Ex. 4-1 & 4-2 & 4-3Name:Section:#:Red Company Chapter 4 - HomeworkExercise 4-1 Gross Profit Margin % (a driver of Profitability)A.1. Numerator line item:Amt.2. Denominator line item:Amt.B.2017 Gross Profit Margin %%2016 Gross Profit Margin % 36.56%C.The Gross Profit Margin % is a(n): (click the drop-down button and select from the list)D.Which year had a better Gross Profit Margin %? (click the drop-down button and select from the list)Exercise 4-2 Operating Profit Margin % (a driver of Profitability)A.1. Numerator line item:Amt.2. Denominator line item:Amt.B.2017 Operating Profit Margin %%2016 Operating Profit Margin % 13.98%C.The Operating Profit Margin % is a(n): (click the drop-down button and select from the list)D.Which year had a better Operating Profit Margin %? (click the drop-down button and select from the list)Exercise 4-3 Accounts Receivable Turnover Ratio (a driver of Efficiency)Number of Days' Sales in ReceivablesA.1. Numerator line item:Amt.2. Denominator line item:Average Receivables, net: CustomersAmt: Beg Yr$157,908End Yr$176,008B.2017 Accounts Receivable Turnover RatioTimes2016 Accounts Receivable Turnover Ratio 14.54 TimesC.The Accounts Receivable Turnover Ratio is a(n): (click the drop-down button and select from the list)D.Which year had a better Accounts Receivable Turnover Ratio? (click the drop-down button) Ex. 3cont & 4-4 & 4-5Name:Section:#:Red Company Chapter 4 - HomeworkExercise 4-3 (continued)E.2017 Number of Days' Sales in ReceivablesDays2016 Number of Days' Sales in Receivables 25.10 DaysF.The Number of Days' Sales in Receivables is a(n): (click the drop-down button and select from the list)G.Which year had a better Number of Days' Sales in Receivables? (click the drop-down button)Exercise 4-4 Inventory Turnover Ratio (a driver of Efficiency)Number of Days' Sales in InventoryA.1. Numerator line item:Amt.2. Denominator line item:Amt: Beg YrEnd YrB.2017 Inventory Turnover RatioTimes2016 Inventory Turnover Ratio 4.73 TimesC.The Inventory Turnover Ratio is a(n): (click the drop-down button and select from the list)D.Which year had a better Inventory Turnover Ratio? (click the drop-down button)E.2017 Number of Days' Sales in InventoryDays2016 Number of Days' Sales in Inventory 77.17 DaysF.The Number of Days' Sales in Inventory is a(n): (click the drop-down button and select from the list)G.Which year had a better Number of Days' Sales in Inventory? (click the drop-down button)Exercise 4-5 Accounts Payable Turnover RatioNumber of Days' Purchases in Accounts PayableA.1. Numerator line item:Amt.2. Denominator line item:Amt: Beg YrEnd YrB.2017 Accounts Payable Turnover RatioTimes2016 Accounts Payable Turnover Ratio 9.29 Times Ex. 5cont & 4-6Name:Section:#:Red Company Chapter 4 - HomeworkExercise 4-5 (continued)C.The Accounts Payable Turnover Ratio is a(n): (click the drop-down button and select from the list)D.Which year had a better Accounts Payable Turnover Ratio? (click the drop-down butto ...

1. Ex. 4-1 & 4-2 & 4-3Name:Section:#:Red Company Chapter 4 -
HomeworkExercise 4-1 Gross Profit Margin % (a driver of
Profitability)A.1. Numerator line item:Amt.2. Denominator line
item:Amt.B.2017 Gross Profit Margin %%2016 Gross Profit
Margin % 36.56%C.The Gross Profit Margin % is a(n): (click
the drop-down button and select from the list)D.Which year had
a better Gross Profit Margin %? (click the drop-down button
and select from the list)Exercise 4-2 Operating Profit Margin %
(a driver of Profitability)A.1. Numerator line item:Amt.2.
Denominator line item:Amt.B.2017 Operating Profit Margin
%%2016 Operating Profit Margin % 13.98%C.The Operating
Profit Margin % is a(n): (click the drop-down button and select
from the list)D.Which year had a better Operating Profit Margin
%? (click the drop-down button and select from the
list)Exercise 4-3 Accounts Receivable Turnover Ratio (a driver
of Efficiency)Number of Days' Sales in ReceivablesA.1.
Numerator line item:Amt.2. Denominator line item:Average
Receivables, net: CustomersAmt: Beg Yr$157,908End
Yr$176,008B.2017 Accounts Receivable Turnover
RatioTimes2016 Accounts Receivable Turnover Ratio 14.54
TimesC.The Accounts Receivable Turnover Ratio is a(n): (click
the drop-down button and select from the list)D.Which year had
a better Accounts Receivable Turnover Ratio? (click the drop-
down button)
Ex. 3cont & 4-4 & 4-5Name:Section:#:Red Company Chapter 4
- HomeworkExercise 4-3 (continued)E.2017 Number of Days'
Sales in ReceivablesDays2016 Number of Days' Sales in
Receivables 25.10 DaysF.The Number of Days' Sales in
Receivables is a(n): (click the drop-down button and select
from the list)G.Which year had a better Number of Days' Sales
in Receivables? (click the drop-down button)Exercise 4-4
Inventory Turnover Ratio (a driver of Efficiency)Number of
Days' Sales in InventoryA.1. Numerator line item:Amt.2.
Denominator line item:Amt: Beg YrEnd YrB.2017 Inventory

2. Turnover RatioTimes2016 Inventory Turnover Ratio 4.73
TimesC.The Inventory Turnover Ratio is a(n): (click the drop-
down button and select from the list)D.Which year had a better
Inventory Turnover Ratio? (click the drop-down button)E.2017
Number of Days' Sales in InventoryDays2016 Number of Days'
Sales in Inventory 77.17 DaysF.The Number of Days' Sales in
Inventory is a(n): (click the drop-down button and select from
the list)G.Which year had a better Number of Days' Sales in
Inventory? (click the drop-down button)Exercise 4-5
Accounts Payable Turnover RatioNumber of Days' Purchases in
Accounts PayableA.1. Numerator line item:Amt.2. Denominator
line item:Amt: Beg YrEnd YrB.2017 Accounts Payable
Turnover RatioTimes2016 Accounts Payable Turnover Ratio
9.29 Times
Ex. 5cont & 4-6Name:Section:#:Red Company Chapter 4 -
HomeworkExercise 4-5 (continued)C.The Accounts Payable
Turnover Ratio is a(n): (click the drop-down button and select
from the list)D.Which year had a better Accounts Payable
Turnover Ratio? (click the drop-down button)E.2017 Number
of Days' Purchases in Accounts PayableDays2016 Number of
Days' Purchases in Accounts Payable 39.29 DaysF.The Number
of Days' Sales Purchases in Accounts Payable is a(n): (click the
drop-down button)G.Which year had a better Number of Days'
Purchases in Accounts Payable? (click the drop-down
button)Exercise 4-6 Cash-to-Cash CycleA.Cash-to-Cash Days
for 2017 and 20162017 Days2016 DayslessNet Number of Days
Cash is Invested in InventoryplusCash-to-Cash
DaysB.Discussion of Toro's Cash-to-Cash Days for 2017
compared to 2016
Ex. 4-7 & 4-8Name:Section:#:Red Company Chapter 4 -
HomeworkExercise 4-7 Fixed Asset Turnover Ratio (a driver of
Efficiency)A.1. Numerator line item:Amt.2. Denominator line
item:Amt: Beg YrEnd YrB.2017 Fixed Asset Turnover
RatioTimes2016 Fixed Asset Turnover Ratio 10.70 TimesC.The
Fixed Asset Turnover Ratio is a(n): (click the drop-down
button and select from the list)D.Which year had a better Fixed

