187 1 Retained 0.9815 0.9902 1
earnings
amazon.com
r = -0.5053 for revenue v net income tells us that as revenue increases, net income falls. A result of
-0.5053 is a significant value of r.
43
Retained earnings are highly correlated with revenue but they are negatively correlated with net income,
albeit in a relatively minor way.
Apple Inc
r = 0.9894 for revenue v net income tells us that as revenue increases, net income increases too. In this
case, the value of r is very high, almost equal to 1 which suggests a very strong relationship.
Retained earnings are highly correlated with revenue and also highly positively correlated with net
income.
We would conclude by saying that Apple Inc is doing a much better job of dealing with profits that
amazon.com.
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Exercise Book With Solutions Technical and Fundamental Analysis
6 Technical and Fundamental

Analysis
Exercise 54 As a warm up exercise, take a look at any company with which you are familiar and try to
answer the questions just shown under the fundamental analysis heading:
1. Is the company’s revenue growing?

2. Is it actually making a profit?
3. Is it in a strong enough position to beat…its competitors in the future?
4. Is it able to repay its debts?
5. Is management trying to “cook the books”?
Here are the solutions!
Exercise 54 As a warm up exercise, take a look at any company with which you are familiar and try to
answer the questions just shown under the fundamental analysis heading:
1. Is the company’s revenue growing?

2. Is it actually making a profit?
3. Is it in a strong enough position to beat…its competitors in the future?
4. Is it able to repay its debts?
5. Is management trying to “cook the books”?
Some of these questions seem simple to answer but others, such as questions three and five in that list,
can be difficult and sometimes impossible for an outsider to answer.
If you don’t have any company data of your own, apply the questions again to amazon.com and Apple
Inc. Otherwise, take a look at these web sites that provide a lot of free financial information:
https://www.google.com/finance
http://finance.yahoo.com/market-overview/
http://www.morningstar.com/
http://markets.ft.com/research/markets/companies-research
45
Exercise Book With Solutions Technical and Fundamental Analysis
This was meant to be a research project but just looking at amazon and Apple Inc will also do:
amazon.com
1. yes
2. no
3. with its constant very high levels of growth we might say yes to this
4. interesting question as it has started to take on a lot of debt recently. In terms of liquidity,
however, the answer is yes
5. I don’t see any evidence for saying yes to this!
Apple Inc
1. yes
2. yes
3. yes but the markets it operates in means that there is always intense competition
4. yes
5. I don’t see any evidence for saying yes to this!
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Exercise Book With Solutions Financial Statements: basis of analysis
7 Financial Statements:
basis of analysis
Exercise 55 Prepare graphs to illustrate the asset, liability and equity situation of Apple Inc for 2014 and
comment on any differences between amazon.com and Apple Inc.
Exercise 56 Fill in the missing information in the sentences that follow.
The income statement of amazon.com, titled statement of income, for the three years 2012 to 2014 is
shown above.
amazon.com’s revenues in 2014 amounted to $____ billion. Of this amount, $____ billion are costs of
operations and other expenses, yielding net income of $____ billion. amazon.com’s earnings have been
_________ during these three years despite a healthy increase in revenues, suggesting that the company
is still __________ __________ __________.
Exercise 57 Fill in the missing information in the sentences relating to the Consolidated Statement of
Stockholders’ Equity that follow.
During this period, shareholders’ equity changes were due mainly to __________ __________
__________, repurchasing stock (treasury shares) and __________ __________. amazon.com details
these changes under _____ headings:
7.1 Statement of Comprehensive Income

amazon.com includes separate information for comprehensive income. Comprehensive Income is a
measure of the ultimate bottom line income, that is, changes to shareholder’s equity excluding transactions
involving exchanges with shareholders. amazon.com’s 2014 comprehensive income is $(567) billion.
In addition to net income, comprehensive income includes certain adjustments classified as other
comprehensive income. The largest constituent of other comprehensive income, is $325 billion for Foreign
Currency Translation Adjustments, Net of Tax.
47
Exercise 58 Compare changes in Net Income and changes in Comprehensive Income for amazon.com
for the period 2012 to 2014: both in $ and % terms and.
Exercise 59 Fill in the missing information in the sentences relating to amazon.com’s statement of cash
flows, as shown below.
amazon.com’s 2014 cash balance increases by $_______ billion, from $_______ billion to $_______
billion. Of this increase in net cash, amazon.com’s operating activities provided $_______ billion, its
investing activities used $_______ billion and its financing activities provided/used $_______ billion.
Exercise 60: getting ready for detailed analysis
See the file ex_60_students.xlsx that has been set up for this exercise and the video too, ex_60_students_
publish.mpg4
Before we work through the formal analysis of financial statements, let’s take a look at some structured
and basic exercises first:
Accounting Information Company A Company B

Sales 21,546.36 2,387.09
Total Costs 13,205.07 1,192.69
Profit as a percentage of sales
48
Company A Company B Company C Company D

Contract costs 52,839.00 81,610.00 135,514.00 107,732.00
Mark up %
Mark up $
Selling price of contract 85,176.47 104,379.19 235,523.33 263,081.54
Profit Margin
Company 1 Company 2 Company 3 Company 4

Sales 150,717.82 221,435.49 108,405.79 258,819.48
Operating Costs 78,458.00 136,773.00 62,990.00 108,338.00
Mark up %
Mark up $
Profit Margin
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SABIC Income Statement for the years ended 31st

December 20X1 20X0 Change $ Change %
Sales 189,898 151970
Cost of Sales 127,768 103423
Gross Profit 62,130 48547
Selling, General and Administration Expenses 13,292 10654
Profit from Operations 28,838 37893
Investment and Other Income 2,039 1256
Financial Charges 2,992 3394
Net Profit before Interest and Taxation 47,885 35754
SABIC Profit Margin Schedule 20X1 20X0

Gross Profit margin
Profit from Operations Margin
NPIT Margin
Exercise 61
1. Express the following income statement information in common size percentages and assess
whether this company’s situation is favourable or unfavourable.
Harbison Corporation
Comparative Income Statements
for the years ended 31st December 2016 2015
Sales 720,000 535,000
Cost of Goods Sold 475,200 280,340
Gross Profit 244,800 254,660
Operating Expenses 151,200 103,790
Net Income 93,600 150,870
2. Common size and trend percentages for JBC Company’s sales, cost of goods sold and expenses
follow:
COMMON SIZE % TREND %

2016 2015 2014 2016 2015 2014
Sales 100.0% 100.0% 100.0% 104.4% 103.2% 100.0%
Cost of goods sold 62.4 60.9 58.1 112.1 108.2 100.0
Expenses 14.3 13.8 14.1 105.9 101.0 100.0
Determine whether net income increased, decreased, or remained unchanged in this three year period.
50
3. Selected comparative financial statements of Cohorn Company follow:
COHORN COMPANY
Comparative Income Statement ($000)
For Years Ended December 31, 2010–2016
2016 2015 2014 2013 2012 2011 2010
Sales 1,594 1,396 1,270 1,164 1,086 1,010 828
Cost of goods sold 1.146 932 802 702 652 610 486
Gross profit 448 464 468 462 434 400 342
Operating expenses 340 266 244 180 156 154 128
Net income 108 198 224 82 278 246 214
COHORN COMPANY
Comparative Balance Sheet ($000)
December 31, 2010–2016
Assets 2016 2015 2014 2013 2012 2011 2010

Cash 68 88 92 94 98 96 99
Accounts receivable, net 480 504 456 350 308 292 206
Merchandise inventory 1,738 1,264 1,104 932 836 710 515
Other current assets 46 42 24 44 38 38 19
Long-term investments 0 0 0 136 136 136 136
Plant and equipment, net 2,120 2,114 1,852 1,044 1,078 960 825
Total assets 4,452 4,012 3,528 2,600 2,494 2,232 1,800
Liabilities and Equity
Current liabilities 1,120 942 618 514 446 422 272
Long-term liabilities 1,194 1,040 1,012 470 480 520 390
Common stock 1,000 1,000 1,000 840 840 640 640
Other contributed capital 250 250 250 180 180 160 160
Retained earnings 888 780 648 596 548 490 338
Total liabilities and equity 4,452 4,012 3,528 2,600 2,494 2,232 1,800
Required
a) Compute trend percentages for the individual items of both statements using 2000 as the
base year.
b) Analyse and comment on the financial statements and trend percentages from part a.
4. Assume you are an analyst evaluating Mesco Company. The following data are available in
your financial analysis (unless otherwise indicated, all data are as at 31st December Year 5):
51
Retained earnings, 31st December Year 4 $98,000

Gross profit margin ratio 25%
Acid test ratio 2.5 to 1
Noncurrent assets $280,000
Days’ sales in inventory 45 days
Days’ sales in receivables 18 days
Shareholders’ equity to total debt 4 to 1
Sales (all on credit) $920,000
Common stock: $15 par value; 10,000 shares issued and outstanding; issued at $21 per share
Required
Using these data, construct the 31st December Year 5, balance sheet for your analysis. Operating expenses
(excluding taxes and cost of goods sold for Year 5) are $180,000. The tax rate is 40%. Assume a 360 day
TMP PRODUCTION NY026057B 4 12/13/2013
year in ratio computations. No cash dividends are paid in either Year 4 or Year 5. Current assets consist
6x4 PSTANKIE ACCCTR00
of cash, accounts receivable and inventories.
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5. You are an analyst reviewing Foxx Company. The following data are available for your financial
analysis (unless otherwise indicated, all data are as at 31st December Year 2):
Current ratio 2 Days’ sales in inventory 36 days

