Accounting 2 – ACCT 122 – Program #222 – Financial Statement Analysis – Conclusion

Hey, here we are! How are y'all?
>>Very good. >>Very good?
>>Fantastic? >>Um hmm.
>>You know I watched the last, this is Lecture 222, is that right? I watched the previous
lecture on Chapter 17. I gave you a lot of information in a short amount of time, did
I not? >>Um hmm.
>>Okay, so I apologize for that. There's really no good stopping point anywhere in there and
I needed to get all that information in. For you folks at home, you have the advantage
of, if you ever need to just take a break and, you know, go and have a glass of wine
or something, just push pause, okay? 'Cause I know I threw a lot of information at you,
okay? So, and I was pretty– doing it pretty rapidly, okay? Like I said, on this chapter,
on Chapter 17, Financial Statement Analysis, it's an extremely important subject and I
wish I could do more than just introduce it but we have a finite amount of time and I
have a set amount of material that I have to get through in Accounting 2 and I just,
we can't spend much more time on it and, it's a little bit that way with the cash flow statement
too, even though it may seem like we spent a lot of time there.

But you readdress both
of those subjects in Managerial Accounting. If you take Managerial Accounting and if you're
getting an accounting degree and maybe even a business degree, you'll have to do that.
How many people have to take Managerial Accounting, raise your hands? Okay, more than half of
you. So again, I acknowledge that this is simply an introduction to financial statement
analysis, okay? Let's go ahead and go through the homework, alright? I will try to stop
and take a few deep breaths this lecture so it's not as frantic as the last one, okay?
Alright. Let's take a look at, the first few were, I think, fairly easy, right? The first
one we did was Quick Study 17-4, is that right? Quick Study 17-4, okay? Compute the annual
dollar changes and percent changes for each of the following accounts, okay? Well, we
can do that.

The dollar change is real easy, right? You just subtract, right? And then
the percent change, you just take the dollar change divided by the base period amount,
okay? Is that what y'all got? Okay. Now this last one, you can not, wait, let me see here,
$88,000 change… why is that not calculable? >>It should be a hundred percent and the $88,000
should be negative. >>Oh, okay, there you go. Alright. I was looking
at my years reversed, okay? So that is not calculable, right? Is that correct? Okay.
Alright, any questions on that? Any questions on that? Okay.
>>How is that not calculable? >>Well, the reason it's not calculable is
this is the base year, right? >>Um hmm.
>>This is the next year so the dollar change is what?
>>$88,000? >>Negative $88,000.
>>Negative $88,000. So negative $88,000 divided by $88,000, I guess that's negative 100%,
right? >>Yeah.
>>Okay, so I guess you really could do it.

The way I read that to begin with, and I wonder
if they almost made a mistake is, I know you can never divide by zero, right? Is that correct?
>>That is very correct. >>So if this would have been zero and this
would have been $88,000, to me that should have been the true not calculable. Do you
agree? >>Um hmm.
>>Okay. So, but I think we know. We good? >>Um hmm, yeah.
>>Okay. You can never divide by zero but I think technically maybe this should've been
a, you know, a negative 100%, okay? But you're not gonna have a whole lot of situations where
it goes from $88,000 to zero anyway, okay? And it's not, you know, you have to take that
measurement with a grain of salt, but… I don't want to spend a whole lot of time on
that but does that make sense? >>Uh hmm.

Alright. >>Do we have a test question on that?
>>I'm not gonna try to trick you or anything. >>Okay.
>>So, but you should be able to figure out the percent changes or whatever, so. I don't
ever try to trick you, do I? No? >>You're the first teacher.
>>Okay, thank you. Alright, let's go through the exercises. Alright, exercise 17-3. Okay,
let's go ahead and take a look at exercise 17-3 which is right here, okay? Compute trend
percents for the following accounts using 2011 as the base year. Round the percents
to whole numbers. State whether the situation as revealed by the trends appears to be favorable
or unfavorable for each account. Okay, well let's go ahead and do that, okay? So we have
our raw data here, right? What we're gonna do here is divide each number on each line
by the 2011 amount, okay? This is the base year, right? And I always like to draw an
arrow from 2011, 12, 13…