3. Asset Turnover Ratio? (click the drop-down button and select
from the list)Exercise 4-8 Debt% (an indicator of Leverage at
year-end)A.1. Schedule to calculate the numerator, Total
Liabilities for 2017:Total Current LiabilitiesLong-term debt,
less current portionDeferred revenueDeferred income
taxesOther long-term liabilitiesTotal Liabilities2. Denominator
line item:Amt.B.2017 Debt %%2016 Debt % 60.27%C.The
Debt % is a(n): (click the drop-down button and select from the
list)D.Which year had more financial leverage? (click the drop-
down button and select from the list)
Ex. 4-9 & 4-10Name:Section:#:Red Company Chapter 4 -
HomeworkExercise 4-9 Debt-to-Equity Ratio (an indicator of
Leverage at year-end)A.1. Numerator line item:Total Liabilities
answer to Exercise 4-8 A.1Amt.2. Denominator line
item:Amt.B.2017 Debt-to-Equity RatioTimes2016 Debt-to-
Equity Ratio 1.52 TimesC.The Debt-to-Equity Ratio is a(n):
(click the drop-down button and select from the list)D.Which
year had more financial leverage? (click the drop-down button
and select from the list)Exercise 4-10 Times Interest Earned
Ratio (an indicator of interest coverage)A.1. Schedule to
calculate the numerator, Earnings before Interest and Taxes for
2017:Net EarningsplusplusEarnings before Interest and Taxes2.
Denominator line item:Amt.B.2017 Times Interest Earned
RatioTimes2016 Times Interest Earned Ratio 18.09
TimesC.The Times Interest Earned Ratio is a(n): (click the
drop-down button and select from the list)D.Which year had a
better Times Interest Earned Ratio? (click the drop-down
button and select from the list)
Lists/ up-arrow indicator2016/ down-arrow indicator2017/
/ up-down arrow indicator
RED COMPANY 35
Chapter 4

4. Drilling Down Into the DuPont Analysis
Profitability – Efficiency – Leverage
To begin this chapter, open the Red Company model 1-Red
Company 15e if it is not already open
on your computer.
.7-DPont. tab
In the last chapter, you learned how the Return on Equity % is
driven by:
-to-Equity Ratio Leverage
In this chapter, you will “drill down” into each of these three
elements of Return on Equity %. You
will be adding thirteen new tools to your financial statement
analysis tool-kit. These new tools will
enable you to analyze: Profitability, Efficiency, and Leverage.
I T A B I L I T Y I N D I C A T O R S
Profitability is the ability of a company to have some number of
cents left over from each $1 of Net
Sales after covering all expenses. As you can see on the .7-
DPont. tab, Net Profit Margin %
measures Profitability and is the first ratio in the DuPont
Analysis. Below you will add two

5. additional Profitability ratios to your tool-kit. These two new
ratios will measure Profitability at two
different points above Net Income on the Income Statement.
Thus these two new ratios will
provide additional insight into what is driving the Net Profit
Margin %, which is measuring
Profitability at the Net Income level on the Income Statement.
-Prof. tab
Gross Profit Margin %
The Gross Profit Margin % measures how many cents of each $1
of Net Sales are left after
deducting Cost of Goods Sold. RC’s Gross Profit Margin % of
43.00% indicates that there are
43.00 cents of each $1 of Net Sales left after deducting 57.00
cents for Cost of Goods Sold. You
have previously seen this 43.00%.
-IS tab
The 43.00% is the Gross Profit percent in the % of Net Sales
column.
36 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
Look at RC’s Income Statement and observe that the 43.00
cents of Gross Profit must cover:

6. hopefully still have a few cents left over for Net Income.
-Prof. tab
-arrow after Gross Profit Margin %—indicating
that a higher value is always
better. A higher value would indicate that fewer pennies are
being consumed by Cost of Goods
Sold and that Gross Profit is increased.
The Gross Profit Margin % is an important Profitability measure
for merchandising and manufacturing
companies. For merchandisers and manufacturers, the Gross
Profit Margin % measures the
combined effectiveness of:
In summary, Gross Profit Margin % shows how many cents of
each $1 of Net Sales is left after
deducting Cost of Goods Sold.
Operating Profit Margin %

7. The Operating Profit Margin % measures how many cents of
each $1 of Net Sales are left after
deducting operating expenses from Gross Profit. RC’s
Operating Profit Margin % of 12.33%
indicates that there are 12.33 cents of each $1 of Net Sales left
after deducting operating expenses
from the 43.00 cents of Gross Profit. You have previously seen
this 12.33%.
Annual Report Project Companies
Look at the Gross Profit Margin % for the ARP companies.
_____________________________
rgin%?
_____________________________
not apply?
_____________________________
companies?
_____________________________________________________
________________
As you can see from the ARP companies, the Gross Profit
Margin % will vary significantly
depending on the company’s industry.

8. Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 37
-IS tab
The 12.33% is the Operating Income percent in the % of Net
Sales column.
Observe that on RC’s Income Statement there are two operating
expense line items, Selling &
General Expenses and Depreciation Expense. The number of
operating expense line items, and
the titles of those operating expense line items, will vary by the
type of company and by how much
detail the company chooses to show on its Income Statement.
The Operating Profit Margin % measures how many cents per
$1 of Net Sales is generated from
operating the business. This is a measure of operating
profitability. Notice on the Income
Statement that the 12.33% is before deducting Interest Expense
and before deducting Provision
for Income Taxes. Interest Expense is the result of how
management chooses to finance (debt vs.
equity) not operate the company. Provision for Income Taxes
(an expense) is the result of tax
rates (government policy) and Pre-Tax Income. Thus you can
see that the Operating Profit Margin
%, which is a measurement before interest and taxes, is a good
indicator of how profitably
management is able to operate the business.
-Prof. tab

9. -arrow after Operating Profit Margin %—
indicating that a higher value is always
better. A higher value would indicate a more profitable
operation of the business.
In summary, Operating Profit Margin % measures the operating
profitability of a company.
Net Profit Margin %
The Net Profit Margin % ratio shown on the .8-Prof. tab is a
repeat of the Net Profit Margin % ratio
shown at the top of the .7-DPont. tab. For a discussion of Net
Profit Margin %, see Pg 26. The
Net Profit Margin % is repeated on the .8-Prof. tab so that you
can see all three Profitability ratios
together on one tab.
Let’s make a change to the Red Company model and see how
the change impacts the three
Profitability ratios.
Annual Report Project Companies
Look at the Operating Profit Margin % for the ARP companies.
_____________________________
_____________________________

10. As you can see from the ARP companies, the Operating Profit
Margin % will vary a lot from
company to company and industry to industry.
38 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
-IS tab
-Prof. tab
All three of the Profitability ratios increased as a result of
decreasing the number of cents Cost of
Goods Sold consumes of each $1 of Net Sales:
45.00%. This is exactly the change
that would be expected when Cost of Goods Sold is decreased
from 57.00% to 55.00%.
Cost of Goods Sold is now consuming 2.00 fewer cents of each
$1 of Net Sales; thus there
are 2.00 more cents of Gross Profit available from each $1 of
Net Sales.
14.33%. This shows that the
additional 2.00 cents of Gross Profit made it to the Operating
Income level on the Income
Statement.

11. This is an increase, but the
increase is less than the 2.00 percentage points increase in the
Gross Profit Margin % and
the Operating Profit Margin %. Let’s take a look at the Income
Statement to see why the
Net Profit Margin % increased less than the other two
Profitability ratios.
-IS tab
By looking at the Income Statement, you can see a 2.00
percentage point increase in Gross Profit,
Operating Income, and Pre-Tax Income. You can also see that
Net Income as a % of Net Sales
(Net Profit Margin %) increased from 7.71% to 9.07%, an
increase of only 1.36 percentage points.
Provision for Income Taxes (an expense) is the reason that all
of the 2.00 additional cents did not
make it down to Net Income. Currently Red Company’s
Effective Income Tax Rate is 32%. This
means that when Pre-Tax Income increases by 2.00 cents, the
Provision for Income Taxes
increases by .64 cents (2.00 cents x 32%). As a result of the .64
cents increase in taxes, only 1.36
cents (2.00 – .64) make it down to Net Income.
As you have seen, a decrease in the Cost of Goods Sold Percent
has a very favorable impact on
all three of the Profitability ratios. One or more of the
following favorable management actions can
cause a decrease in Cost of Goods Sold as a percent of Net
Sales and an increase in profitability:

12. to increase prices.
Let’s examine the impact an increase in sales would have on the
three Profitability ratios.
-IS tab
ey
-Prof. tab
Two of the three Profitability ratios increased as a result of
increasing Net Sales by $400,000.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 39
because the Cost of Goods
Sold Percent stayed at 57%. The total Gross Profit dollars (the
numerator) did increase,
but that increase was in the same proportion as the increase in
Net Sales dollars (the
denominator); thus there was no change in the Gross Profit
Margin %.