Accounts receivable turnover 16 Gross profit margin ratio 50%
Beginning accounts receivable $50,000 Expenses (excluding cost of goods sold) $450,000
Return on end of year common equity 20% Total debt to equity ratio 1
Sales (all on credit) $1,000,000 Non current assets $300,000
Required
Using these data, construct the 31st December Year 2, balance sheet for your analysis. Current assets
consist of cash, accounts receivable and inventory. Balance sheet classifications include cash, accounts
receivable, inventory, total noncurrent assets, total current assets, total current liabilities, total noncurrent
liabilities and equity.
6. You are planning to analyse Voltek Company’s 31st December Year 6, balance sheet. The
following information is available:
1. Opening and closing balances are identical for both accounts receivable and inventory.
2. Net income is $1,300.
3. Times interest earned is 5 (income taxes are zero). Company has 5% bonds outstanding and
issued at par.
4. Net profit margin is 10%. Gross profit margin is 30%. Inventory turnover is 5.
5. Days’ sales in receivables is 72 days.
6. Sales to end of year working capital is 4. Current ratio is 1.5.
7. Acid test ratio is 1.0 (excludes prepaid expenses).
8. Plant and equipment (net) is $6,000. It is one third depreciated.
9. Dividends paid on 8% non participating preferred stock are $40. There is no change in common
shares outstanding during Year 6. Preferred shares were issued two years ago at par.
10. Earnings per common stock are $3.75.
11. Common stock has a $5 par value and was issued at par.
12. Retained earnings at 1st January Year 6, are $350.
Required
a) Given the information available, prepare this company’s balance sheet as at 31st December Year
6 (include the following account classifications: cash, accounts receivable, inventory, prepaid
expenses, plant and equipment (net), current liabilities, bonds payable and stockholders’ equity).
b) Determine the amount of dividends paid on common stock in Year 6.
53
Here are the Solutions!
Exercise 55 Prepare graphs to illustrate the asset, liability and equity situation of Apple Inc for 2014 and
comment on any differences between amazon.com and Apple Inc.
Current liabilities NON-CURRENT ASSETS

35000 140000
30000 120000
100000
25000 80000
20000 60000
40000
15000
20000
10000 0
5000
0
Short-term Accounts Taxes Accrued Deferred Other
debt payable payable liabilities revenues current
liabilities
CURRENT LIABILIT IES CHART TITLE

Long-term
Short-term debt debt
Other current
liabilities 10% 25%
13%
Deferred
revenues Total non-
15% current
liabilities
Accrued Accounts 50%
liabilities payable
12% 48% Deferred
Taxes payable taxes
2% Other long-
Deferredliabilities
term liabilities
revenues 18%
4% 3%
Stockholders' equity
Common stock Additional paid-in capital

Retained earnings Accumulated other comprehensive income
Amazon.com 2014
Current assets NON CURRENT ASSETS

20,000 25,000
18,000 20,000
16,000
15,000
14,000
12,000 10,000
10,000 5,000
8,000
-
6,000
4,000 (5,000)
2,000 (10,000)
-
Cash and cash Short-term Total cash Receivables Inventories
equivalents investments
CURRENT LIABILIT IES NON CURRENT LIABILITIES

Other Long
Term
Deferred Liabilities
revenues Deferred
6% taxes
liabilities
Accrued
liabilities
Accounts Long term
35%
payable debt
59%
Capital leases
54
Stockholders' equity
Common stock Additional paid in capital

Retained earnings Treasury stock
Accumulated other comprehensive income
Comments:
The Apple balance sheet is 4.25 times bigger than the amazon balance sheet: total assets of $231839 v
$54,505 million
Apple’s retained earnings are 45 times larger than amazon’s at $87.2 billion
Where amazon has greater value in its balance sheet includes,
Cash although Apple has 4 times the value of short term investments than amazon
Inventories
Accruals: both companies have billions of dollars in accruals, but amazon wins that race!
You can see the table I created for these comparisons in the apple_results.xlsx file

eLibrary


Exercise 56 Fill in the missing information in the sentences that follow.
The income statement of amazon.com, titled statement of income, for the three years 2012 to 2014 is
shown above.
amazon.com’s revenues in 2014 amounted to $____ billion. Of this amount, $____ billion are costs of
operations and other expenses, yielding net income of $____ billion. amazon.com’s earnings have been
_________ during these three years despite a healthy increase in revenues, suggesting that the company
is still __________ __________ __________.
Suggested solution
amazon.com’s revenues in 2014 amounted to $88.988 billion. Of this amount, $26.058 billion are costs of
operations and other expenses, yielding net income of $(0.241) billion. amazon.com’s earnings have been
very weak during these three years despite a healthy increase in revenues, suggesting that the company
is still seeking to maximize sales growth.
Exercise 57 Fill in the missing information in the sentences relating to the Consolidated Statement of
Stockholders’ Equity that follow.
During this period, shareholders’ equity changes were due mainly to ____________________________
and the repurchasing stock (treasury shares) and. amazon.com details these changes under _____
headings:
Suggested solution
During this period, shareholders’ equity changes were due mainly to stock based compensation and
issuance of employee benefit plan stock, repurchasing stock (treasury shares) and. amazon.com details
these changes under seven headings:
7.1 Statement of Comprehensive Income

amazon.com includes separate information for comprehensive income. Comprehensive Income is a
measure of the ultimate bottom line income, that is, changes to shareholder’s equity excluding transactions
involving exchanges with shareholders. amazon.com’s 2014 comprehensive income is $(567) billion.
In addition to net income, comprehensive income includes certain adjustments classified as other
comprehensive income. The largest constituent of other comprehensive income, is $325 billion for Foreign
Currency Translation Adjustments, Net of Tax.
56
Exercise 58 Compare changes in Net Income and changes in Comprehensive Income for amazon.com
for the period 2012 to 2014: both in $ and % terms and.
2013–2014 2012–2013
Net Income/(Loss) -$515 -188% $313 803%
Comprehensive Income (Loss) -$895 -273% $290 763%
Exercise 59 Fill in the missing information in the sentences relating to amazon.com’s statement of cash
flows, as shown below.
amazon.com’s 2014 cash balance increases by $_______ billion, from $_______ billion to $_______
billion. Of this increase in net cash, amazon.com’s operating activities provided $_______ billion, its
investing activities used $_______ billion and its financing activities provided/used $_______ billion.
Suggested solution
amazon.com’s 2014 cash balance increases by $5.899 billion, from $8.658 billion to $14.557 billion. Of
this increase in net cash, amazon.com’s operating activities provided $6.842 billion, its investing activities
used $-5.065 billion and its financing activities provided/used $4.432 billion.
57
Exercise 60: getting ready for detailed analysis
Before we work through the formal analysis of financial statements, let’s take a look at some structured
and basic exercises first:
Accounting Information Company A Company B

Sales 21,546.36 2,387.09
Total Costs 13,205.07 1,192.69
Profit as a percentage of sales
Profit $ 8,341.29 1,194.40
% 38.71% 50.04%
Company A Company B Company C Company D

Contract costs 52,839.00 81,610.00 135,514.00 107,732.00
Mark up % 61.20% 27.90% 73.80% 144.20%
Mark up $ 32,337.47 22,769.19 100,009.33 155,349.54
Selling price of contract 85,176.47 104,379.19 235,523.33 263,081.54
Profit Margin 37.97% 21.81% 42.46% 59.05%

Company 1 Company 2 Company 3 Company 4

Sales 150,717.82 221,435.49 108,405.79 258,819.48
Operating Costs 78,458.00 136,773.00 62,990.00 108,338.00
Mark up % 47.94% 38.23% 41.89% 58.14%
Mark up $ 72,259.82 84,662.49 45,415.79 150,481.48
Profit Margin 47.94% 38.23% 41.89% 58.14%
SABIC Income Statement for the years ended

20X1 20X0 Change $ Change %
31st December
Sales 189,898 151970 37928 -75.04%
Cost of Sales 127,768 103423 24345 -76.46%
Gross Profit 62,130 48,547 13,583 -72.02%
Selling, General and Administration Expenses 13,292 10654 2638 -75.24%
Profit from Operations 48,838 37,893 10,945 -71.12%
Investment and Other Income 2,039 1256 783 -37.66%
Financial Charges 2,992 3394 -402 -111.84%
Net Profit before Interest and Taxation 53,869 42,543 11,326 -73.38%
SABIC Profit Margin Schedule 20X1 20X0 Change %

Gross Profit margin 32.72% 31.95% 2.42%
Profit from Operations Margin 25.72% 24.93% 3.14%
NPIT Margin 28.37% 27.99% 1.33%
Exercise 61
Use this Exercise to help you to appreciate and understand the work of this section before you work on
the larger problems in the spreadsheet file.
1. Express the following income statement information in common size percentages and assess
whether this company’s situation is favourable or unfavourable.
Harbison Corporation
Comparative Income Statements
for the years ended 31st December 2016 2015
Sales 720,000 535,000
Cost of Goods Sold 475,200 280,340
Gross Profit 244,800 254,660
Operating Expenses 151,200 103,790
Net Income 93,600 150,870
59
Harbison Corporation Values Common Size

Comparative Income Statements $ $ % %
for the years ended 31st December 2016 2015 2016 2015
Sales 720,000 535,000 100.00% 100.00%
Cost of Goods Sold 475,200 280,340 66.00% 52.40%
Gross Profit 244,800 254,660 34.00% 47.60%
Operating Expenses 151,200 103,790 21.00% 19.40%
Net Income 93,600 150,870 13.00% 28.20%
2. Common size and trend percentages for JBC Company’s sales, cost of goods sold and
expenses follow:

2016 2015 2014 2016 2015 2014
Sales 100.0% 100.0% 100.0% 104.4% 103.2% 100.0%
Cost of goods sold 62.4 60.9 58.1 112.1 108.2 100.0
Expenses 14.3 13.8 14.1 105.9 101.0 100.0
Determine whether net income increased, decreased, or remained unchanged in this three year period.