Because time is moving this way, right? And I do that because
sometimes other places will list it the other way, won't it? So I just like to clarify,
okay? So you're gonna take each number in each line divided by the base year amount
and that, okay? So take a look at this data, we can see that sales is increasing, we can
see the cost of goods sold is predictably increasing as well as accounts receivable,
predictably, increasing, correct? Once we divide those amounts, we get this data right
here, okay? These are obviously 100% because something divided by itself is 100%.

159% and so on, okay? So check your numbers there for a second, I'll give you a minute
before I talk. Okay. Alright, any questions on that? Let's talk about the interpretation
of it but did you get those numbers? >>No, I got…
>>Yeah, I just took– >>I did it the other way, I did it the way
we did it in the very first problem so I got like 89%, I didn't do like the hundred, so
I used 100% off on all of them. But I had like the 89 but I just, I took–
>>Like where'd you have 89? >>I took, like, so what I did is I took–
>>Took sales 2015. >>So what I did was I took, like, 150 or like
234560 minus 150 took, like, the change– >>Yeah, so what you said, what you said here
is like, well let's just do this one.

You had 56% here? Okay. You had 56% right there.
Well, they're both pretty much saying the same thing. What they're saying is the 2012
amount is 156% of the 2011 amount, okay? And if you want to figure that up, you could just
take, like, 1.56 times that base period amount and that would equal that amount there, okay?
But so you got 56, 68, 81 and 89? >>Uh hmm. I did all of them, too.
>>That's alright, I mean, there are different ways of doing this. There really are different
ways of doing this, okay? So I think you're gonna be able to reach the same conclusions
that we're gonna discuss here by the way you did it, and that is this… let's take a look.
Sales is increasing, clearly sales is increasing, right? Now, we don't, that's good that sales
are increasing. We don't know off the bat, though, if that's a completely favorable thing
because what if our competitors are increasing at a much greater rate, you see what I'm saying?
So you can't just say, "Increase, that's good.

Well, if our competitor's rate of growth is
a lot more than ours then we, I'm glad we had a rate of growth that we grew but we're
lagging behind our competitors so you have to compare it with something else, okay? Now
the other alarming thing here, well we don't know if that's alarming or not, we don't know
the competitor's rate of growth but something that is alarming is that our cost of goods
sold is increasing at a greater rate than our sales. Would you agree?
>>Uh hmm. >>Cost of goods sold is increasing at a greater
rate than our sales so I can tell you what is happening here is that our gross profit,
which is sales minus costs of goods sold or gross margin, same thing, we definitely have
gross margin erosion here, don't we? Okay? Our costs are increasing and we are either
not passing them on to the customer or we're not able to, okay? The other thing is our
receivables are building up at a quicker rate, okay? Our receivables are building up at a
quicker rate.

Why is that happening? I don't know. Maybe we are, maybe we ourselves are
increasing because we're taking on customers that have less credit worthiness, and that
might be a good thing. But we need to know why are our receivables building up quicker
than our sales, okay? So I want you to see, though, that those conclusions really can't
be reached if you're just looking at this, especially that one 'cause that's the wrong
one. It can't be reached if you're looking at, where did it go, this one. The raw data,
okay? If you're just looking at this raw data, you can't really see that gross margin erosion
is occurring, is that correct? Okay? Make sense?
>>Um hmm. >>Alright, so this all a means of transforming
data into a method that can be better understandable and thus you can make better decisions on
it, okay? Cool? Okay, questions on that? Alright, let's go to the next one.