13. 14.60%, an increase of 2.27
percentage points. This increase in the Operating Profit Margin
% is the result of Operating
Income dollars (the numerator) increasing faster than Net Sales
dollars (the denominator).
Let’s take a look at the Income Statement to see the details of
why the Operating Profit
Margin % increased.
-IS tab
On the Income Statement, observe that Operating Income in the
% of Net Sales column is
14.60% and that it was 12.33% before the $400,000 increase in
Net Sales. Also observe
that Gross Profit in the % of Net Sales column is 43.00% both
before and after the sales
increase. If the Gross Profit Margin % stayed the same and the
Operating Profit Margin %
increased, it must mean that operating expenses decreased as a
percent of Net Sales.
That is exactly what happened. Selling & General Expenses
decreased from 27.22% down
to 25.50% of Net Sales. Depreciation Expense decreased from
3.45% down to 2.90% of
Net Sales. As a result of these two operating expenses
decreasing as a percent of Net
Sales, the Operating Profit Margin % increased by 2.27
percentage points.
-Prof. tab
This increase of 1.65
percentage points is .62 percentage points smaller than the

14. increase in the Operating Profit
Margin %. The two non-operating expenses on RC’s Income
Statement are what caused
this .62 percentage points smaller increase. Interest Expense, a
non-operating item,
decreased by .16 percentage points; this helped the Net Profit
Margin %. Provision for
Income Taxes, the other non-operating item, increased by .78
percentage points; this hurt
the Net Profit Margin %.
Note: The discussion in this box is not necessary for your
understanding of the Gross Profit
Margin %. This discussion is based on managerial accounting
concepts – but there is
certainly an interplay between Financial Statement Analysis and
managerial accounting.
Cost of Goods Sold is programmed in the Red Company model
to be a totally variable
cost. This means that Cost of Goods Sold will change by the
same proportion as the
change in Net Sales (and assumes that the change in Net Sales
resulted from a change in
the number of units sold and not a change in selling price).
For a merchandising company, Cost of Goods Sold is normally a
totally variable cost. For
a manufacturing company, Cost of Goods Sold is normally a
mixture of variable costs and
fixed costs. Thus for most manufacturing companies, the Gross
Profit Margin % would be
expected to increase as a result of an increase in Net Sales.
Note: The discussion in this box is not necessary for your
understanding of the Operating Profit

15. Margin %. Like the discussion in the box above, this discussion
is based on managerial
accounting concepts.
Selling & General Expenses (S&G Expenses) are programmed
in the Red Company model
as a mixture of fixed costs and variable costs. Saying the same
thing in a different way—
some of the S&G Expenses stay the same when sales increase (a
fixed cost) and some of
the S&G Expenses increase proportionally with the increase in
sales (a variable cost). This
results in the total S&G Expenses increasing at a lower rate than
the increase in Net Sales.
Depreciation Expense is programmed in the Red Company
model as a fixed cost.
Depreciation does not change with a change in sales.
Depreciation Expense only changes
when new Equipment is purchased.
40 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
In summary, the three Profitability ratios provide insight into
how much of each $1 of Net Sales
makes it from the Net Sales (top) line of the Income Statement
to the Net Income (bottom) line on
the Income Statement.
-DPont. tab

16. Efficiency, as used in DuPont Analysis, is the measurement of
how effective a company is at
utilizing its assets to generate sales. As you can see on the .7-
DPont. tab, the Total Assets
Turnover Ratio is the second ratio in the DuPont Analysis and is
the ratio that measures Efficiency.
The Total Assets Turnover Ratio shows how many dollars of
Net Sales are generated from each
$1 of Total Assets.
By looking at the Total Assets Turnover Ratio, you can see that
the denominator of the ratio is
Average Total Assets. To better understand what is driving this
ratio, it would be helpful to develop
some tools that measure the Efficiency of each of the major
categories of assets that make up
Total Assets. Most companies have three major asset
categories:
Next you will be introduced to a new set of financial statement
analysis tools that will measure how
efficiently these asset categories are being managed.
-Eff. tab
Annual Report Project Companies
For the ARP companies, observe the Profitability pattern that is

17. shown by their: Gross Profit
Margin %, Operating Profit Margin %, and Net Profit Margin
%.
also have the highest
Operating Profit Margin % and Net Profit Margin %? ____
Yes ____ No
(enter an X in one box)
ame industry have similar
Gross Profit Margin %’s?
____ Yes ____ No (enter an X in one box)
also have the lowest Net
Profit Margin %? ____ Yes ____ No (enter an X in
one box)
Read the box titled Discussion of Profitability.
As you can see from the ARP companies, Profitability will vary
a lot from company to
company and industry to industry.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 41
Accounts Receivable Turnover Ratio – Number of Days’ Sales
in Receivables

18. To help you understand these two Efficiency Indicators for
Accounts Receivable, let’s assume that
a hypothetical company named Goofy Pattern Company (GPC)
has the following sales and cash
collection pattern. GPC sells $100 of product each day, and all
of those sales are on credit. The
following day GPC collects all $100 of the previous day’s credit
sales—and then GPC makes
another $100 of sales on credit. This sales and cash collection
pattern continues for all 365 days
of the year. This pattern will result in the following:
times each year.
le
will be $100. The $100
Accounts Receivable balance is from that 1 day’s sales (the
current day’s sales).
365 days in a year).
The Accounts Receivable Turnover Ratio measures how many
times per year a company collects
its average Accounts Receivable balance. Based on the above
facts, you can easily see that GPC
collects its Accounts Receivable balance 365 times per year;
thus the value of GPC’s Accounts
Receivable Turnover Ratio should be 365 times.
Number of Days’ Sales in Receivables measures how many
days’ sales are in a company’s
average Accounts Receivable balance. Based on the above
facts, you can easily see that GPC
has 1 day of sales in its Accounts Receivable balance; thus the

19. value of GPC’s Number of Days’
Sales in Receivables should be 1 day.
Using the calculation formula shown on the .9-Eff. tab and the
data for GPC, we can verify our
observation that GPC’s Accounts Receivable Turnover Ratio is
365 times.
Net Sales $36,500
= 365.00 Times
Average Accounts Receivable, net ($100 + $100) / 2
(A/R bal. beg. of yr + A/R bal. end of yr) / 2
Using the calculation formula shown on the .9-Eff. tab and
GPC’s Accounts Receivable
Turnover Ratio value, we can verify our observation that GPC’s
Number of Days’ Sales in
Receivables is 1 day.
365 Days in a Year 365
= 1.00 Day
Accounts Receivable Turnover Ratio 365.00
While no company would have the sales and cash collection
pattern of GPC, hopefully the use of
this hypothetical company has given you an intuitive feel for
what is being measured by the
Accounts Receivable Turnover Ratio and Number of Days’
Sales in Receivables.
42 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage

20. Look at the .9-Eff. tab and observe RC’s values for these two
Accounts Receivable Efficiency
Indicators. RC’s values are fairly typical for a company that
makes most of its sales to customers
on credit1.
RC’s Accounts Receivable Turnover Ratio of 8.69 indicates that
RC collects its average Accounts
Receivable balance 8.69 times per year. Using RC’s Accounts
Receivable Turnover Ratio value of
8.69, we can calculate that RC’s Number of Days’ Sales in
Receivables is 42.00 days. Saying that
RC’s Accounts Receivable Turnover Ratio is 8.69 times and that
RC’s Number of Days’ Sales in
Receivables is 42.00 days is saying the same thing, just in a
different way.
RC’s Number of Days’ Sales in Receivables value of 42.00 days
indicates that when RC makes a
sale to a customer on credit, 42.00 days later that customer pays
the cash to RC for the credit sale.
Note that the 42.00 days is an average and will vary from
customer to customer. A company’s
Number of Days’ Sales in Receivables will vary depending on
many factors, some of those factors
are:
company operates.

21. Accounts Receivable collection efforts of the company.
-arrow after Accounts Receivable Turnover
Ratio—indicating that a higher value
-arrow after Number of
Days’ Sales in Receivables—
indicating that a lower value is always better. These two arrows
are indicating the same thing,
collecting Accounts Receivable more often (higher turnover);
and thus collecting from customers in
a shorter period of time (lower days), results in a lower average
Accounts Receivable balance. A
lower average Accounts Receivable balance means that we are
getting our cash quicker, and
getting cash quicker is always a good thing.
While the discussion above about the Accounts Receivable up
and down arrows is normally true, it
is important to keep in mind that credit terms granted to
customers and collection efforts on past-
due Accounts Receivable are always a balancing act between
two competing factors:
payment is expected and/or giving
credit to customers with only the absolute best credit rating),
customers will be
dissatisfied and the company will miss out on sales. If
collection efforts are too
aggressive, customers will be alienated and could be lost
forever.
is expected and/or granting
credit to customers with questionable credit ratings), the