2016 2015 2014 2016 2015 2014
Sales 100.00% 100.00% 100.00% 104.40% 103.20% 100.00%
Cost of goods sold 62.40% 60.90% 58.10% 112.10% 108.20% 100.00%
Expenses 14.30% 13.80% 14.10% 105.90% 101.00% 100.00%
Total Costs % 76.70% 74.70% 72.20%
Net Income % 23.30% 25.30% 27.80%
3. Selected comparative financial statements of Cohorn Company follow:
COHORN COMPANY
Comparative Income Statement ($000)
For Years Ended December 31, 2010–2016
2016 2015 2014 2013 2012 2011 2010
Sales 1,594 1,396 1,270 1,164 1,086 1,010 828
Cost of goods sold 1.146 932 802 702 652 610 486
Gross profit 448 464 468 462 434 400 342
Operating expenses 340 266 244 180 156 154 128
Net income 108 198 224 82 278 246 214
60
COHORN COMPANY
Comparative Balance Sheet ($000) December 31,2010–2016
Assets 2016 2015 2014 2013 2012 2011 2010

Cash 68 88 92 94 98 96 99
Accounts receivable, net 480 504 456 350 308 292 206
Merchandise inventory 1,738 1,264 1,104 932 836 710 515
Other current assets 46 42 24 44 38 38 19
Long-term investments 0 0 0 136 136 136 136
Plant and equipment, net 2,120 2,114 1,852 1,044 1,078 960 825
Total assets 4,452 4,012 3,528 2,600 2,494 2,232 1,800
Current liabilities 1,120 942 618 514 446 422 272
Long-term liabilities 1,194 1,040 1,012 470 480 520 390
Common stock 1,000 1,000 1,000 840 840 640 640
Other contributed capital 250 250 250 180 180 160 160
Retained earnings 888 780 648 596 548 490 338
Total liabilities and equity 4,452 4,012 3,528 2,600 2,494 2,232 1,800
Required
a) Compute trend percentages for the individual items of both statements using 2000 as the
base year.
b) Analyse and comment on the financial statements and trend percentages from part a.
a 2016 2015 2014 2013 2012 2011 2010

Sales 192.51% 168.60% 153.38% 140.58% 131.16% 121.98% 100.00%
Cost of goods sold 0.24% 191.77% 165.02% 144.44% 134.16% 125.51% 100.00%
Gross profit 130.99% 135.67% 136.84% 135.09% 126.90% 116.96% 100.00%
Operating expenses 265.63% 207.81% 190.63% 140.63% 121.88% 120.31% 100.00%
Net income 50.47% 92.52% 104.67% 38.32% 129.91% 114.95% 100.00%
61
Comparative Balance Sheet ($000)

December 31, 2010–2016
Assets 2016 2015 2014 2013 2012 2011 2010

Cash 68.69% 88.89% 92.93% 94.95% 98.99% 96.97% 100.00%
Accounts receivable, net 233.01% 244.66% 221.36% 169.90% 149.51% 141.75% 100.00%
Merchandise inventory 337.48% 245.44% 214.37% 180.97% 162.33% 137.86% 100.00%
Other current assets 242.11% 221.05% 126.32% 231.58% 200.00% 200.00% 100.00%
Long-term investments 0.00% 0.00% 0.00% 100.00% 100.00% 100.00% 100.00%
Plant and equipment, net 256.97% 256.24% 224.48% 126.55% 130.67% 116.36% 100.00%
Total assets 247.33% 222.89% 196.00% 144.44% 138.56% 124.00% 100.00%
Current liabilities 411.76% 346.32% 227.21% 188.97% 163.97% 155.15% 100.00%
Long-term liabilities 306.15% 266.67% 259.49% 120.51% 123.08% 133.33% 100.00%
Common stock 156.25% 156.25% 156.25% 131.25% 131.25% 100.00% 100.00%
Other contributed capital 156.25% 156.25% 156.25% 112.50% 112.50% 100.00% 100.00%
Retained earnings 262.72% 230.77% 191.72% 176.33% 162.13% 144.97% 100.00%
Total liabilities and equity 247.33% 222.89% 196.00% 144.44% 138.56% 124.00% 100.00%
4. Assume you are an analyst evaluating Mesco Company. The following data are available in
your financial analysis (unless otherwise indicated, all data are as at 31st December Year 5):
Retained earnings, 31st December Year 4 $98,000

Gross profit margin ratio 25%
Acid test ratio 2.5 to 1
Noncurrent assets $280,000
Days’ sales in inventory 45 days
Days’ sales in receivables 18 days
Shareholders’ equity to total debt 4 to 1
Sales (all on credit) $920,000
Common stock: $15 par value; 10,000 shares issued and outstanding; issued at $21 per share
Required
Using these data, construct the 31st December Year 5, balance sheet for your analysis. Operating expenses
(excluding taxes and cost of goods sold for Year 5) are $180,000. The tax rate is 40%. Assume a 360 day
year in ratio computations. No cash dividends are paid in either Year 4 or Year 5. Current assets consist
of cash, accounts receivable and inventories.
62
Income Statement Balance Sheet

Sales (all on credit) 920,000 Noncurrent assets 280,000
Cost of goods sold 690,000 Current Assets
Gross Profit 230,000 25% Inventory 86,250
Operating Expenses 180,000 Receivables 46,000
Profit before Tax 50,000 Cash
Taxation 20,000 40% Net WC 290,250
Profit after Tax 30,000 Net Assets 422,500
Calculations Common stock:

Inventory 86250 Par value 150,000
Receivables 46000 Share Premium 60,000
Retained Profits 128,000
WC 142,500 Sharehorlders’ Equity 338,000
Total Debt 84,500
Capital Employed 422,500
5. You are an analyst reviewing Foxx Company. The following data are available for your financial
analysis (unless otherwise indicated, all data are as at 31st December Year 2):
Current ratio 2 Days’ sales in inventory 36 days

Accounts receivable turnover 16 Gross profit margin ratio 50%
Beginning accounts receivable $50,000 Expenses (excluding cost of goods sold) $450,000
Return on end of year common equity 20% Total debt to equity ratio 1
Sales (all on credit) $1,000,000 Non current assets $300,000
Required
Using these data, construct the 31st December Year 2, balance sheet for your analysis. Current assets
consist of cash, accounts receivable and inventory. Balance sheet classifications include cash, accounts
receivable, inventory, total noncurrent assets, total current assets, total current liabilities, total noncurrent
liabilities and equity.
63
Income Statement
Sales 13,000
Cost of Sales 9,100
Gross Profit 3,900 0.3
Expenses 2,600
Net Income 1,300 0.1
Interest 260 5
Earnings before Taxation 1,040
Taxation 0
EAT 1,040
Preferred Dividends 40
Income Available 1,000
EPS 3.75
AXA Global
Graduate Program

Balance Sheet
Current assets
cash
accounts receivable 2,564.38
inventory 1,820.00
prepaid expenses 1,625.00
Total Current Assets 4,875.00
Non Current Assets
plant and equipment (net) 6,000.00
Total Assets 10,875.00
current liabilities 3,250.00
bonds payable 5,200.00
preferred shares 500.00
stockholders’ equity 1,333.33
Retained Earnings 1,350.00
Total Liabilities and Equity 11,633.33
Workings
Inventory via inventory turnover COGS/Inventory 5 1,820.00
Recivables via receivables turnover 72 2,564.38
WC 3250
CA 1.5 4875 2
CL 1 3250 1
1.5
Prepaid Expenses (CA-Inventory)/CL 1 939.38
No of common shares 266.6667
6. You are planning to analyse Voltek Company’s 31st December Year 6, balance sheet. The
following information is available:
1. Opening and closing balances are identical for both accounts receivable and inventory.
2. Net income is $1,300.
3. Times interest earned is 5 (income taxes are zero). Company has 5% bonds outstanding and
issued at par.
4. Net profit margin is 10%. Gross profit margin is 30%. Inventory turnover is 5.
5. Days’ sales in receivables is 72 days.
6. Sales to end of year working capital is 4. Current ratio is 1.5.
7. Acid test ratio is 1.0 (excludes prepaid expenses).
8. Plant and equipment (net) is $6,000. It is one third depreciated.
65
9. Dividends paid on 8% non participating preferred stock are $40. There is no change in common
shares outstanding during Year 6. Preferred shares were issued two years ago at par.
10. Earnings per common stock are $3.75.
11. Common stock has a $5 par value and was issued at par.
12. Retained earnings at 1st January Year 6, are $350.
Required
a) Given the information available, prepare this company’s balance sheet as at 31st December Year 6
(include the following account classifications: cash, accounts receivable, inventory, prepaid
expenses, plant and equipment (net), current liabilities, bonds payable and stockholders’ equity).
b) Determine the amount of dividends paid on common stock in Year 6.
7.2 The Financial Ratio Analysis of Organisations Some Basic Analysis

Exercise 62 Give a brief analysis of the following summary: it relates to amazon.com and is taken from
the file amazon_results.xlsx and provides just a snapshot for us to begin our analysis of an organisation.
66
Exercise 63 Complete the table below by calculating the ratios for 2012 and 2013.
Exercise 64 Say what you think about amazon.com’s profitability performance for the three years for
which you have data and ratio results.
Exercise 65 Here are the summary results of amazon.com for ten years, in Sparkline format. Does this
additional information help you with your analysis of the company?
The Wake

