ZETA CORPORATION Notes to Consolidated Financial Statements (S thousands) Notel:
ID: 2594865 • Letter: Z
Question
ZETA CORPORATION Notes to Consolidated Financial Statements (S thousands) Notel: Change in accounting principle During 2011 the company broadened its definition of overhead costs to be included in the determination of inventories to more properly match costs with revenues. The effect of the change in 2011 is to increase income from continuing operations by $400. The adjustment of $1,000 (after reduction for income taxes of $1,000) for the cumulative effect for prior years is shown in the net income for 20 Note 2: Inventories Inventories are priced at cost (principally last-in, first-out [LIFO] method of determination) not in excess of replacement market. If the first-in, first-out (FIFO) method of inventory accounting had been used, inventories would have been S6,000 and $4,500 higher than reported at December 31, 2011 and December 1, 2010 respectively. Note 3: Acquisition of TRO Company Effective December 31, 2011, the company purchased most of the outstanding common stock of TRO Company for $8,000 in cash. The excess of the acquisition cost over fair value of the net assets acquired $2,000 will be recorded as goodwill and not amortized. The following unaudited supplemental pro forma information shows the condensed results of operations as though TRO Company had been acquired as of January 1, 2010.
Explanation / Answer
1. For conducting a comprehensive financial ratios analysis full set of financial statements are necessary. Notes to financial statements are just supplementary information to the mainstream statements and cannot replace the primary financial statements. However, I am trying to give a brief outline of how the analysis is done under general circumstances.
The ratios that are used for these purpose can be in the form of Liquidity/Solvency ratios, Activity ratios etc. Under liquidity ratios, current ratio, quick ratio, cash ratio etc. fall. Accounts receivables turnover ratio, Accounts payable turnover ratio, Fixed asset turnover ratio etc. come under activity ratios.
Current ratio measures the degree to which current assets cover current liabilities
CR = Current Assets / Current Liabilities
Quick (Acid Test) ratio examines the liquidity from a more immediate aspect than does the current ratio by eliminating inventory from current assets.
QR = (Cash + Marketable securities + Accounts receivable) / Current liabilities
Cash ratio compares only cash and marketable securities to current liabilities eliminating receivables and inventory from the asset portion.
CR = (Cash + Marketable securities) / Current liabilities
Accounts receivable turnover ratio measures the average number of times that receivables from sales are collected during a year.
A/R Turnover = Credit sales / Average gross accounts receivable
Inventory turnover ratio measures the average number of times that inventory was sold during a year.
Inventory Turnover = Cost of Goods Sold / Average inventory
Accounts payable turnover ratio measures the average number of times that payables are paid during a year.
A/P Turnover = Credit purchases / Average accounts payable
2. From the investor’s perspective, growing companies are to be considered from a variety of range from its operations, liquidity in short run and solvency in the long run, profitability, customer acquisition, market shares etc.
Investors are also keenly interested to know about the earnings per share amounts.
Basic earnings per share expresses net income on a per-share basis. Portion of a company’s profit for each outstanding shares of common stock.
Basic EPS = (Net income – Preferred dividends) / Weighted average number of common shares outstanding
Diluted earnings per share measures net income on a per share basis if all convertible securities were exercised. These securities include convertible preferred stock, convertible bonds, stock options and warrants.
Diluted EPS = (Net income – Preferred dividends) / Diluted weighted average number of common shares outstanding
3. Profitability ratios calculate gross profit margin, net profit margin, operating profit margin, ROA, ROE etc.
ROA indicates how a company is using its assets to generate earnings. Measures the amount of net income returned as a percentage of total assets
Return on Assets = Net Income / Average total assets
ROE amount of net income returned as a percentage of shareholder’s equity
Return on Equity = Net income / Average Equity
$10000 / {($24000 + $27000)/2} = 39.22%
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