22. investment in Accounts
Receivable will be excessive and bad debt expense will be
large.
1 Selling to customers on credit does not mean that the
customer used a credit card for the transaction.
Selling on credit means a company has extended certain credit
terms to its customers allowing the
customers to pay for the sale after a certain amount of ti me.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 43
The following are calculation notes related to the Accounts
Receivable Efficiency Indicators:
2021:
Dec 31, 2020 Dec 31, 2021 Average Accounts
( Accounts Receivable, net + Accounts Receivable, net ) / 2 =
Receivable, net for 2021
( $246,000 + $237,288 ) / 2 = $241,644
Note: The Accounts Receivable amounts come from RC’s
Balance Sheets 2-BS tab. The
two Accounts Receivable amounts used for the calculation are
the amounts at the
beginning of 2021 and at the end of 2021. The Dec 31, 2020
amount is 2020’s ending
Accounts Receivable amount and is also 2021’s beginning
Accounts Receivable

23. amount.
Average Accounts Receivable, net was rounded to a whole
number—that is, to 0
decimal places. All averages in this book and in the Red
Company software will always
be rounded to a whole number. See the appendix on Pg 86 for
rounding examples and
directions.
Accounts Receivable Turnover Ratio
would be Net Credit Sales. In their published financial
statements, companies do not split
sales into cash sales and credit sales; thus the Net Sales amount
shown on a company’s
Income Statement will be used for the numerator in the
Accounts Receivable Turnover Ratio.
Days’ Sales in Receivables. This
alternative calculation method will result in the same value
(sometimes there might be a slight
difference due to rounding) as the method shown on the .9-Eff.
tab . This alternative calculation
method does not require that you first calculate the Accounts
Receivable Turnover Ratio.
Average Accounts Receivable, net ($246,000 + $237,288) / 2 =
$241,644
= 42.00 Days
Average Daily Net Sales $2,100,000 / 365 days = $5,753

24. In summary, the Accounts Receivable Turnover Ratio and the
Number of Days’ Sales in
Receivables provide insight into how efficiently a company is
managing the Accounts Receivable
asset.
Annual Report Project Companies
Look at the Accounts Receivable Turnover Ratio and the
Number of Days’ Sales in
Receivables for the ARP companies.
times per year (has the
highest Accounts Receivable Turnover Ratio)?
_____________________________
Receivables (excluding any
company with zero Accounts Receivable)?
_____________________________
As you can see from the ARP companies, these indicators will
vary a lot from company to
company and industry to industry.
44 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
Inventory Turnover Ratio – Number of Days’ Sales in
Inventory

25. -Eff. tab
Look at the .9-Eff. tab and observe how the Inventory Turnover
Ratio is calculated. The Inventory
Turnover Ratio measures how many times per year a company
sells its average Inventory balance.
To make this ratio easier to think about, assume that a
hypothetical company has only one item in
inventory. If the company’s Inventory Turnover Ratio is 4.00
times, that would mean that 4 times
per year the company would:
and
Look at the .9-Eff. tab and observe how the Number of Days’
Sales in Inventory is calculated.
Number of Days’ Sales in Inventory measures the number of
days between when an inventory item
is purchased from a vendor or produced internally and when that
item is sold to a customer.
Saying the same thing in a different way, Number of Days’
Sales in Inventory measures how long a
company could make sales out of its current inventory before
the inventory balance would be down
to zero.
RC’s Inventory Turnover Ratio of 3.84 indicates that for the
average item in inventory, RC
purchases or produces the item and then sells the item to a

26. customer 3.84 times per year. Using
RC’s Inventory Turnover Ratio value of 3.84, we can calculate
that RC’s Number of Days’ Sales in
Inventory is 95.05 days. Saying that RC’s Inventory Turnover
Ratio is 3.84 and that RC’s Number
of Days’ Sales in Inventory is 95.05 is saying the same thing,
just in a different way.
A company’s Inventory Turnover Ratio and Number of Days’
Sales in Inventory will be impacted by
many factors. Some of these factors are:
predict that demand.
duced, if the company is
a manufacturer.
systems.
-arrow after Inventory Turnover Ratio—
indicating that a higher value is better.
-arrow after Number of Days’ Sales in
Inventory—indicating that a lower value
is better. These two arrows are indicating the same thing,
holding inventory for a shorter period of
time before selling the inventory to a customer, results in a
lower average Inventory balance. A
lower Inventory balance means that less cash is invested in
inventory, and that is a good thing.

27. While the discussion above about the Inventory up and down
arrows is normally true, it is important
to keep in mind that the amount of inventory a company keeps
on-hand is always a balancing act
between two competing factors:
-hand, customer service goes
down as shipments are
missed or delayed due to an out-of-stock condition. This will
result in missed sales and
customer dissatisfaction.
-hand, financial performance
goes down as a result of the
excess investment in inventory. Also, as the amount of
inventory on-hand increases, the
possibility of obsolete inventory increases.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 45
The following are calculation notes related to the Inventory
Efficiency Indicators:
Dec 31, 2020 Dec 31, 2021
( Inventory + Inventory ) / 2 = Average Inventory for
2021
( $280,000 + $343,096 ) / 2 = $311,548
Note: The Inventory amounts come from RC’s Balance Sheets

28. 2-BS tab. The two Inventory
amounts used for the calculation are the amounts at the
beginning of 2021 and at the
end of 2021. The Dec 31, 2020 amount is 2020’s ending
Inventory amount and is also
2021’s beginning Inventory amount.
Average Inventory was rounded to a whole number.
ive calculation method for Number of
Days’ Sales in Inventory. This
alternative calculation method will result in the same value
(sometimes there might be a slight
difference due to rounding) as the method shown on the .9-Eff.
tab. This alternative calculation
method does not require that you first calculate the Inventory
Turnover Ratio.
Average Inventory ($280,000 + $343,096) / 2 = $311,548
= 95.01 Days
Average Daily Cost of Goods Sold $1,197,000 / 365 days =
$3,279
In summary, the Inventory Turnover Ratio and the Number of
Days’ Sales in Inventory provide
insight into how efficiently a company is managing the
Inventory asset.
-Eff. tab
Annual Report Project Companies

29. Look at the Inventory Turnover Ratio and the Number of Days’
Sales in Inventory for the
ARP companies.
-over its Inventory the most times per
year (has the highest
Inventory Turnover Ratio)? _____________________________
les in
Inventory?
_____________________________
company?
_____________________________
As you can see from the ARP companies, these indicators will
vary a lot from company to
company and industry to industry. Observe that a service
company does not have inventory
and thus the Inventory Efficiency Indicators do not apply.
46 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
Accounts Payable Turnover Ratio – Number of Days’ Purchases
in Accounts Payable
At the start of this section on Efficiency Indicators, there was a
listing of the three major categories

30. of assets that most businesses have: Accounts Receivable,
Inventory, and Fixed Assets. The two
Accounts Payable indicators that will be presented next are not
directly related to measuring the
efficient management of these three categories of assets. The
reasons for including the Accounts
Payable indicators as part of this Efficiency Indicators section
are:
efficient management of Accounts Payable can delay
when the payment of cash is
made for the purchase of inventory. Delaying the payment of
Accounts Payable reduces
the time cash is tied up in the Inventory asset.
ts Payable is needed
for the Cash-to-Cash Cycle
indicator, which will be introduced later.
Look at the .9-Eff. tab and observe how the Accounts Payable
Turnover Ratio is calculated. The
Accounts Payable Turnover Ratio measures how many times per
year a company pays its average
Accounts Payable balance.
Look at the .9-Eff. tab and observe how the Number of Days’
Purchases in Accounts Payable is
calculated. The Number of Days’ Purchases in Accounts
Payable measures how many days of
inventory purchases are in a company’s average Accounts
Payable balance.
RC’s Accounts Payable Turnover Ratio of 7.60 indicates that
RC pays its average Accounts
Payable balance 7.60 times per year. Using RC’s Accounts
Payable Turnover Ratio value of 7.60,

31. we can calculate that RC’s Number of Days’ Purchases in
Accounts Payable is 48.03 days. This
indicates that after making a purchase from a vendor, RC waits
an average of 48.03 days before
making a cash payment to the vendor. Saying that RC’s
Accounts Payable Turnover Ratio is 7.60
and that RC’s Number of Days’ Purchases in Accounts Payable
is 48.03 days is saying the same
thing, just in a different way.
-arrow after the Accounts Payable Turnover
Ratio—indicating that a lower
value is always b -arrow after Number of
Days’ Purchases in Accounts
Payable—indicating that a higher value is always better. These
two arrows are indicating the
same thing, paying Accounts Payable less often; thus waiting
more days before paying vendors,
results in a higher average Accounts Payable balance. A higher
Accounts Payable balance means
that we are keeping our cash longer, and that is always a good
thing. Think of Accounts Payable
as an interest free loan from our vendors.
While the discussion above about the Accounts Payable up and
down arrows is normally true, it is
important to keep in mind that holding on to our cash as long as
possible and good vendor
relations are always a balancing act between two competing
factors:
payments to vendors are delayed for too many days, the
company’s relationships with
its vendors can be damaged. The vendors can place the
company on payment-in-
advance or cash-on-delivery (COD) terms. Vendors that feel

32. they have been treated
badly by delayed payments, will not work with the company to
meet special rush order
requirements.
does not get the benefit of
higher Accounts Payable balances, which are interest free loans
from the vendors.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 47
The following are calculation notes related to the Accounts
Payable indicators:
Dec 31, 2020 Dec 31, 2021
( Accounts Payable + Accounts Payable ) / 2 = Average
Accounts Payable for 2021
( $140,000 + $174,827 ) / 2 = $157,414
Note: The Accounts Payable amounts come from RC’s Balance
Sheets 2-BS tab. The two
Accounts Payable amounts used for the calculation are the
amounts at the beginning of
2021 and at the end of 2021. The Dec 31, 2020 amount is
2020’s ending Accounts
Payable amount and is also 2021’s beginning Accounts Payable
amount.