Exercise 66
a) Compare and comment on the percentage change in revenues with the percentage change in
operating profits from the following information for amazon.com:
b) Evaluate the dividends paid out by the company over the last ten years
c) How would you summarise amazon.com’s equity base over the last ten years? See the table
that follows question part d.
i. Increased consistently
ii. Decreased consistently
iii. Increased in stages
iv. Decreased in stages
d) Evaluate amazon.com’s return on equity ratio and the debt to equity ratio (gearing or leverage)
over the ten years:
Exercise 67 Projecting Interest Expense
Over the last two years, 2013–2015, amazon.com has borrowed large amounts of money: $8.75 billion.
These corporate bonds range in size from $750 million to $1.50 billion and are set out in the table below.
68
a) The file amazon_bonds_students.xlsx has also been created for this task and the other three
tasks that follow:
Your first task is to prepare a schedule of interest payments and redemptions for these bonds
assuming they go to term and interest payments are due on the dates derived from their issue dates.
Coupon Maturity Ratings Ratings Yield Amount Payment First

Moody S&P Frequency Payment
(x per year)
2.6 5/12/2019 Baal AA- 2.451 1,000,000,000 2 15/6/2015
3.3 5/12/2021 Baal AA- 3.016 1,000,000,000 2 15/6/2015
3.8 5/12/2024 Baal AA- 3.725 1,250,000,000 2 29/5/2013
4.8 5/12/2034 Baal AA- 4.783 1,250,000,000 2 5/6/2013
4.95 5/12/2044 Baal AA- 5.014 1,000,000,000 2 15/6/2015
0.65 27/11/2015 Baal AA- 0.779 750,000,000 2 27/5/2013
1.2 29/11/2017 Baal AA- 1.459 1,000,000,000 2 29/5/2013
2.5 29/11/2022 Baal AA- 3.031 1,500,000,000 2 5/6/2015
Exercise 68 Ratings and Inter Firm Comparison
a) what is the significance of the ratings by Moody and S&P?

b) compare the data for amazon.com with the corporate bonds data for Apple Inc that you will
also find in the file amazon_bonds_students.xlsx
Exercise 69 Analysis of Apple Inc
Using the data you see below for Apple Inc, carry out the same analysis for Apple Inc as you carried out
for amazon.com earlier.
69
Complete the table below by calculating the ratios for 2012 and 2013.
Exercise 70 Say what you think about Apple Inc’s performance for the three years for which you have
data and ratio results.

Exercise 71 Here are the summary results of Apple Inc for ten years, in Sparkline format. Does this
Exercise 72
operating profits from the following information for Apple Inc:
c) How would you summarise Apple Inc’s equity base over the last ten years? See the table that
follows question part d.
d) Evaluate Apple Inc’s return on equity ratio and the debt to equity ratio (gearing or leverage)
over the ten years:
71
Exercise 62 Give a brief analysis of the following summary: it relates to amazon.com and is taken from
the file amazon_results.xlsx and provides just a snapshot for us to begin our analysis of an organisation.
All results are showing positive changes except for Net Income and EPS, earnings per share.
Exercise 63 Complete the table below by calculating the ratios for 2012 and 2013.
72

Gross Profit Margin Gross profit/Revenue 29.48% 27.23% 24.75%
Operating Income Margin Operating income/Revenue 0.20% 1.00% 1.11%
Net Income Margin Net income/Revenue -0.27% 0.37% -0.06%
Return on Total Assets Operating income/Total assets 0.33% 1.86% 2.08%
Return on Capital employed Net income/Total stockholders’ equity -2.24% 2.81% -0.48%
Working Capital Total current assets -Total Current Liabilities 3,238 1,645 2,294
Current Ratio Total current assets/Total Current Liabilities 1.12 1.07 1.12
(Total current assets – Inventories)/
Acid Test Ratio Total Current Liabilities 0.82 0.75 0.80
Debt to Equity Long term debt/Total stockholders’ equity 76.95% 32.74% 37.65%
Exercise 64 Say what you think about amazon.com’s profitability performance for the three years for
which you have data and ratio results.
Gross margins are steady at the high 20% but operating and net margins are really very poor, reflecting
amazon.com as a break even company.

Exercise 65 Here are the summary results of amazon.com for ten years, in Sparkline format. Does this
The Sparklines reveal the overall trends over the last ten years. Most metrics are showing positive signs
but profitability is very weak and debt to equity is suddenly increasing. Working capital is decreasing
too, according to the Sparklines.
Exercise 66
operating profits from the following information for amazon.com:
It is difficult to conclude a great deal from just three years’ data but we do see a sudden change in fortunes
in 2014 as operating profits have dropped, giving a negative change.
Unfortunately, data for three years doesn’t reveal a great deal so here is the full 10 year data:
74
What we see here is as the company grows slowly, it turns a profit: as it grows quickly, profits disappear!
b) Evaluate the dividends paid out by the company over the last ten years amazon.com pays no
cash dividends as a matter of policy
c) How would you summarise amazon.com’s equity base over the last ten years? See the table
that follows question part d.
I would say answer iii but not perfectly!
d) Evaluate amazon.com’s return on equity ratio and the debt to equity ratio (gearing or leverage)
over the ten years:
ROCE = Net Income/Total stockholders’ equity:
ROCE is not so good for amazon.com is it?
75
Debt to Equity Ratio (gearing or leverage)
The gearing ratio fell early on in amazon.com’s life but now it is on the rise again: wait for the 2015
results to come out to see if that trend has continued.
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Exercise 67 Projecting Interest Expense
Over the last two years, 2013–2015, amazon.com has borrowed large amounts of money: $8.75 billion.
These corporate bonds range in size from $750 million to $1.50 billion and are set out in the table below.
a) The file amazon_bonds_students.xlsx has also been created for this task and the other three
tasks that follow:
Your first task is to prepare a schedule of interest payments and redemptions for these bonds assuming
they go to term and interest payments are due on the dates derived from their issue dates.
Coupon Maturity Ratings Ratings Yield Amount Payment Frequency First

Moody S&P (x per year) Payment
2.6 5/12/2019 Baal AA- 2.451 1,000,000,000 2 15/6/2015
3.3 5/12/2021 Baal AA- 3.016 1,000,000,000 2 15/6/2015
3.8 5/12/2024 Baal AA- 3.725 1,250,000,000 2 29/5/2013
4.8 5/12/2034 Baal AA- 4.783 1,250,000,000 2 5/6/2013
4.95 5/12/2044 Baal AA- 5.014 1,000,000,000 2 15/6/2015
0.65 27/11/2015 Baal AA- 0.779 750,000,000 2 27/5/2013
1.2 29/11/2017 Baal AA- 1.459 1,000,000,000 2 29/5/2013
2.5 29/11/2022 Baal AA- 3.031 1,500,000,000 2 5/6/2015
In my file, there is the schedule, from which I have taken data to show the following:
Exercise 68 Ratings and Inter Firm Comparison
a) what is the significance of the ratings by Moody and S&P?

These ratings give us an expert view or the market view of how a company is seen to be
performing: AAA or AAA+ is generally the highest rating and then CCC or DDD or EEE is
the lowest, depending on which company is doing the rating.
77
b) compare the data for amazon.com with the corporate bonds data for Apple Inc
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Exercise 69 Analysis of Apple Inc
Using the data you see below for Apple Inc, carry out the same analysis for Apple Inc as you carried out
for amazon.com earlier.
Apple Inc is performing very well here: everything is going in the right direction, unless you are worried
about gearing and stockholders’ equity, which are both a little suspect.
78
Complete the table below by calculating the ratios for 2012 and 2013.
Gross Profit Margin Gross profit/Revenue 38.59% 37.62% 43.87%
Operating Income Margin Operating income/Revenue 28.72% 28.67% 35.30%
Net Income Margin Net income/Revenue 21.61% 21.67% 26.67%
Return on Total Assets Operating income/Total assets 22.65% 23.67% 31.38%
Return on Capital employed Net income/Total stockholders’ equity 35.42% 29.98% 35.30%
Working Capital Total current assets -Total current liabilities 5,083 29,628 19,111
Current Ratio Total current assets/Total current liabilities 1.08 1.68 1.50
(Total current assets – Inventories)/ 1.05 1.64 1.48

Acid Test Ratio Total current liabilities
Debt to Equity Long term debt/Total stockholders’ equity 25.99% 13.73% 0.00%
Exercise 70 Say what you think about Apple Inc’s performance for the three years for which you have
data and ratio results.
Again we can say that Apple Inc is doing well as all of its metrics are showing good signs. However,
working capital is a bit erratic and the current ratio has fallen: is this a good or a bad sign? Debt to
equity has suddenly risen quite cramatically, too.
Exercise 71 Here are the summary results of Apple Inc for ten years, in Sparkline format. Does this
79
In this case, the Sparklines simply mirror the comments I have already made: Apple Inc is performing
well although in the longer term profitability and returns on capital employed and total assets are falling.
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Exercise 72
operating profits from the following information for Apple Inc:
Over the long term, revenues and operating profits have moved in a highly correlated way. Over the
final three years, however, they have become a little erratic. Is this a cause for concern? Let’s see what
the new product launches do for the company in 2015 nd 2016.
There have not been many dividends from Apple Inc as a matter of policy: that was Steve Jobs’
philosophy I think.
c) How would you summarise Apple Inc’s equity base over the last ten years? See the table that
follows question part d.
81
I should say i
d) Evaluate Apple Inc’s return on equity ratio and the debt to equity ratio (gearing or leverage)
over the ten years:
ROCE increasing steadily with a small blip in 2013

Gearing very low until the last two years when it jumped significantly

Exercise Book With Solutions Financial Statements Analysis: in detail
8 Financial Statements Analysis:

in detail
8.1 1 Comparative financial statement analysis
No exercises for this section.
8.2 2 Common Size Financial Statement Analysis