Exercise 17-5, is
that correct? Okay. Exercise 17-5 is right here, okay? Express the following comparative
income statements in common-size percents and assess whether or not this company's situation
has improved in the most recent year. Round the percents to one decimal. Okay? Alright.
Let me say one thing real quick, too, come off the ELMO for a second. How many of you
regularly use Microsoft Excel? Anybody? There's like two hands out of 13, okay, so that's
not even 20%. I give this speech in my Managerial Accounting class but do you ever see somebody
who still hand writes term papers instead of using, like, a word processing? Nobody
does that anymore, right? Okay. Well that's because it's extremely inefficient and crazy
to write out a term paper. We used to do it back in the olden days, okay? But when I see
people, and I did a homework check today, when I see people doing their homework of
this nature and doing it with a calculator and a pencil, I feel the same way as you would
if you saw somebody writing out a 12 page term paper.

Microsoft Excel is the software
you need to know if you're getting a business degree. I mean this is all so much easier
if you use Microsoft Excel, okay? Now if you take Managerial Accounting from me, I actually
am going to teach you Microsoft Excel the first week of class and I'm going to make
you use it the whole semester and at the end of the semester you'll thank me because everything
will be easier. Is it easier to write out, is it easier to type a term paper than write
it out? Yes. Is it easier to use Excel? I bet whatever time you spent doing your homework,
you could've cut it in half if you would have had a working knowledge of Microsoft Excel
so that's my advertisement for Bill Gates and Microsoft Excel, okay? Learn how to use
it, it's a powerful program, okay? Alright, let's take a look at this, though. Okay, they
want us to do vertical analysis and they want us to divide, what we're gonna do is let me
zoom in here a little bit, we're gonna divide each one of these amounts by the sales number
to figure out what percentage of sales it is, is that correct? Okay? So once we do that,
here is what we get.

Zoom out a little bit. Time is going this way. Take a look at your
numbers before I start yakkin', see if you calculated them right. Okay? Anybody get this?
Got this, Crayton? Okay. Did you do it different? >>I didn't even do that at all. I just did
the exact thing that we've been doing, I did, like, the change between the two.
>>That's alright, I don't mind when you make mistakes in your homework. I always say a
mistake you make in your homework is one that you would've made on a quiz or test and you
just got it out of the way, okay? Alright, now, okay any question on how we got any of
these numbers? Okay.

What is the thing that just stands out like a sore thumb here?
>>That the percentage of their net income was significantly lower in 2013 than it was
in 2012. >>Yeah, this is significantly lower than that,
that is major net income erosion as a percentage of sales.
>>Gross profit. >>And it mainly stems from right here, doesn't
it? >>Um hmm.
>>Okay? Our gross profit margin, our gross margin percentage went from 53 1/2 to 24.3?
That is more than half, I mean it's less than half of what it was, right? Okay? Now, is
that a problem? Is that a concern? >>Yeah.
>>Yes, it is a concern.

Now this also, well, hold off, let me… that is obviously a concern
that you need to look into, right? What is happening here? What is happening here? This
will kill your company quickly. Now the only thing I don't like about the way that I see
accounting textbooks teach this information is this, you don't usually see that drastic
of a change in a sample of data of two, does that make sense? In real life what you see
is you see gross margin, if it's getting worse, it's doing this, okay? Okay? It's doing this,
I think we talked about that last time, didn't we? Okay? They only give you two data points
so they're doing this. Well that's fine but that's not real life, okay? Okay? You ever
watch the show "The Biggest Loser?" Have you ever watched that show where people weigh
themselves and then they try to lose weight, okay? I have a son who likes that show and
they'll weigh somebody and they'll weigh 500 pounds and my son says, "How does somebody
get to weigh 500 pounds?" And I said, "Just one pound at a time," right? You don't see
changes as drastic as this in real life.

That person's weight slowly went up. They weren't
190 one day and 500 the next, right? What I wish they would do in these problems is
not concentrate so much on you calculating things but just give you the data that's calculated
and work on analyzing it, does that make sense? But you really need 10– you know I would
have like to have 10 years or have quarterly data for the last five or six years and we
could have really analyzed those trends because that's closer to what real life is.