33. Average Accounts Payable was rounded to a whole number.
Days’ Purchases in Accounts
Payable. This alternative calculation method will result in the
same value (sometimes there
might be a slight difference due to rounding) as the method
shown on the .9-Eff. tab. This
alternative calculation method does not require that you first
calculate the Accounts Payable
Turnover Ratio.
Average Accounts Payable ($140,000 + $174,827) / 2 =
$157,414
= 48.01 Days
Average Daily Cost of Goods Sold $1,197,000 / 365 days =
$3,279
In summary, the Accounts Payable Turnover Ratio and the
Number of Days’ Purchases in
Accounts Payable provide insight into how long a company
waits before paying its vendors for
purchases made on credit.
-Eff. tab
Annual Report Project Companies
Look at the Accounts Payable Turnover Ratio and the Number
of Days’ Purchases in
Accounts Payable for the ARP companies.

34. ge Accounts Payable balance
the least times per year
(has the lowest Accounts Payable Turnover Ratio)?
____________________________
in A/P?
_____________________________
As you can see from the ARP companies, these indicators will
vary a lot from company to
company and industry to industry.
48 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
Cash-to-Cash Cycle
To better understand the Cash-to-Cash Cycle indicator, let’s
follow the flow of cash through a
company’s operating cycle. This discussion assumes that the
company is a merchandising
company. The following are the steps in the operating cycle:
1. The company orders and receives inventory. At this point the
company does not pay out
any cash because normally the inventory vendor grants the
company credit terms. Let’s
say the vendor expects payment in 48 days.
2. Cash is paid out to the vendor 48 days after the purchase of

35. the inventory.
3. The inventory sits on the company’s shelf for some period of
time—let’s say the inventory
sits on the shelf for 95 days. While the company has had the
inventory for 95 days, it did
not have any cash invested in the inventory for the first 48 of
those 95 days, because of the
48 day delay in paying cash to the vendor. Thus while the
company has had the inventory
on its shelf for 95 days, it only has its cash invested in the
inventory for 47 days (95 total
days minus 48 days before paying the vendor).
4. After 95 days the inventory is sold to a customer. At this
point the company does not
receive in any cash, because the company grants credit terms to
its customer. Let’s say
the company expects its customer to pay 42 days after the sale.
5. Cash is received in from the customer 42 days after the sale;
thus completing the
operating cycle.
The Cash-to-Cash Cycle indicator combines the Number of
Days’ indicators for Inventory, Accounts
Payable, and Accounts Receivable to quantify the number of
days in the operating cycle between
when cash is paid out and when cash is received in. As you can
see on the .9-Eff. tab: RC’s
Inventory sits on the shelf for 95.05 days – RC takes 48.03 days
to pay its vendors – the 95.05 days
reduced by the 48.03 days results in the 47.02 days RC has its
cash invested before selling the
Inventory – after selling the Inventory it takes RC 42.00 days to
collect cash from the customer –

36. the net result is 89.02 days between when RC pays cash out and
when RC receives cash in.
By looking at the Cash-to-Cash Cycle indicator, you can see
what can be done to reduce the time
between when cash is paid out and when cash is received in:
shelf before being sold
to a customer.
You can increase the number of days between when inventory
is purchased from a
vendor and when cash is paid out to the vendor.
inventory is sold to a
customer and when cash is collected from that customer.
-arrow after Cash-to-Cash Cycle—indicating
that a lower value is always
better. A lower value means that we are receiving our cash
back-in faster, and that is always a
good thing.
If RC’s management was to make some positive operational
changes in the areas of: Inventory
management, Accounts Payable policies, and Accounts
Receivable policies and collection efforts,
then what would be the impact on RC’s: Cash balance, Turnover
Ratios, Number of Days’
indicators, and Cash-to-Cash Cycle indicator?
Chapter 4 – Profitability – Efficiency – Leverage RED

37. COMPANY 49
First, let’s see what the effects would be of reducing by 10 the
number of days Inventory sits on the
shelf before it is sold to a customer. This reduction of 10 days
is the result of RC making positive
changes to its Inventory management system.
-BS tab
Observe the following positive changes that result from holding
Inventory for 10 fewer days:
—a decrease
of $65,589.
—an increase of
$65,589.
-Eff. tab
4.29 times—th -arrow
after this ratio’s name indicates that an increase is good.
95.05 days to 85.08 days—the
-arrow after this item’s name indicates that a decrease is
good.
-to-Cash Days decreased from 89.02 to 79.05 days—
-arrow after

38. this indicator’s name shows that a decrease is good.
Next let’s see what the effects would be of increasing by 7 the
number of days taken to pay
Accounts Payable. This increase in the number of days taken
before paying cash to vendors is the
result of RC negotiating longer (better) credit terms with its
vendors.
-BS tab
Observe the following positive changes that result from
increasing by 7 days the time taken to pay
Accounts Payable:
—an
increase of $45,913.
—an increase of
$45,913. The combined
increase in Cash from the Inventory and Accounts Payable
changes is $111,502
($149,783 to $261,285). Observe the red message indicating
that Cash is greater than
$250,000. After a few more changes, RC will do something
with this excess cash.
Note: Given that you entered 85 into the Number of Days’ Sales
in Inventory input variable, you
would have expected Number of Days’ Sales in Inventory on the
9-Eff tab to be 85.00 rather
than 85.08. This slight .08 difference is caused by rounding the
Inventory Turnover Ratio to
2 decimal places and then using this rounded value to calculate

39. the Number of Days’ Sales
in Inventory. When you are doing your homework and your
Annual Report Project, always
follow the rounding rules given in the appendix on Pg 86 and
you will always be correct.
50 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
-Eff. tab
times to 6.64 times—the
-arrow after this ratio’s name indicates that a decrease is
good.
f Days’ Purchases in Accounts Payable
increased from 48.03 days to
54.97 days— -arrow after this item’s name indicates that
an increase is good.
-to-Cash Days decreased by about 7 more days—the
-arrow after this
indicator’s name shows that a decrease is a good thing. The
combined decrease in the
Cash-to-Cash Days from the Inventory and Accounts Payable
changes is about 17
days.
Next let’s see what the effects would be of decreasing by 6 the
number of days it takes to collect
Accounts Receivable. The decrease in the number of days to
collect cash from customers is the
result of RC changing its credit terms granted to customers and

40. an increased emphasis on
collecting past-due accounts.
-BS tab
Observe the following positive changes that result from
decreasing by 6 days the time taken to
collect Accounts Receivable:
—
a decrease of $69,041.
from $261,285 to $330,326—an increase of
$69,041. The combined
increase in Cash from the Inventory, Accounts Payable, and
Accounts Receivable
changes is $180,543 ($149,783 to $330,326).
-Eff. tab
ed from 8.69
times to 10.14 times—
-arrow after this ratio’s name indicates that an increase
is good.
decreased from 42.00 days to
36.00 days— -arrow after this item’s name indicates
that a decrease is good.
-to-Cash Days decreased by 6 more days—the
-arrow after this
indicator’s name shows that a decrease is a good thing. By
comparing the gray box

41. values to the current values for the Cash-to-Cash Cycle
indicator, you can see what
caused Cash-to-Cash Days to decrease by about 23 days.
As a result of the significant decrease in its Cash-to-Cash Days,
RC now has excess cash. RC
now needs to do something with that excess cash to get a
positive impact on the Total Assets
Turnover Ratio in the DuPont Analysis.
-BS tab
–115,000 in New Borrowing (Pay Off) on Jan. 1
(Be sure to enter this amount as a negative number.)
key
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 51
RC has now used the excess cash to reduce the Note Payable
Long-Term balance from $300,000
to $185,000, and to buy back 2,400 shares of its outstanding
Common Stock.
-DPont. tab
Observe that the Total Assets Turnover Ratio in the DuPont
Analysis has increased from 1.82 to
-arrow after this ratio’s
name this is a good change. Also
observe that the positive change in this ratio has resulted from
the decrease in the denominator,