Exercise 73
Create common Size Statements for the following examples:
Income Statement Year 2 S Year 1 $
Sales 123,116 73,371
Cost of Sales 115,027 62,314
Gross Profit 13,336 11,057
Administration 5,459 4,844
Selling 2,840 2,641
Balance Sheet Year 2 S Year 1 $
Inventories 8,500 6,872
Receivables 4,454 3,948
Bank 8,001 4,132
Total Current Assets 20,955 14,952
Property, Plant and Equipment 36,846 30,494
Intangibles 7,076 6,656
Total Non Current Assets 43,922 37,150
Total Assets 64,877 52,102
Payables 3,229 2,857
Accruals 1,417 1,289
Loans 7,412 4,061
Total Current Liabilities 12,058 8,207
Debt 30,719 23,494
Long Term Creditors 13,474 12,132
Total Non Current Liabilities 44,193 35,626
Equity 32,742 24,683
Total Liabilities and Equity 64,877 52,102
83
Statement of Cash Flow Year 2 S Year 1 $
Net Income 14,344 10,866
Non Cash Adjustments 4,307 2,655
Changes in working capital 10,350 7,082
Cash from Operations 29,001 20,603
Investing – –
Net cash from investing activities (13,438) (7,947)
Financing – –
Net Cash from financing activities 15,786 9,755
Net Cash 31,349 22,411
Opening cash balance (24,324) (19,132)
Closing cash balance 8,001 4,132
8.3 3 Ratio Analysis

Exercise 74
1. DW plc’s year end balance sheets show the following:
2016 2015 2014
Cash 30,800 35,625 36,800
Accounts receivable, net 88,500 62,500 49,200
Merchandise inventory 111,500 82,500 53,000
Prepaid expenses 9,700 9,375 4,000
Plant assets, net 277,500 255,000 229,500
Total assets 518,000 445,000 372,500
Accounts payable 128,900 75,250 49,250
Long term notes payable secured by mortgages on plant assets 97,500 102,500 82,500
Common stock, $10 par value 162,500 162,500 162,500
Retained earnings 129,100 104,750 78,250
Total liabilities and equity 518,000 445,000 372,500
84
Required
Compare the year end short term liquidity position of DW plc at the end of 2016, 2015 and 2014 by
computing the:
a) current ratio and

b) acid test ratio.
Comment on the ratio results.
2. Refer to the information in part 1 about DW plc. The company’s income statements for the
years ended 31st December 2016 and 2015 show the following:
2016 2015
Sales 672,500 530,000
Cost of goods sold 410,225 344,500
Other operating expenses 208,550 133,980
Interest expense 11,100 12,300
Income taxes 8,525 7,845
Total costs and expenses (638,400) (498,625)
Net income 34,100 31,375
Earnings per share 2.10 1.93

Required
For the years ended 31st December 2016 and 2015, assume all sales are on credit and then compute the
following:
a) collection period
b) accounts receivable turnover
c) inventory turnover and
d) days’ sales in inventory. Comment on the changes in the ratios from 2015 to 2016.
3. Refer to the information in parts 1 and 2 about DW plc. Compare the long term risk and
capital structure positions of the company at the end of 2016 and 2015 by computing the
following ratios:
a) total debt ratio

b) times interest earned
Comment on these ratio results.
4. Refer to the financial statements of DW plc in parts 1 and 2. Evaluate the efficiency and
profitability of the company by computing the following:
a) net profit margin,
b) total asset turnover
c) return on total assets
5. Refer to the financial statements of DW plc in parts 1 and 2. The following additional information
about the company is known:
Common stock market price 31st December 2016 15.00
Annual cash dividends per share in 2016 0.60
To help evaluate the profitability of the company, compute the following for 2016 and 2015:
a) return on common stockholders’ equity

b) price earnings ratio on December 31 and
c) dividend yield.
86
8.4 4 Cash Flow Analysis

Let’s look at a Statement of Cash Flows: again we will use amazon.com because they are a very well
known organisation:
Exercise 75
AMAZON.COM INC (AMZN) Statement of CASH FLOW
Fiscal year ends in December. USD in millions except per share data. 2014-12 2013-12 2012-12
Cash Flows From Operating Activities
Net income (241) 274 (39)
Depreciation & amortization 4,746 3,253 2,159
Investments losses (gains) (3) 1 (9)
Deferred income taxes (316) (156) (265)
Stock based compensation 1,497 1,134 833
Accounts receivable (1,039) (861)
Inventory (1,193) (1,410) (999)
Accrued liabilities 706 736 1,038
Other working capital 741 (447) 275
Other non-cash items 185 202 (22)
Net cash provided by operating activities 6,842 5,475 4,180
Cash Flows From Investing Activities
Investments in property, plant, and equipment (4,893) (3,444) (3,785)
Acquisitions, net (979) (312) (745)
Purchases of investments (2,542) (2,826) (3,302)
Sales/Maturities of investments 3,349 2,306 4,237
Net cash used for investing activities (5,065) (4,276) (3,595)
Cash Flows From Financing Activities
Long-term debt issued 6,359 394 3,378
Long-term debt repayment (1,933) (1,011) (588)
Excess tax benefit from stock based compensation 6 78 429
Common stock issued
Repurchases of treasury stock (960)
Other financing activities
Net cash provided by (used for) financing activities 4,432 (539) 2,259
Effect of exchange rate changes (310) (86) (29)
Net change in cash 5,899 574 2,815
Cash at beginning of period 8,658 8,084 5,269
Cash at end of period 14,557 8,658 8,084
Free Cash Flow
Operating cash flow 6,842 5,475 4,180
Capital expenditure (4,893) (3,444) (3,785)
Free cash flow 1,949 2,031 395
87
Match the descriptions above with this summary statement of cash flows for the years 2012 – 2014 for
amazon.com:
• What did it generate from operations?

• How much has the company spent on CAPEX, capital expenditure?
• Has it received or paid out money to its financiers/shareholders?
8.5 Analysis of the Statement of Cash Flows

In evaluating sources and uses of cash, the analyst should focus on questions like:
• Are asset replacements financed from internal or external funds?

• What are the financing sources of expansion and business acquisitions?
• Is the company dependent on external financing?
• What are the company’s investing demands and opportunities?
• What are the requirements and types of financing?
• Are managerial policies (such as dividends) highly sensitive to cash flows?
This e-book
is made with SETASIGN
SetaPDF
PDF components for PHP developers
www.setasign.com

Exercise 76
Take a look at the above questions and apply them to amazon.com: what are your findings?
8.6 Alternative Cash Flow Measures

Exercise 77
Calculate EBITDA for amazon.com just to compare it with the real cash flow from operations figures!
2014 2013 2012

Net Income -241 274 -39
Taxation 177 169 112
Interest 91 97 31
Depreciation/Amortisation 4746 3253 2159
EBITDA 4,773 3,793 2,263
Cash Flow from Operating Activities 6,842 5,475 4,180
8.7 Free Cash Flow

A useful addition to the statement of cash flows is the computation of free cash flow. While there is
disagreement on its exact definition, one of the more useful measures of free cash flow is:
Cash flows from operations

Less: Net capital expenditures required to maintain productive capacity
Less: Dividends on preferred stock and common stock (assuming a payout policy)
= Free cash flow (FCF)
Another definition that is widely used and similar in concept is:
FCF = NOPAT – Change in NOA
Exercise 78
Use both of the definitions of free cash flow just given and find amazon.com’s free cash flow: interpret
and explain your results.
8.8 Specialised Cash Flow Ratios

8.8.1 Cash Flow Adequacy Ratio
Exercise 79
For 2012, 2013 and 2014 the cash flow adequacy ratio for amazon.com is…how much?
Find the adequacy ratio for 2010 to 2014 now: is the situation better or worse?
89
8.9 Cash Reinvestment Ratio

Exercise 80
Fill in the gaps in the following two paragraphs for 2014:
amazon.com’s statement of cash flows is a useful starting point for cash flow analysis. amazon.
com generated $_____ billion from operating activities. It then used $_____ billion for investing
activities, primarily for capital expenditure and payment for acquisitions. amazon.com also
received $_____ billion from debt issuance. Overall, amazon.com’s financing activities resulted
in a net cash in/outflow to the tune of $_____ billion. After accounting for foreign currency
exchange rate fluctuations, amazon.com’s cash flow in/decreased by $_____ billion during 2014.
This preliminary analysis shows that amazon.com generated a little/a lot of cash flows from its
operations. After using some of it for capital expenditure and acquisitions, the rest of the generated
cash was ____________________________________.
8.9 Valuation
8.9.1 Valuation Models
Equity Valuation
Exercise 81
Amazon.com pays no dividends so let’s try a theoretical example to use the dividend discount model:
An investor plans to hold DW plc’s stock for 3 years. In that time period, DW plc plans to grow at a rate
of 6% in the first two years and 3% thereafter. DW plc’s last dividend was $0.25. Given a rate of return
of 10%, what is the value of DW plc’s common stock at the end of the three year time period?
8.10 Free Cash Flow to Equity Model

Exercise 82
Back to amazon.com: find the value of amazon.com using its 2014 and then 2013 data by using the above
Free Cash Flow to Equity Model formula assuming that k = 7.5%
90
8.11 Residual Income Model

Exercise 83
At the end of year 2014, Beagle Co owns 51% of the equity of Retriever, an entirely equity financed company. By
agreement with Retriever’s shareholders, Beagle agrees to acquire the remaining 49% of Retriever shares at the end of
year 2019 at a price of $25 per share. Retriever also agrees to maintain annual cash dividends at $1 per share through
2019. An analyst makes the following projections for Retriever. At this same time (end of year 2014), we wish to compute
the intrinsic value of the remaining 49% of Retriever’s shares using the alternative valuation models (assume a cost of
capital of 10%).
(in $ per share) 2014 2015 2016 2017 2018 2019
Dividends - 1.00 1.00 1.00 1.00 1.00
Operating cash flows - 1.25 1.50 1.50 2.00 2.25
Capital expenditures - - - 1.00 1.00 -
Increase (decrease) in long term debt (0.25) (0.50) 0.50 (1.25)
Net income - 1.20 1.30 1.40 1.50 1.65
Book value 5.00 - - - - -
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EXCEL you should use the following Excel files for this section
common_size_intro.xlsx
amazon_2014_ann_qtr.xlsx
8.12 Common Size Financial Statement Analysis