So they're
making it extreme, but I want you to recognize that in real life, that's probably not gonna
be the case, cool? Alright. And I also want you to recognize that if you are writing this
out using a calculator and a pencil, doing monthly data for the last four years would
be extremely time consuming but if you use Microsoft Excel, boom. It could be very easy
and that's what we do with our clients and it's not that hard but, boy, you could spot
some great trends, some excellent trends doing this stuff, okay? Alright, let's take a look
at, the next ones are 17-7, 8, 9, 10 and 11, is that correct?

>>Okay. So what they do here is, let's take
a look, they give us this balance sheet, okay? They give us this balance sheet. Simon's year-end
balance sheet follows, express, the first thing they want us to do is express the balance
sheet in common-size percents. Round amounts to nearest one-tenth of a percent. That's
the first thing they want us to do so let's do that, okay? Alright, let's take a look
at the answers. Once again, go ahead and check your numbers before I start yakkin'. Okay,
we're dividing every one of those numbers by total assets, right? Okay? Did you get
this one, Jeremiah? >>I didn't start this one.
>>You didn't do this one? Okay.

>>So on the last one, you did it by sales,
on this one you're gonna do it by total assets? >>Yes, when we do common-size, good point,
when we do common-size financial statements with an income statement, we're dividing every
item by sales. On a common-sized balance sheet we're dividing everything by total assets.
>>Okay. >>Okay? Which would be the same thing as total
liabilities plus the equity, right? Okay? So this the numbers that we get. Okay, we're
moving from this way to this way, right? What do we see here? What sort of observations
do we see? Anybody want to throw one out there? >>Accounts receivables going up as well as
their inventory. >>Accounts receivable, okay, has increased
as a percentage of our assets, right? Okay? So this could, you know we want to look into
this, is there some risk of uncollection here? I don't know. Why is this increasing? Now
this is a lot like when you go to the doctor and you do a medical test, okay? The medical
tests might tell you where the problem is and if there is a problem but then the doctor
has to go in and do more analysis on whatever area it is, right? And that's how this is,
we need to go figure out why are receivables increasing? Why are receivables increasing
as a percent? I don't know.

All we know right now is that there are a larger percentage
of total assets, okay? We also know that cash is a smaller percentage of total assets. Now
that may not be a negative thing. Maybe we're putting things into productive plants and
equipment or whatever, okay? Or plant equipment is going down as a percentage of assets as
well, but we need to look into why these are changing, right? Okay? Inventory is a higher
percentage of total assets, isn't it? It's getting larger each time, as well. And payables
is a larger percentage, is that correct? I'm starting to not feel real good about this
Simon Company. Now I don't know yet, I don't know yet but when I see receivables, inventory
and accounts payable increasing as a percentage of total sales, I'm getting a little nervous.
We're gonna do some more analysis, though, on this company, that will help us, okay?
Alright, any questions? >>Does liabilities and equity always equal
the assets? >>Yes.
>>As far as the totals? >>Yes, I mean if you go back to the original
data, your balance sheet has to balance, right? >>Right.
>>So whatever your total assets is has to be the same number as liabilities plus equity.
>>Okay then, thanks.

>>Okay? If the balance sheet doesn't balance
then you've got real big problems, okay? Good question. Okay, let's go to the next one.
The next question 17-8 says they want us to refer to that balance sheet and analyze its
year-end short-term liquidity position at the end of each year by computing the current
ratio and the acid-test ratio. You with me? So let's go ahead and do that. Let's go ahead
and do that. Alright, take a look at the computations to see if you got them right. I always like
to draw arrows whichever way we're moving. >>They all say to one?
>>Say what? >>All year ratios say to one.
>>Oh they say to one? Well, if you say something is 1.88, that's the same thing as 1.88 over
1 or sometimes it's stated as 188.88 to 1, I don't usually use that terminology, I usually
just put these numbers right here, okay? So, good point. Okay? Alright, as far as these
ratios, what do these ratios measure? They both measure the same thing.
>>Your ability to pay debt.