42. Average Total Assets. There has not been any increase in the
numerator, Net Sales.
And finally, look at the Return on Equity % and observe the
significant change from 27.34% up to
31.29%. This positive change is the result of RC more
efficiently managing its assets.
-Eff. tab
Next you will learn one last Efficiency Indicator. This indicator
will be for assets that are not part of
a company’s Cash-to-Cash cycle, but these assets are normally a
significant component of Total
Assets.
Fixed Asset Turnover Ratio
The Fixed Asset Turnover Ratio is discussed separately from
the other Efficiency Indicators
because Fixed Assets are not part of a company’s Cash-to-Cash
cycle. A company does not
purchase Fixed Assets (property, plant, and equipment) with the
intent of selling them to
customers. A company purchases Fixed Assets to use in the
production and sale of products.
Thus the logical efficiency measurement for Fixed Assets is
how many dollars of Net Sales is the
company producing with each $1 invested in Fixed Assets—that
is exactly what is measured by
the Fixed Asset Turnover Ratio.
As shown by the Fixed Asset Turnover Ratio, RC is currently
generating $4.50 of Net Sales from

43. each $1 of Average Net F -arrow after this
ratio’s name indicates that the
more dollars of sales that can be produced from each $1 of
Fixed Assets the better.
Annual Report Project Companies
Look at the Cash-to-Cash Cycle indicator for the ARP
companies.
when cash is paid out and
when cash is received in (has the lowest Cash-to-Cash Days)?
____________________________
when cash is paid out and
when cash is received in (has the highest Cash-to-Cash Days)?
_____________________________
As you can see from the ARP companies, Cash-to-Cash Days
will vary a lot from company to
company and industry to industry.
52 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
The following are calculation notes related to the Fixed Asset
Turnover Ratio:

44. Dec 31, 2020 Dec 31, 2021
( Net Prop., Plant, & Equip. + Net Prop., Plant, & Equip. ) / 2
= Average Net Fixed Assets for 2021
( $440,000 + $492,500 ) / 2 = $466,250
Note: The Net Prop., Plant, & Equip. amounts come from RC’s
Balance Sheets 2-BS tab.
The two Net Prop., Plant, & Equip. amounts used for the
calculation are the amounts at
the beginning of 2021 and at the end of 2021. The Dec 31, 2020
amount is 2020’s
ending Net Prop., Plant, & Equip. amount, and is also 2021’s
beginning Net Prop.,
Plant, & Equip. amount.
Average Net Fixed Assets was rounded to a whole number.
for Fixed Assets. The most often
used titles are Net Property, plant, and equipment and Property,
plant, and equipment, net.
iation is shown on the Balance Sheet,
the amounts used in the Average
Net Fixed Assets calculation are the amounts for Property,
Plant, and Equipment after
deducting Accumulated Depreciation. Look at RC’s Balance
Sheets for examples of this.
Let’s see the impact on this ratio if RC is able to increase Net
Sales without having to purchase
any additional Property, Plant, and Equipment.

45. -IS tab
-Eff. tab
The Fixed Asset Turnover Ratio increased significantly as a
result of the numerator, Net Sales,
increasing and the denominator, Average Net Fixed Assets, not
changing.
This concludes this section on Efficiency Indicators. In this
section, you added eight additional
tools to your financial statement analysis tool-kit.
Annual Report Project Companies
Look at the Fixed Asset Turnover Ratio for the ARP companies.
____________________________
set Turnover Ratio?
_____________________________
For the ARP companies, review all of their Efficiency
Indicators and then read the box titled
Discussion of Efficiency Indicators.
As you can see from the ARP companies, the Efficiency
Indicators will vary a lot from
company to company and industry to industry.

46. Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 53
-DPont. tab
Leverage, as used in the DuPont Analysis, is the measurement
of how the stockholders’
investment is leveraged up to obtain the assets used in the
business. As can see on the
.7-DPont. tab, the Assets-to-Equity Ratio is the third ratio in the
DuPont Analysis and is the ratio
that measures Leverage. The Assets-to-Equity Ratio measures
how many dollars of assets a
company has for each $1 of stockholders’ (owners’) investment.
As discussed in Chapter 3,
leverage is also referred to as financial leverage; thus the terms
Leverage and financial leverage
will be used interchangeably in this section.
Before leaving the .7-DPont. tab, observe the following about
the Assets-to-Equity Ratio:
measures average Leverage for
the year being analyzed. Saying the same thing in a different
way, the numerator is
Average Total Assets and the denominator is Average Total
Stockholders’ Equity. The
two additional Leverage ratios that you will learn in this section
will not measure the

47. average Leverage for the year, but rather will measure the
company’s Leverage at the end
of the year.
-DPont. tab, RC’s Assets-to-
Equity Ratio has a value of 1.95 to
1. This indicates that on average, for the year 2021, RC has
$1.95 of assets for each $1 of
stockholders’ investment. The additional $.95 of assets is the
result of RC borrowing from
creditors. Saying the same thing in a different way, on average
for the year 2021, for each
$1 of stockholders’ investment RC has borrowed $.95 from
creditors. This shows that RC
has a little less debt than equity.
-Lev. tab
On the .10-Lev. tab, you see two additional Leverage Indicators,
the Debt % and the Debt-to-
Equity Ratio. Like the Assets-to-Equity Ratio, these two new
indicators are also measuring
Leverage. The new indicators are just measuring Leverage in
different ways. The reason you are
being introduced to these two new indicators is because the
three Leverage Indicators:
-to-Equity Ratio
Debt-to-Equity Ratio
are often used interchangeably in the financial press when
discussing a company’s leverage.

48. Debt %
The Debt % shows the percent of each $1 of Total Assets that is
financed with debt. RC’s Debt %
shows that 47.42 cents of each $1 of Total Assets is financed
with debt. If 47.42 cents of each $1
of Total Assets is financed with debt, then 52.58 cents of each
$1 of Total Assets must be financed
with equity.
54 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
The Debt % is measuring the amount of financial leverage a
company has at the end of the
accounting year. RC’s Debt % shown on the .10-Lev. tab is for
2021; thus the Total Liabilities
amount of $579,827 and the Total Assets amount of $1,222,667
are the December 31, 2021
amounts from RC’s 2021 Balance Sheet.
-BS tab
Observe where the dollar amount for Total Liabilities and the
dollar amount for Total Assets
come from on RC’s December 31, 2021 Balance Sheet. Also
note that the Debt % value of
47.42% is also shown in the % of Total column for Total
Liabilities.
-Lev. tab
Like the DuPont Analysis Leverage indicator, Assets-to-Equity
-down-

49. arrows after its name—indicating that the desirable value
depends on various factors. For a
discussion of the factors that determine the desirable value of a
Leverage indicator see Pg 23.
Debt-to-Equity Ratio
The Debt-to-Equity Ratio shows the amount of Total Liabilities
(debt) for each $1 of Total
Stockholders’ Equity (equity). RC’s Debt-to-Equity Ratio of
.90 to 1 shows that RC has $.90 of
debt for each $1.00 of equity.
The Debt-to-Equity Ratio is measuring the amount of financial
leverage a company has at the end
of the accounting year. RC’s Debt-to-Equity Ratio shown on
the .10-Lev. tab is for 2021; thus the
Total Liabilities amount of $579,827 and the Total
Stockholders’ Equity amount of $642,840 are the
December 31, 2021 amounts from RC’s 2021 Balance Sheet.
-BS tab
Observe where the dollar amount for Total Liabilities and the
dollar amount for Total Stockholders’
Equity come from on RC’s December 31, 2021 Balance Sheet.
-Lev. tab
Like the two other Leverage indicators, Assets-to-Equity Ratio
and Debt %, the Debt-to-Equity
-down-arrows after its name—indicating that
the desirable value depends on
various factors.
Observe that the Debt % and the Debt-to-Equity Ratio are each

50. indicating the same thing—just in a
different way:
of
debt and 52.58 cents of
equity for each $1 of assets—a little less debt than equity.
-to-Equity Ratio of .90 shows that RC has $.90 of debt
for each $1.00 of equity—
a little less debt than equity.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 55
Let’s significantly increase RC’s financial leverage and see if
the Debt % and the Debt-to-Equity
Ratio indicate the same change in financial leverage.
-BS tab
f) on Jan. 1
key
As a result of the above changes, Notes Payable Long-Term has
increased from $300,000 to
$550,000—increased debt. Treasury Stock has gone from $0 to
($250,000)—decreased equity.
-Lev. tab