Exercise 73
Create common Size Statements for the following examples:

Sales 123,116 73,371
Cost of Sales 115,027 62,314
Gross Profit 13,336 11,057
Administration 5,459 4,844
Selling 2,840 2,641

Inventories 8,500 6,872
Receivables 4,454 3,948
Bank 8,001 4,132
Total Current Assets 20,955 14,952
Property, Plant and Equipment 36,846 30,494
Intangibles 7,076 6,656
Total Non Current Assets 43,922 37,150
Total Assets 64,877 52,102
Payables 3,229 2,857
Accruals 1,417 1,289
Loans 7,412 4,061
Total Current Liabilities 12,058 8,207
Debt 30,719 23,494
Long Term Creditors 13,474 12,132
Total Non Current Liabilities 44,193 35,626
Equity 32,742 24,683
Total Liabilities and Equity 64,877 52,102
92

Net Income 14,344 10,866
Non Cash Adjustments 4,307 2,655
Changes in working capital 10,350 7,082
Cash from Operations 29,001 20,603
Investing – –
Net cash from investing activities (13,438) (7,947)

Financing – –
Net Cash from financing activities 15,786 9,755
Net Cash 31,349 22,411
Opening cash balance (24,324) (19,132)

Closing cash balance 8,001 4,132
Solutions
Sales 100.00% 100.00%
Cost of Sales 93.43% 84.93%
Gross Profit 10.83% 15.07%
Administration 4.43% 6.60%
Selling 2.31% 3.60%

Inventories 13.10% 13.19%
Receivables 6.87% 7.58%
Bank 12.33% 7.93%
Total Current Assets 32.30% 28.70%
Property, Plant and Equipment 56.79% 58.53%
Intangibles 10.91% 12.77%
Total Non Current Assets 67.70% 71.30%
Total Assets 100.00% 100.00%
Payables 4.98% 5.48%
Accruals 2.18% 2.47%
Loans 11.42% 7.79%
Total Current Liabilities 18.59% 15.75%
Debt 47.35% 45.09%
Long Term Creditors 20.77% 23.29%
Total Non Current Liabilities 68.12% 68.38%
Equity 50.47% 47.37%
Total Liabilities and Equity 100.00% 100.00%
93

Net Income 49.46% 52.74%
Non Cash Adjustments 14.85% 12.89%
Changes in working capital 35.69% 34.37%
Cash from Operations 100.00% 100.00%
Investing
Net cash from investing activities -46.34% -38.57%
Financing
Net Cash from financing activities 54.43% 47.35%
Net Cash 108.10% 108.78%
Opening cash balance -83.87% -92.86%
Closing cash balance 27.59% 20.06%
Here are screenshots of the common size statements you should prepare:
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8.13 Ratio Analysis

Exercise 74
1. DW plc’s year end balance sheets show the following:
2016 2015 2014

Cash 30,800 35,625 36,800
Accounts receivable, net 88,500 62,500 49,200
Merchandise inventory 111,500 82,500 53,000
Prepaid expenses 9,700 9,375 4,000
Plant assets, net 277,500 255,000 229,500
Total assets 518,000 445,000 372,500
Long term notes payable secured by mortgages on plant assets 97,500 102,500 82,500
Common stock, $10 par value 162,500 162,500 162,500
Retained earnings 129,100 104,750 78,250
Total liabilities and equity 518,000 445,000 372,500
Required
Compare the year end short term liquidity position of DW plc at the end of 2016, 2015 and 2014 by
computing the:
a) current ratio and

b) acid test ratio.
Comment on the ratio results.
2. Refer to the information in part 1 about DW plc. The company’s income statements for the
years ended 31st December 2016 and 2015 show the following:
2016 2015
Sales 672,500 530,000
Cost of goods sold 410,225 344,500
Other operating expenses 208,550 133,980
Interest expense 11,100 12,300
Income taxes 8,525 7,845
Total costs and expenses (638,400) (498,625)
Net income 34,100 31,375
Earnings per share 2.10 1.93
95
Required
For the years ended 31st December 2016 and 2015, assume all sales are on credit and then compute the
following:
a) collection period
b) accounts receivable turnover
c) inventory turnover and
d) days’ sales in inventory. Comment on the changes in the ratios from 2015 to 2016.
3. Refer to the information in parts 1 and 2 about DW plc. Compare the long term risk and
capital structure positions of the company at the end of 2016 and 2015 by computing the
following ratios:
a) total debt ratio

b) times interest earned
4. Refer to the financial statements of DW plc in parts 1 and 2. Evaluate the efficiency and
profitability of the company by computing the following:
a) net profit margin,

b) total asset turnover
c) return on total assets
5. Refer to the financial statements of DW plc in parts 1 and 2. The following additional information
about the company is known:

Common stock market price 31 December 2015
st
14.00
96
To help evaluate the profitability of the company, compute the following for 2016 and 2015:
a) return on common stockholders’ equity

b) price earnings ratio on December 31 and
c) dividend yield.
1 2016 2015 2014

(a) current ratio 1.87 2.52 2.90
(b) acid test ratio 1.00 1.43 1.83
Comment Liquidity has systematically reduced over the three years
2 2016 2015 2014
(a) accounts receivable turnover 48.03 43.04
(b) inventory turnover 99.21 87.41
Comment both receivables and inventories are slower to turn into cash
3 2016 2015 2014
(a) total debt ratio 18.82% 23.03%
(b) times interest earned 18.17 17.12
Comment total debt has fallen, relatively and the TIE ratio has improved
4 2016 2015 2014
(a) net profit margin 5.07% 5.92%
(b) total asset turnover 1.30 1.19
(c) return on total asset 38.93% 47.31%
Comment Profitability has reduced whilst total asset turnover has improved
5 2016 2015 2014
(a) return on common stockholders’ equity 11.69% 11.74%
(b) price earnings ratio on December 31 7.14 7.25
(c) dividend yield. 4.00% 2.14%
Comment Returns to shareholders have improved
97
8.14 Cash Flow Analysis

Exercise 75
Let’s look at a Statement of Cash Flows: again we will use amazon.com because they are a very well
known organisation:
AMAZON.COM INC (AMZN) Statement of CASH FLOW

Fiscal year ends in December. USD in millions except per share data. 2014-12 2013-12 2012-12
Cash Flows From Operating Activities
Net income (241) 274 (39)
Depreciation & amortization 4,746 3,253 2,159
Investments losses (gains) (3) 1 (9)
Deferred income taxes (316) (156) (265)
Stock based compensation 1,497 1,134 833
Accounts receivable
360° (1,039) (861)
.
Inventory (1,193) (1,410) (999)
thinking
Accrued liabilities 706 736 1,038
Other working capital 741 (447) 275
Other non-cash items 185 202 (22)
Net cash provided by operating activities 6,842 5,475 4,180
360°
thinking . 360°
thinking .
Discover the truth


Cash Flows From Investing Activities

Investments in property, plant, and equipment (4,893) (3,444) (3,785)
Acquisitions, net (979) (312) (745)
Purchases of investments (2,542) (2,826) (3,302)
Sales/Maturities of investments 3,349 2,306 4,237
Net cash used for investing activities (5,065) (4,276) (3,595)
Cash Flows From Financing Activities
Long-term debt issued 6,359 394 3,378
Long-term debt repayment (1,933) (1,011) (588)
Excess tax benefit from stock based compensation 6 78 429
Common stock issued
Repurchases of treasury stock (960)
Other financing activities
Net cash provided by (used for) financing activities 4,432 (539) 2,259
Effect of exchange rate changes (310) (86) (29)
Net change in cash 5,899 574 2,815
Cash at beginning of period 8,658 8,084 5,269
Cash at end of period 14,557 8,658 8,084
Free Cash Flow
Operating cash flow 6,842 5,475 4,180
Capital expenditure (4,893) (3,444) (3,785)
Free cash flow 1,949 2,031 395
Match the descriptions above with this summary statement of cash flows for the years 2012 – 2014 for
amazon.com:
• What did it generate from operations?

• How much has the company spent on CAPEX, capital expenditure?
• Has it received or paid out money to its financiers/shareholders?
Total Cash Generated from Operations, spent on CAPEX and received or paid out for financing are
as follows

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99
8.15 Analysis of the Statement of Cash Flows

In evaluating sources and uses of cash, the analyst should focus on questions like:

Exercise 76
Take a look at the above questions and apply them to amazon.com: what are your findings?
In all three years there is enough money from operating activities to finance the CAPEX
They have been issuing debt over these three years
No because we have already seen that it can generate cash from operating activities
It is investing in CAPEX in all three years
New financing comprises debt
There are no dividends and other items do not seem to be sensitive to cash flows
100
8.16 Alternative Cash Flow Measures

Exercise 77
Calculate EBITDA for amazon.com just to compare it with the real cash flow from operations figures!
2014 2013 2012

Net Income -241 274 -39
Taxation 177 169 112
Interest 91 97 31
Depreciation/Amortisation 4746 3253 2159
EBITDA 4,773 3,793 2,263
8.17 Free Cash Flow

TMP PRODUCTION NY026057B 4 12/13/2013
6 xA
4 useful addition to the statement of cash flows is the computation of free cashPSTANKIE
flow. While there is ACCCTR00
disagreement
gl/rv/rv/baf on its exact definition, one of the more useful measures of free cash flowBookboon
is: Ad Creative
Cash flows from operations

Less: Net capital expenditures required to maintain productive capacity
Less: Dividends on preferred stock and common stock (assuming a payout policy)
= Free cash flow (FCF)

© 2013 Accenture.