>>Ability to pay debt in the short-term, okay?
Current ratio is current assets divided by current liabilities. The acid-test ratio realizes
and recognizes that not all current assets are equal so they only count in the numerator,
certain items quick assets, which are cash, short-term investments and receivables, okay?
Okay, are things getting better or are things getting worse in regards to these two ratios?
>>Worse. >>They are definitely getting worse. Once
again, the trend is pretty extravagant here, okay, because they wanted to show it, okay?
The trend is pretty obvious, okay? It's usually not that obvious in real life, okay? So I
would be curious to see what the industry ratios are, okay? Can you, let me ask you
this, let's come off there for a second. A current ratio, all things being equal, do
we want a current ratio to be high or low? >>High.
>>High. Can a current ratio or an acid-test ratio, can that ever be too high? Can it ever
be too high? >>What do you mean they're not utilizing their
cash? >>Yes, the answer is, as Henry is addressing
here, the answer is yes, a current ratio could be too high, okay? I mean, think about it,
if let's say a company was getting behind their competitors because they weren't putting
money into new plants and equipment.

They weren't putting cash into research and development,
they weren't working on more efficient processes. They were just hoarding their cash. Would
that make sense? Okay? Does that make sense? You're saying okay that's great that we have
a lot of cash but we're getting behind because we're not putting that cash to use in developing
a new product or developing a more efficient process, okay? Think about it on a personal
level. Let's say every now and then you'll hear of somebody dying and they lived in an
old beat up house and their health was horrible but they had tons of cash.

You ever hear about
that, somebody, and they're usually, like, really elderly? Well is that a healthy situation?
Well they had a lot of cash. Can you have too much cash? Yeah. You should've used some
cash to take care of yourself, to keep up the house that you live in, right? You see
what I'm saying? Here's what it kind of reminds me of. Has anybody here, did anybody here
ever take, like, a weightlifting class? Or anybody ever done that?
>>Um hmm. >>Okay, I took a weightlifting class, believe
it or not, I took a weightlifting class when I was a senior year.

Well we had these guys
in our weightlifting class that we would laugh at kind of behind their backs because here's
the only exercises they did were this: They did the bench press, they did curls and they
did triceps. That was it. Did you ever know guys like that? And they would stand in front
of the mirror, and they would… and meanwhile, they had little chicken legs like Daffy Duck.
Did you ever know guys like this? And you're like, "Hey! Buddy! I know the mirror only
goes from here up. You look ridiculous. How about working a little bit less on the bench
press and working on your legs because you want to be an overall healthy, muscular person,"
right? Did any of you guys lift with people like this? Okay? Okay? So it's a little bit
like the current ratio.

That's great, your current ratio is healthy, if is is, but it's
one measurement, right? Okay, so the current ratio can be too high if the rest of the company
is suffering, right? Your biceps can be too big, okay?
>>Just thinking if your current ratio is really high but you have, like, no debt and that's
why it's high, like, it doesn't matter how much cash you have, it's gonna be super high
because you have no debt, wouldn't that be a case in which it would be okay to have–
>>Yes but here's what I would need to know. What he's asking is, "Well, what if," because
you're acknowledging you don't want to be hoarding a lot of cash if you have a lot of
debt maybe at a high interest rate but what if you have no debt? I still would say this:
How is our property plant and equipment looking? >>Well what if, like, a total percentage of
your assets, that's really high and you only have like maybe five percent of its cash but
you have even less debt than that and so it inflates your current ratio to be super high?
>>Oh, because your current liabilities are low?
>>Because your current liabilities– >>Yeah, you're right there.

Yeah, I see what
you're saying. What if you're saying it's not so much of a result of the numerator being
high, it's the denominator being low? It could be and, again, it's just something that you
have to analyze. >>Have you ever to like a company where you've
had, like, say, your current ratio is too high?
>>I've been a consultant with companies that I said, "You need to not just be focused on,
you need to be developing new products, you're getting behind the competitors.

They're developing
new products and you need to be making sure that you have a plan to invest some of your
cash into research and development or into new fixed assets that are more efficient,"
yeah. Okay? So I think you get the general gist of what I'm saying, right? But this company,
going back to it, it's getting worse, isn't it? Getting worse.