51. Observe that the Debt % and the Debt-to-Equity Ratio still
provide a consistent message:
debt and 31.46 cents of
equity for each $1 of assets—a lot more debt than equity.
-to-Equity Ratio of 2.18 shows that RC has $2.18 of
debt for each $1.00 of
equity—a lot more debt than equity.
In summary, the three Leverage indicators:
-to-Equity Ratio
-to-Equity Ratio
are all measuring the same thing, Leverage.
Annual Report Project Companies
Look at the Debt % and the Debt-to-Equity Ratio for the ARP
companies.
financial leverage (the highest
Debt %)? ____________________________
ich company has the lowest financial leverage (the lowest
Debt % and the lowest
Debt-to-Equity Ratio)? ____________________________

52. to assets than the
creditors? ____ Yes ____ No (enter an X in one
box)
Read the discussion about these two Leverage indicators in the
box titled Discussion of
Financial Leverage and Interest Coverage.
As you can see from the ARP companies, the blending of debt
and equity varies a lot from
company to company and industry to industry.
56 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
-Lev. tab
The Times Interest Earned Ratio is included on the .10-Lev. tab
with the Debt % and the Debt-to-
Equity Ratio because the debt that creates financial leverage
also creates the requirement for a
company to pay interest on that debt.
The Times Interest Earned Ratio measures a company’s ability
to pay the interest on its debt. This
ratio is currently showing that RC has available $12.33 of
earnings before interest and taxes for
each $1 of interest it must pay to creditors. At this level of

53. coverage, the creditors can feel quite
certain there will be adequate earnings to cover their interest.
The amounts needed to calculate this ratio are shown on the
Income Statement.
-IS tab
The numerator of the Times Interest Earned Ratio is earnings
before interest expense and before
income tax expense. It is calculated as follows:
Net Income .......................................... $161,840
plus Interest Expense ......................... 21,000
plus Provision for Income Taxes ......... 76,160
Earnings before interest and taxes ... $259,000
Income taxes are paid on income after interest has been
deducted; therefore the earnings
available to pay interest are before income taxes. Saying the
same thing in a different way,
creditors get their interest before the government gets its
income taxes. Given the structure of
RC’s Income Statement, earnings before interest and taxes is
the same as Operating Income.
This will not always be true, but in RC’s case it is.
Let us see what the Income Statement and the Times Interest
Earned Ratio would look like if RC
had just enough earnings before interest and taxes to cover
interest expense.

54. At this greatly reduced level of sales and increased cost of
goods sold percent, RC has just
enough earnings before interest and taxes to cover interest
expense. Notice that Pre-Tax Income,
Provision for Income Taxes, and Net Income are all now zero.
-Lev. tab
Observe that the Times Interest Earned Ratio is now equal to
1.00. RC now has available just $1
of earnings before interest and taxes for each $1 of interest
expense.
Before you made the changes to Net Sales and the Cost of
Goods Sold Percent, the Times
Interest Earned Ratio had a value over 12. With a value that
high, the creditor’s interest payments
had a good margin of safety. The fact that RC still has adequate
earnings to cover interest
expense, after Net Sales decreased by over $850,000 (a decrease
of over 40%) and after the Cost
of Goods Sold Percent increased from 57 to 60, shows how
large that margin of safety was.
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 57
-arrow after this ratios name—indicating that a
higher value is always better. A
higher value indicates a greater ability to pay interest out of
current earnings.

55. In summary, the Times Interest Earned Ratio provides
information about a company’s ability to pay
the interest on its debt. Creditors look to this ratio as one
indication of the safety of their future
interest payments.
Annual Report Project Companies
Look at the Times Interest Earned Ratios for the ARP
companies.
Ratio?
____________________________
lowest Times Interest Earned Ratio?
____________________________
Read the discussion about this ratio in the box titled Discussion
of Financial Leverage and
Interest Coverage.
As you can see from the ARP companies, interest coverage
varies a lot from company to
company and industry to industry.
58 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
Chapter 4 Homework

56. In these exercises, you will be calculating financial statement
analysis indicators that provide
additional insight into what drives The Toro Company’s DuPont
ratios. Specifically you will be
drilling down into Toro’s: Profitability, Efficiency, and
Leverage. Use the form in the Excel file
Red Company Chapter 4 Homework Form to record your
answers. For information and
examples on how to round your answers, see the appendix on Pg
86 in the file 6 – Annual Report
Project and Rounding Rules.pdf.
For these exercises, you will be using the financial statements
of The Toro Company. Use Toro's
financial statements that you printed when you worked the
Chapter 2 Homework. For an
introduction to Toro's financial statements, see Pg 18 in the file
2 – Vertical and Horizontal
Analysis.pdf.
Exercise 4-1 Gross Profit Margin % (a driver of Profitability)
A. When calculating the 2017 Gross Profit Margin %, which
financial statement line items are
used for the:
1. Numerator? – The line item name on Toro’s financial
statement and the $ amount.
2. Denominator? – The line item name on Toro’s financial
statement and the $ amount.
B. Calculate Toro’s Gross Profit Margin % for 2017. Round
your percent answer to 2 decimal
places.

57. C. The Gross Profit Margin % is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Gross Profit Margin %.
Which year, 2017 or 2016, had a better Gross Profit Margin %?
Exercise 4-2 Operating Profit Margin % (a driver of
Profitability)
A. When calculating the 2017 Operating Profit Margin %, which
financial statement line items
are used for the:
1. Numerator? – The line item name on Toro’s financial
statement and the $ amount.
2. Denominator? – The line item name on Toro’s financial
statement and the $ amount.
B. Calculate Toro’s Operating Profit Margin % for 2017.
Round your percent answer to 2
decimal places.
C. The Operating Profit Margin % is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Operating Profit Margin
%. Which year, 2017 or 2016, had a better Operating Profit
Margin %?

58. Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 59
Exercise 4-3 Accounts Receivable Turnover Ratio (a driver of
Efficiency)
Number of Days’ Sales in Receivables
A. When calculating the 2017 Accounts Receivable Turnover
Ratio, which financial statement
line items are used for the:
1. Numerator? – The line item name on Toro’s financial
statement and the $ amount.
2. Denominator? – (Note that the answers for this item are on
the Answer Sheet. Just the
Receivables, net: Customers amount should be used for the
denominator.)
B. Calculate Toro’s Accounts Receivable Turnover Ratio for
2017. Round Average Accounts
Receivable to a whole number. Round your final answer to 2
decimal places.
C. The Accounts Receivable Turnover Ratio is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Accounts Receivable
Turnover Ratio. Which year, 2017 or 2016, had a better
Accounts Receivable Turnover
Ratio?
E. Calculate Toro’s Number of Days’ Sales in Receivables for
2017. Utilize the Turnover Ratio

59. calculated in B. above. Round your final answer to 2 decimal
places.
F. Number of Days’ Sales in Receivables is a(n):
- - -
down-arrow indicator
G. On the Answer Sheet under your answer for item E. is Toro’s
2016 Number of Days’ Sales
in Receivables. Which year, 2017 or 2016, had a better Number
of Days’ Sales in
Receivables?
Exercise 4-4 Inventory Turnover Ratio (a driver of Efficiency)
Number of Days’ Sales in Inventory
A. When calculating the 2017 Inventory Turnover Ratio, which
financial statement line items
are used for the:
1. Numerator? – The line item name on Toro’s financial
statement and the $ amount.
2. Denominator? – The line item name on Toro’s financial
statement and the $ amounts.
B. Calculate Toro’s Inventory Turnover Ratio for 2017. Round
Average Inventory to a whole
number. Round your final answer to 2 decimal places.
C. The Inventory Turnover Ratio is a(n):
- -arrow indicator -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Inventory Turnover

60. Ratio. Which year, 2017 or 2016, had a better Inventory
Turnover Ratio?
E. Calculate Toro’s Number of Days’ Sales in Inventory for
2017. Utilize the Turnover Ratio
calculated in B. above. Round your final answer to 2 decimal
places.
F. Number of Days’ Sales in Inventory is a(n):
- - -
down-arrow indicator
G. On the Answer Sheet under your answer for item E. is Toro’s
2016 Number of Days’ Sales
in Inventory. Which year, 2017 or 2016, had a better Number
of Days’ Sales in Inventory?
60 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
Exercise 4-5 Accounts Payable Turnover Ratio
Number of Days’ Purchases in Accounts Payable
A. When calculating the 2017 Accounts Payable Turnover
Ratio, which financial statement line
items are used for the:
1. Numerator? – The line item name on Toro’s financial
statement and the $ amount.
2. Denominator? – The line item name on Toro’s financial
statement and the $ amounts.
B. Calculate Toro’s Accounts Payable Turnover Ratio for 2017.