Another definition that is widely used and similar in concept is:
FCF = NOPAT – Change in NOA
Exercise 78
Use both of the definitions of free cash flow just given and find amazon.com’s free cash flow: interpret
and explain your results.
2014 2013 2012

Net capital expenditures required to maintain productive capacity 4,893 3,444 3,785
Free cash flow (FCF) 1,949 2,031 395
8.18 Specialised Cash Flow Ratios

8.18.1 Cash Flow Adequacy Ratio
Exercise 79
For 2012, 2013 and 2014 the cash flow adequacy ratio for amazon.com is… how much?
Find the adequacy ratio for 2010 to 2014 now: is the situation better or worse?
2014 2013 2012 2011 2010

CASH FLOW ADEQUACY (1.87) (2.81) (4.26) 24.86 26.77
This calculation is done in the amazon_results.xlsx file
The situation is getting worse now.
8.19 Cash Reinvestment Ratio

Exercise 80
Fill in the gaps in the following two paragraphs for 2014:
com generated $_____ billion from operating activities. It then used $_____ billion for investing
received $_____ billion from debt issuance. Overall, amazon.com’s financing activities resulted
in a net cash in/outflow to the tune of $_____ billion. After accounting for foreign currency
exchange rate fluctuations, amazon.com’s cash flow in/decreased by $_____ billion during 2014.
102
This preliminary analysis shows that amazon.com generated a little/a lot of cash flows from its
operations. After using some of it for capital expenditure and acquisitions, the rest of the generated
cash was ____________________________________.
Suggested Solution
com generated $6.842 billion from operating activities. It then used $5.065 billion for investing
received $4.426 billion from debt issuance. Overall, amazon.com’s financing activities resulted in
a net cash inflow to the tune of $6.209 billion. After accounting for foreign currency exchange
rate fluctuations, amazon.com’s cash flow increased by $5.899 billion during 2014.
This preliminary analysis shows that amazon.com generated a lot of cash flows from its operations.
After using some of it for capital expenditure and acquisitions, the rest of the generated cash was
from the issuance of new debt.
8.20 Valuation
8.21 Valuation Models
Equity Valuation
Exercise 81
Amazon.com pays no dividends so let’s try a theoretical example to use the dividend discount model:
An investor plans to hold DW plc’s stock for 3 years. In that time period, DW plc plans to grow at a rate
of 6% in the first two years and 3% thereafter. DW plc’s last dividend was $0.25. Given a rate of return
of 10%, what is the value of DW plc’s common stock at the end of the three year time period?
Solution
To begin, the dividend in each time period must be calculated [D = D0(1+g)]
D1 = (0.25)(1.06) = 0.265

D2 = (0.265)(1.06) = 0.281
D3 = (0.281)(1.03) = 0.289
103
Since we expect the dividend to grow indefinitely in year 3 and on, the present value of the stock price
in year 3 is calculated as follows:
P3 = 0.289 = 4.133

(0.10-0.03)
The value of DW plc’s common stock is as follows:
DW plc’s common stock

8.22 Free Cash Flow to Equity Model

Exercise 82
Back to amazon.com: find the value of amazon.com using its ten year data by using the Free Cash Flow
to Equity Model formula assuming that k = 7.5%

ሺ‫ݐܧܨܥܨ‬൅ͳ ሻ ሺ‫ݐܧܨܥܨ‬൅ʹ ሻ ሺ‫ݐܧܨܥܨ‬൅͵ ሻ
ܸ‫ ݐ‬ൌ ൅ ൅ ൅ ‫ڮ‬
ሺͳ ൅ ݇ሻͳ ሺͳ ൅ ݇ሻʹ ሺͳ ൅ ݇ሻ͵
where FCFEt+n is free cash flow to equity in period t+n and k is cost of capital.
104
8.23 Residual Income Model

Exercise 83
At the end of year 2014, Beagle Co owns 51% of the equity of Retriever, an entirely equity financed company. By agreement
with Retriever’s shareholders, Beagle agrees to acquire the remaining 49% of Retriever shares at the end of year 2019 at a
price of $25 per share. Retriever also agrees to maintain annual cash dividends at $1 per share through 2019. An analyst
makes the following projections for Retriever. At this same time (end of year 2014), we wish to compute the intrinsic
value of the remaining 49% of Retriever’s shares using the alternative valuation models (assume a cost of capital of 10%).
(in $ per share) 2014 2015 2016 2017 2018 2019

Dividends - 1.00 1.00 1.00 1.00 1.00
Operating cash flows - 1.25 1.50 1.50 2.00 2.25
Capital expenditures - - - 1.00 1.00 -
Increase (decrease) in long term debt (0.25) (0.50) 0.50 (1.25)

Net income - 1.20 1.30 1.40 1.50 1.65
Book value 5.00 - - - - -
Solution
Since Beagle will acquire Retriever at the end of 2009 for $25 per share, the terminal value is set – this spares us the
task of estimating continuing (or terminal) value. Using the dividend discount model, we determine intrinsic value at
the end of year 2004 as:

Next, to apply the free cash flow to equity model, we compute the following amounts for Retriever:
(in $ per share) 2015 2016 2017 2018 2019

Operating cash flows* 1.25 1.50 1.50 2.00 2.25
- Capital expenditures* - - (1.00) (1.00) -
± Debt increase (decrease) (0.25) (0.50) 0.50 - (1.25)
= Free cash flow to equity 1.00 1.00 1.00 1.00 1.00
* Amounts taken from analyst’s projections.
The excess cash flows not needed for the payment of dividends are used to reduce long term debt. The free cash flows
to equity, then, are the cash flows available to pay the dividend requirement of $1. Then, using the free cash flows to
equity model, we determine the value of the firm as:

The free cash flows to equity model values the cash flows generated by the firm, whether or not paid out as dividends.
105
Finally, to apply the residual income model, we compute the following amounts for Retriever:
(in $ per share) 2015 2016 2017 2018 2019

Net income* 1.20 1.30 1.40 1.50 1.65
- Capital charge (10% of beg. book value*) (0.50) (0.52) (0.55) (0.59) (0.64)
= Residual income 0.70 0.78 0.85 0.91 1.01
+ Gain on sale of equity to Pitbull (terminal value) 17.95+
*Amounts taken from analyst’s projections.

+
$25 _ $7.05.
Using the residual income model, we compute intrinsic value at the end of year 2014 as:

All three models yield the same intrinsic value.

eLibrary


Exercise Book With Solutions Benchmarking of Financial and Non Financial Performance
9 Benchmarking of Financial and

Non Financial Performance
9.1 Key Result Indicators
What are KRI& KRIs are measures that have often been mistaken for KPIs, including
• Customer satisfaction
• Net profit before tax
• Profitability of customers
Exercise 84
Give two more examples of KRIs.
Exercise 85
From what you have already read, try to define what you mean by PIs…
9.2 Seven Characteristics of KPIs

From extensive analysis and from Parmenter’s discussions with over 1,500 participants in his KPI
workshops, covering most organisation types in the public and private sectors, he defines seven KPI
characteristics:
1. Nonfinancial measures (not expressed in dollars, yen, Dollars, euros, etc.)

2. Measured frequently (eg daily or 24/7)
3. Acted on by the CEO and senior management team
4. Understanding of the measure and the corrective action required by all staff
5. Ties responsibility to the individual or team
6. Significant impact (e.g. affects most of the core critical success factors [CSFs] and more than
one BSC perspective)
7. Positive impact (e.g. affects all other performance measures in a positive way)
Exercise 86
Explain any two of these seven characteristics to someone who is considering implementing a system
of KPIs in their organisation.
107
9.3 Balanced Scorecard

Exercise 87
Now that you have heard of one, what, then, is a Balanced Scorecard?
9.4 Beyond Budgeting

Exercise 88
Beyond Budgeting can be a great source of liberation and empowerment for some organisations. Find
examples of organisations that have used the Beyond Budgeting system and explore the successes they
claim to have had. The Beyond Budgeting Round Table web site is a good starting point: www.bbrt.org
and take a look at this book by the originators of Beyond Budgeting: Jeremy Hope and Robin Fraser
(2003) Beyond Budgeting Harvard Business School Press. That book is a little old now but still an excellent
primer for the subject.
Exercise 84
Give two more examples of KRIs.
Suggestions:
Employee satisfaction
Return on capital employed
Performance indicators that lie beneath KRIs could include:
• Profitability of the top 10% of customers

• Net profit on key product lines
• Percentage increase in sales with top 10% of customers
• Number of employees participating in the suggestion scheme
Exercise 85
From what you have already read, try to define what you mean by PIs…
Performance indicators are mid level metrics that sit between KRIs and KPIs and can include Profitability
by product group or by product.
108
9.5 Seven Characteristics of KPIs

From extensive analysis and from Parmenter’s discussions with over 1,500 participants in his KPI
workshops, covering most organisation types in the public and private sectors, he defines seven KPI
characteristics:

9. Measured frequently (e.g. daily or 24/7)

Exercise 86
Explain any two of these seven characteristics to someone who is considering implementing a system
of KPIs in their organisation.
You are given outline solutions to the first four of these characteristics!
A non financial measure is a metric or result which has nothing directly to do with money.
Very simple examples include output per hour, reject rates, kilometres per hour
2. Measured frequently (e.g. daily or 24/7)
Imagine making a product at the rate of 1,000 units per minute for which the humidity content
is critical…such products are likely to be measured/tested every few seconds.
This includes any measure or indicator that both affects the CEO’s performance rating and/or
that could bring things to a halt if they were to go out of control.
Even though a metric is written up on a notice board for all to see does not mean that everyone
appreciates the numbers there and when action has to be taken, let alone what that action
ought to be.
Try the rest of these examples for yourself.
9.6 Balanced Scorecard