Now that one thing that
I would like to do here that I can't do is I would like to compare it to competitors
or to the industry averages, okay? Because there are some industries that typically have
higher certain ratios or lower certain ratios because of the nature of what they do, okay?
We don't really know. Alright, any other comments or questions on exercise 17-8? Okay, no? Okay
well then let's take a look at, it's kind of a continuation of this, isn't it? Alright
let's take a look at exercise 17-9, is that right?
>>Um hmm. >>Okay. Alright, they give us some more information.
You can actually just see all the data for 17-9, 10 and 11 but they give us an income
statement, two of them, right? Okay? They give us an income statement and they ask us,
they say refer to the information from the previous exercises.

The income statements
are below. They want us to compute days' sales uncollected, accounts receivable, inventory
turnover and days' sales in inventory. Okay? These are really important ratios, okay? Let's
go ahead and compute those. Once again I'll let you look at your computations and then
we will comment on them, okay? Anybody get those?
>>Yeah. >>Yeah?
>>Um hmm. >>These aren't real hard to calculate, are
they? Okay? Not real hard to do. Okay, you can see the direction of time going from 13
to 14, 13 to 14 and so on. We only have two data points but let's take a look at our receivables.
Is this situation getting better or worse? >>Worse.
>>It's getting worse. Our receivables in 13, turned over nine and a half times almost,
a year.

Now they're turning over slower, 8.9 times, correct? Alright, days' sales uncollected.
Well 42.9 was the days' sales uncollected last year now it's getting, the receivables
are getting older, right? Okay? Now we want our receivables to turn over, okay? Did I
use the restaurant analogy last time? >>Um hmm.
>>You want the table to turn over, right? You want it to turn over.

You want your receivables
to turn over. What are some reasons that accounts receivable could be slowing down? They're
not getting collected as much. >>People aren't paying.
>>Well people aren't paying, that's definitely what's happening but why might that be happening,
that they're not paying. >>Your billing could be slowing down.
>>Your billing could be slowing down, it could be a process situation. Maybe you have a new
billing department and they're, quite frankly, behind or they're not as efficient as they
people you used to have. Maybe you used to have a person who was really good about calling
the people and saying, "Hey, your bill is 25 days old, is there a problem? You need
to get that paid." And then the new person, he doesn't do that, okay? What are some other
reasons that receivables could be slowing down?
>>You're taking on customers with less credit and they aren't able to pay.
>>Taking on customers that don't have as good credit, right? Okay? Their creditworthiness
is not as good.

Okay, what are some other reasons?
>>State of the economy? >>Yeah, the economy, the state of the economy
could be worsening, okay? So you know a lot of times what you'll see, well I'll wait to
give that interpretation until we go through the next ones. But there's a lot of reasons
and this would tell us that we need to go investigate why are receivables slowing down?
Now, take a look at the inventory turnover. Inventory is slowing down too, right? Inventory
is slowing down, is that a good thing? No. No. Why might inventory be slowing down? What
does that mean? >>Less customers, people aren't buying–
>>People aren't buying it as quickly.

We want to buy inventory, we sell it, we get the cash,
we buy more inventory, we sell it, just like that table that you work at at the restaurant,
right? Inventory slowing down, what's the reasons that that could be occurring?
>>Prices could be going up. >>Maybe prices are going up.
>>You're just stocking way more inventory than you need.
>>You could be stocking more inventory than you need, okay? There's risks of stocking
too much inventory, there's risks of stocking too little inventory, right? One of the main
things that we do when I go in and consult is I look at the quality of their inventory.
A lot of times we have inventory that's slowing down, it's because they have what we call
dead inventory, right? What are some examples of inventory that maybe was once very popular
for customers to purchase and now is a lot less popular for customers to purchase?
>>Holiday ornaments.