Exercise 87
Now that you have heard of one, what, then, is a Balanced Scorecard?
110
A Balanced Scorecard is a management system that enables your organisation to set, track, and achieve
its key business strategies and objectives. After the business strategies are developed, they are deployed
and tracked through the Four Legs of the Balanced Scorecard perspectives:
Customers
Finance
Internal Business Processes
Learning and Growth
9.7 Beyond Budgeting

Exercise 88
Beyond Budgeting can be a great source of liberation and empowerment for some organisations. Find
examples of organisations that have used the Beyond Budgeting system and explore the successes they
claim to have had. The Beyond Budgeting Round Table web site is a good starting point: www.bbrt.org
and take a look at this book by the originators of Beyond Budgeting: Jeremy Hope and Robin Fraser
(2003) Beyond Budgeting Harvard Business School Press. That book is a little old now but still an excellent
primer for the subject.
AXA Global
Graduate Program

Exercise Book With Solutions Review Annual Report and Accounts
10 Review Annual Report

and Accounts
Exercise 89
Download an organisation’s Annual Report and Accounts and find other examples of non financial data
to review.
10.1 Qualitative analysis of financial and non financial data

We will use the Chairman’s letter from the amazon.com annual report and accounts 2014 as the basis
of our discussion here.
10.2 2014 Chairman’s letter from the amazon.com

Locate the file AMAZON_2014_chair_letter.pdf in the notes that accompany this section: it is the annual
letter to stockholders from the CEO of amazon.com for 2014.
Exercise 90
Summarise the CEO’s letter under the four headings you will find in the letter:
• Marketplace
• Amazon Prime
• Career Choice
In your summaries, stress the aspects of the qualitative analysis of both financial and non financial data.
Conclude by saying whether you think this letter is credible. Do you think the CEO is being open and
honest? Do you feel that amazon.com is in good hands for the future?
Exercise 91
In the BT Group plc annual report for 2014 there are many tables of data showing five year results. Find
the file trends_fin_nonfin_2015_BT_ann_rep.pdf in the notes to this section and review what you see
there. Create your own summaries, possibly including graphs and charts, to highlight what you have
found. The key headings from this file include:
112
Selected Financial Data
Summary group income statement

Summary group balance sheet
Financial and Operational Statistics
Financial statistics
Financial ratios
Operational statistics
Exercise 92
By contrast to the work of exercise 91, here are some data from amazon.com that is completely different
from the BT Group plc data and tables
a) The summary five year income statement and highly summarised balance sheets for five years
follow: comment on what you see here, include graphs and charts and any other device that
you feel will enhance your message.
113
b) Comment on the usefulness of the data in the following table and explain what you think they
mean for the average stockholder.
c) Summarise the following table: the aim is to simplify the table for the average non financial
manager.
114
10.3 Sensitivity Analysis in Forecasting Financial Statements

Exercise 93
Take the following base data and make the changes that are suggested below them to see the possible
impacts these changes might have which in turn might suggest the sensitivity of, for example, changes
in profitability or cash flow to changes in costs, assets, equity or even non financial results.
DW plc Year Ended 31st December 2016 ($m)

Base Case
Sales 2,110
Cost of goods sold 1,161
Selling, general and administrative expense 528
Depreciation 121
Research and development 84
Total costs and expenses 1,894
Operating Income 216
Interest expense 34
Interest (income) (5)
Earnings before Income Taxes 187
Provision for Income Taxes 64
Net Income 123
The Wake

Given the base case above, calculate the:
1. independent effects of a 1% increase in Gross Margin, a 1% decline in the tax rate, and a 5%
increase in Sales.
decrease in Sales.
3. composite effects of a 5% increase in Sales, a 2% decline in Gross Margin, a 5% increase is
SG&A as % of Sales, and a 2% decline in the tax rate.
4. independent effects of a 1% increase in Gross Margin, a 1% increase in the tax rate, and a 5%
increase in Sales.
5. composite effects of a 5% increase in Sales; a 2% decline in Gross Margin, a 3% increase is
Exercise 89
Download an organisation’s Annual Report and Accounts and find other examples of non financial data
to review.
Why not look at the BT Group plc annual report that’s mentioned in Exercise 91 and please make sure
you do this AND study what you download. If your organisation has an annual report and accounts
online, take a look at that one as well as any others.
10.4 Qualitative analysis of financial and non financial data

We will use the Chairman’s letter from the amazon.com annual report and accounts 2014 as the basis
of our discussion here.
10.5 2014 Chairman’s letter from the amazon.com

Locate the file AMAZON_2014_chair_letter.pdf in the notes that accompany this section: it is the annual
letter to stockholders from the CEO of amazon.com for 2014.
Exercise 90
Summarise the CEO’s letter under the four headings you will find in the letter:
• Marketplace
• Amazon Prime
• Career Choice
116
In your summaries, stress the aspects of the qualitative analysis of both financial and non financial data.
Conclude by saying whether you think this letter is credible. Do you think the CEO is being open and
honest? Do you feel that amazon.com is in good hands for the future?
There is no solution to present here since there are subjective elements to the answer that only you can
provide for yourself.
Exercise 91
In the BT Group plc annual report for 2014 there are many tables of data showing five year results.
Find the file trends_fin_nonfin_2015_BT_ann_rep.pdf in the notes to this section and review what you
see there. Create your own summaries, possibly including graphs and charts, to highlight what you have
found. The key headings from this file include:
Selected Financial Data

Summary group income statement
Summary group balance sheet
Financial and Operational Statistics

Financial statistics
Financial ratios
Operational statistics
Exercise 92
By contrast to the work of exercise 91, here are some data from amazon.com that is completely different
from the BT Group plc data and tables
a) The summary five year income statement and highly summarised balance sheets for five years
follow: comment on what you see here, include graphs and charts and any other device that
you feel will enhance your message.
117

b) Comment on the usefulness of the data in the following table and explain what you think they
mean for the average stockholder.
c) Summarise the following table: the aim is to simplify the table for the average non financial
manager.
By now you should be so good at these kinds of analysis that you no longer need help from me: in fact,
you will find some very good clues and advice in the BT Group report anyway.
119
10.6 Sensitivity Analysis in Forecasting Financial Statements

Exercise 93
Take the following base data and make the changes that are suggested below them to see the possible
impacts these changes might have which in turn might suggest the sensitivity of, for example, changes
in profitability or cash flow to changes in costs, assets, equity or even non financial results.
DW plc Year Ended 31st December 2016 ($m)

Base Case
Sales 2,110
Cost of goods sold 1,161
Selling, general and administrative expense 528
Depreciation 121
Research and development 84
Total costs and expenses 1,894
Operating Income 216
Interest expense 34
Interest (income) (5)
Earnings before Income Taxes 187
Provision for Income Taxes 64
Net Income 123
Given the base case above, calculate the:
increase in Sales.
2. 2 independent effects of a 2% increase in Gross Margin, a 2% decline in the tax rate, and a
5% decrease in Sales.
3. 3 composite effects of a 5% increase in Sales, a 2% decline in Gross Margin, a 5% increase is
4. 4 independent effects of a 1% increase in Gross Margin, a 1% increase in the tax rate, and a
5% increase in Sales.
5. 5 composite effects of a 5% increase in Sales; a 2% decline in Gross Margin, a 3% increase is
120


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Finance for the Non Financial Manager

2 Building the Accounting Picture 10

3 Building Financial Statements 18

5 Correlation and Correlation Matrices

6 Technical and Fundamental Analysis 45

© Deloitte & Touche LLP and affiliated entities.

Deloitte & Touche LLP and affiliated entities.

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7 Financial Statements: basis of analysis 47

8 Financial Statements Analysis: in detail 83

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8.14 Cash Flow Analysis 98

9 Benchmarking of Financial and Non Financial Performance 107

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10 Review Annual Report and Accounts 112

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6. This financial statement is an example of part of a balance sheet. True or false?

2 Building the Accounting Picture

Choose the answer you believe to be correct:

The bookkeeping and accounting cycle comprises

a) Invoices, returns notes, petty cash vouchers, journals vouchers

Choose the answer you believe to be correct:

a) Statement of Comprehensive Balances and Statement of Changes in Equity

Choose the answer you believe to be correct:

Choose the answer you believe to be correct:

a) Total Assets = Total Liabilities – Capital

Choose the answer you believe to be correct:

In a balance sheet, the word current means

a) Try to find the names of two methods of calculating depreciation.

Give an example of how the prudence concept might work in reality.

Suggest an example of why the entity concept is so important for a business.

How did you do? Here are the answers:

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c) Try to find the names of two methods of calculating depreciation.

Give an example of how the prudence concept might work in reality.

Suggest an example of why the entity concept is so important for a business.

DW plc Balance Sheet as at 31st December 2014

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3 Building Financial Statements

Item Balance Income Statement of

Item Balance Income Statement of

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How did you do? Here are the answers:

Item Balance Income Statement of

Item Balance Income Statement of

Exercise 34 Complete the following table of ratios:

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Exercise 37 What do you make of those results?

Exercise 40 Trends in Equity Shares?

4.1 Business Activities

4.2 Planning Activities

5 Correlation and Correlation Matrices

6 Technical and Fundamental Analysis 45

7 Financial Statements: basis of analysis 47

8 Financial Statements Analysis: in detail 83

9 Benchmarking of Financial and Non Financial Performance 107

10 Review Annual Report and Accounts 112

5 Correlation and Correlation

6 Technical and Fundamental