>>Well holiday ornaments, but the only good
thing about holiday ornaments is it happens every year, right? Let me give you some extreme
examples. What if you had a bunch of VHS tapes that you were trying to sell. How are those
selling these days? Are they selling as quickly as they did 10 years ago?
>>No. >>Okay. How about Tim Tebow and Adrian Pearson
jerseys? How are those selling right now? Huh?
>>They're not. >>They're not selling. What about a bunch
of iPhone 3s? Do you see what I'm saying? What if you really stocked up on all those
items thinking, because they were selling so quickly and now the inventory's slow. After
a while you have to look at the quality of the inventory and sometimes you even have
to say, "This inventory is not worth anything anymore," and then you write it off the books,
which hurts their P & L, their profit and loss, because you write it off, you expense
it and they hate that.

Hurts their assets, hurts their bottom line, okay? But a lot of
times they'll hold on to that inventory, "No, this is still good. This is still good. People
still want Tim Tebow Denver Bronco football jerseys," even though he doesn't play in there
any more and he's not even in the NFL, right? "People still want 2012 calendars." No they
don't. It's not worth anything, it's dead inventory. You with me? Okay? So1 do you think
these sort of ratios and analysis, over time, would be useful to a manager or an owner of
a business? >>Yes.
>>Yes, it would be and yet, do you know how little business managers do this? I think,
did I tell about my buddy who plays fantasy football? He spends more time analyzing his
fantasy football team than he does these ratios for his business. Doesn't make any sense,
does it? Okay? Alright, good stuff. This is such good stuff, such good stuff. If you can
learn and be able to analyze financial statements and see trends and see things that maybe other
people can't see because they don't know how to use those tools or they don't have the
experience, that is an unbelievably, an unbelievably beneficial trait.

You can make money off of
that, okay? It's a wonderful skill to have, okay? I work with somebody who is very good
at financial statement analysis, he can just look at things and see what's going on, okay?
It's like he spots, it's like Da Vinci Code, he can spot what's going in there. The other
thing that sometimes you can find is fraud. He said there's something happening that's
not quite right here, something's happening and he can tell it just because of the trends
and the way things are moving. He's very good at it. He's taught me a lot. Matter of fact,
he's taught me more about it than anything I ever learned in my accounting degrees because
they didn't teach financial statement analysis very well back in the old days, okay?
>>Are we gonna look at actual financial statements later on?
>>Are we what? >>Are we gonna look at, like, some actual
financial statements later on? >>No, and the reason is is that's, that would
be, he's asking like if we would take like a real life annual report or something like
that? It's a matter of time.

I still have six chapters I gotta get through, you see
what I'm saying? >>Yeah.
>>If you take Managerial Accounting, it's a very common business project to do what
you're saying. I'm introducing you to this subject but you might, if you get an accounting
review, you'll probably spend the whole semester doing this but it takes a while to do, okay?
Great question. Alright let's go through 17-10, alright? What does 17-10 ask us? Refer to
that information, compute the long-term risk in capital structure positions at the end
of 14 and 13 by computing the debt and equity ratios, the debt-to-equity ratio, the TIE
ratio. These are all ratios that have to do with solvency, is that correct? And the ability
to pay your debt in the long term, is that correct? Okay? Let's look at our debt and
equity ratios.

Okay our debt used to be 39.7% of total assets, now it's 43.7. That indicates,
as well as a declining equity ratio because obviously these have to add up to 100%, what
this is telling me is that our financing is more with external finan– not with owner
financing but with banks, credit unions, those sort of things, right? We're taking on more
debt, correct? Taking on more debt, it's becoming a higher percentage, okay? Think of all the
Johnson County families out there. They gradually, gradually get more debt but that debt has
to be repaid, doesn't it? Okay, that can cause problems. Alright? The debt-to-equity ratio
is also growing. That's really just another way of measuring these up here because you
take the total that divided by the total equity.

And then there is the TIE ratio, okay? Now,
the TIE ratio is the times interest earned ratio and it is calculated by taking EBIT,
which stands for earnings before interest and taxes have been subtracted, divided by
interest expense. Now, do you want, all things being equal, do you want this ratio to be
high or low? >>High.
>>High, and I always ask myself well, what would give me a high TIE ratio? A high numerator?
Wouldn't you rather your earnings be really high and your interest expense low?
>>Um hmm.

>>So you'd rather, you certainly don't want
low earnings and a high interest expense which would give you a low TIE ratio, right? So
all things being equal you want this to be high and it is actually growing a little bit,
right? It did improve, okay? Why is that? Why could this say our debt is growing and
this is, which seems to say more debt but our EBIT ratio seems to be improving.
>>Maybe interest rates are dropping. >>It could be interest rates dropping but
it could also be that this is mainly occurring because of short-term debt that doesn't even
have interest like accounts payable.

You see what I'm saying?
>>Okay. >>You see how your total debt could be increasing
but if it's accounts payable that's increasing, it won't have have interest expense so this
ratio could maybe show improvement. Make sense? >>Um hmm.
>>Okay? You know this is, the first time you go through this stuff it's like, it's kind
of difficult, but the more you analyze these things, the better you get at it, okay? Alright,
any other questions on the debt and equity? >>How do you get EBIT? I couldn't figure that
part out.

>>Earnings– how do you get EBIT? Earnings
before interest and taxes, that's a good question, okay? Well, what we do here is, let me find
the right page. Okay, let me zoom in. Well, you can't just take this net income number.
Now they don't have a subtotal for EBIT so what does EBIT stand for? Earnings before
interest and taxes have been subtracted so EBIT would equal $31,100 plus interest expense
plus income taxes, is that right? Somebody who got it? Crayton?
>>Yeah. >>So you have to add those back. In a way,
you're making a subtotal before these two items are subtracted. It's a great question,

Does that make sense, folks? Very good. Okay, let's do the last one which is
17-11, and they're asking us about this data. Evaluate the efficiency and profitability
by computing the following for 14 and 13. The profit margin ratio, the total asset turnover
return on assets, okay, let's do that, okay? Let's do that. Well, I think we've already
noted before that our profit margin is declining. Didn't we note that in a previous exercise,
okay? Alright, our profit margin is declining from 5.5 to 4.6, okay? Let me take a look
at something real quick.

So profit margin's getting worse. Now our asset turnover, what
is asset turnover? That's how efficiently we are generating sales from our assets, okay?
That's actually improved, okay? Now if you recall and I know I had to hurry through this
quickly last time but one way we can figure out ROA, also the same thing as ROI, is by
taking a profit margin times our asset turnover, okay? Profit margin times our asset turnover,
okay? And the results of that will be a return on assets. This situation, the return on assets
actually, oh I'm sorry, the… here, we're up here. The asset turnover actually improved,
didn't it, from 1.3 to 1.4 but it certainly wasn't enough to offset this deterioration
of profit margin, so the result was that ROA actually worsened, does that make sense? You
with me? Okay? Alright, that was it for homework, wasn't it? Here's what I'm going to do, okay,
as we close out. There's no pencil and paper homework next time, for the next lecture.
We are going to start Chapter 18 next time but here's what I'm doing in regards to Chapter

Let me back up. Chapter 16, did I tell you about that Connect project? The 15 point?
It's not… even though it's on Connect, it's not calculated with your other Connect scores.
It's 15 stand-alone points towards your overall grade, face-to-face and online, for doing
that Connect project on the cash flow statement. I'm doing something similar with Chapter 17.
On Connect, I have a mini-project, so to speak, that's worth 25 points toward your overall

Once again, the 25 points on that Chapter 17 mini-project are not part of your overall
Connect scores, totally separate, so if you are one who always forgets to do Connect assignments,
you do not want to forget to do this Chapter 17 twenty-five point one or the Chapter 16
fifteen-point one because they are worth a lot more than the other Connect assignments.
They're not included in that computation, you guys following me? So go look at the due
dates on that, go do those, you have the knowledge that you need. Consider both of those things
kind of open-book, take home little projects, okay? And then next time we will start Chapter
18, alright? See you guys later, have a good one. Bye bye..

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