61. Round Average Accounts
Payable to a whole number. Round your final answer to 2
decimal places.
C. The Accounts Payable Turnover Ratio is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Accounts Payable
Turnover Ratio. Which year, 2017 or 2016, had a better
Accounts Payable Turnover Ratio?
E. Calculate Toro’s Number of Days’ Purchases in Accounts
Payable for 2017. Utilize the
Turnover Ratio calculated in B. above. Round your final
answer to 2 decimal places.
F. Number of Days’ Purchases in Accounts Payable is a(n):
- - -
down-arrow indicator
G. On the Answer Sheet under your answer for item E. is Toro’s
2016 Number of Days’
Purchases in Accounts Payable. Which year, 2017 or 2016, had
a better Number of Days’
Purchases in Accounts Payable?
Exercise 4-6 Cash-to-Cash Cycle
A. On the Answer Sheet complete Toro’s Cash-to-Cash Cycle
table for 2017 and 2016.
B. Utilizing your answer for item A., discuss Toro’s Cash-to-
Cash Days for 2017 compared to
2016.

62. Exercise 4-7 Fixed Asset Turnover Ratio (a driver of
Efficiency)
A. When calculating the 2017 Fixed Asset Turnover Ratio,
which financial statement line items
are used for the:
1. Numerator? – The line item name on Toro’s financial
statement and the $ amount.
2. Denominator? – The line item name on Toro’s financial
statement and the $ amounts.
B. Calculate Toro’s Fixed Asset Turnover Ratio for 2017.
Round Average Fixed Assets to a
whole number. Round your final answer to 2 decimal places.
C. The Fixed Asset Turnover Ratio is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Fixed Asset Turnover
Ratio. Which year, 2017 or 2016, had a better Fixed Asset
Turnover Ratio?
Chapter 4 – Profitability – Efficiency – Leverage RED
COMPANY 61
Exercise 4-8 Debt % (an indicator of Leverage at year-end)
A. When calculating the 2017 Debt %, which financial
statement line items are used for the:

63. 1. Numerator? – (Note that the answer to this item is a schedule
on which you will
calculate the numerator, Total Liabilities for 2017. Toro does
not show a line item on
their Balance Sheet for Total Liabilities.)
2. Denominator? – The line item name on Toro’s financial
statement and the $ amount.
B. Calculate Toro’s Debt % for 2017. Round your final answer
to 2 decimal places.
C. The Debt % is a(n):
- wn- -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Debt %. Based on the
Debt % which year, 2017 or 2016, had more financial leverage
at the end of the year?
Exercise 4-9 Debt-to-Equity Ratio (an indicator of Leverage at
year-end)
A. When calculating the 2017 Debt-to-Equity Ratio, which
financial statement line items are
used for the:
1. Numerator? – See the answer to Exercise 4-8 item A.1.
2. Denominator? – The line item name on Toro’s financial
statement and the $ amount.
B. Calculate Toro’s Debt-to-Equity Ratio for 2017. Round your
final answer to 2 decimal

64. places.
C. The Debt-to-Equity Ratio is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s
2016 Debt-to-Equity Ratio.
Based on the Debt-to-Equity Ratio which year, 2017 or 2016,
had more financial leverage
at the end of the year?
Exercise 4-10 Times Interest Earned Ratio (an indicator of
interest coverage)
A. When calculating the 2017 Times Interest Earned Ratio,
which financial statement line
items are used for the:
1. Numerator? – (Note that the answer to this item is a schedule
on which you will
calculate the numerator, Earnings before Interest and Taxes for
2017.)
2. Denominator? – The line item name on Toro’s financial
statement and the $ amount.
B. Calculate Toro’s Times Interest Earned Ratio for 2017.
Round your final answer to 2
decimal places.
C. The Times Interest Earned Ratio is a(n):
- - -
down-arrow indicator
D. On the Answer Sheet under your answer for item B. is Toro’s

65. 2016 Times Interest Earned
Ratio. Which year, 2017 or 2016, had a better Times Interest
Earned Ratio?
62 RED COMPANY Chapter 4 – Profitability – Efficiency –
Leverage
This page intentionally left blank.
Textfield-0: Textfield-1: Textfield-2: Textfield-3: Textfield-4:
Textfield-5: Operating Profit Margin and Net Profit Margin:
Yes: Textfield-6: Yes-0: Profit Margin: Yes-1: highest Accounts
Receivable Turnover Ratio: company with zero Accounts
Receivable: Inventory Turnover Ratio: Textfield-8: Textfield-9:
has the lowest Accounts Payable Turnover Ratio: Textfield-10:
Textfield-11: Textfield-12: Textfield-13: Textfield-14: Debt-0:
DebttoEquity Ratio-0: creditors: Yes-2: Textfield-16: Textfield-
17:
Chapter 3
Financial Statement Analysis Tools
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Analysis Tools Covered in this Chapter
In this chapter will see:
How to calculate many financial ratios
How to use financial ratios to make predictions about potential
bankruptcy
How to calculate the economic profit (as opposed to net income)

66. that a firm earned in a period
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Financial Ratios
Financial ratios are simply comparisons of two financial
statement items
These comparisons help us to draw conclusions about the
financial health of the firm that aren’t immediately obvious by
looking at the raw values (e.g., net income may be positive, but
what matters is how large it is relative to sales, assets, or
equity)
We will calculate five categories of ratios:
Liquidity ratios
Efficiency ratios
Leverage ratios
Coverage ratios
Profitability ratios
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Liquidity Ratios
Liquidity ratios describe the ability of a firm to meets its short-
term obligations by comparing current assets to current
liabilities
Current assets will be converted to cash which will then be used
to retire current liabilities
For both ratios, higher values are indicative of a higher

67. probability of being able to pay off short-term debts
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Efficiency Ratios
Efficiency ratios, also called asset management ratios, provide
information about how well the company is using its assets to
generate sales
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Leverage Ratios (1 of 2)
Leverage ratios describe the degree to which the firm uses debt
in its capital structure
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.

68. Leverage Ratios (2 of 2)
Generally, lower leverage ratios are preferred though a
reasonable amount of debt is usually considered to be a good
thing
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Coverage Ratios
Coverage ratios describe the quantity of funds available to
“cover” certain expenses, particularly interest expense (though
this is not the only one)
We generally prefer higher coverage ratios as that indicates a
level of debt that is easy for the firm to service
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Profitability Ratios (1 of 2)
Profitability ratios measure how profitable a firm is relative to
sales, total assets, or equity
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be

69. scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Profitability Ratios (2 of 2)
Without exception, higher profitability ratios are preferred over
lower ones
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
10
E P I’s Financial Ratios
The image to the right shows the calculations of all financial
ratios that we discussed
These values were calculated using the financial statements
given in Chapter 2
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
DuPont Analysis
DuPont analysis refers to a method of decomposing the return
on equity into its components to better understand the R O E
and why it may have changed (or why it is different than that of
some other firm)
There are two versions of DuPont analysis:

70. Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Using Financial Ratios
Financial ratios can be analyzed in three ways:
Trend Analysis
Comparing to Industry Averages
Compared to Company Goals and Debt Covenants
Additionally, ratios can be used in valuation analysis and for
financial distress prediction
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Financial Distress Prediction (Z-Scores)
In 19 68, Edward Altman first used discriminant analysis to
classify firms into one of three categories: bankruptcy
predicted, possible bankruptcy, and no financial distress
Today, this model would be considered to be a “machine
learning” model alongside other classification methods (e.g., k-
means or support vector machines)
We covered two Z-Score models:
The Original Z-Score Model
The Z-Score Model for Private Firms
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
The Original Z-Score Model
The original Z-Score model was for publicly traded firms:

71. Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5
where
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Z-Score Model for Private Firms
Altman also estimated a model for privately held firms to allow
for the fact that you cannot calculate the market value of equity
for a private firm
This model is very similar, but the coefficients changed (note
that X4 has been redefined):
Z = 0.717X1 + 0.847X2 + 3.107X3 + 0.420X4 + 0.998X5
where
Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Economic Profit Measures of Performance
Economic profit is the profit earned in excess of the firm’s
costs, including its implicit opportunity costs (primarily its cost
of equity, which is ignored by accounting profit)
Definition of Economic Profit:
Note that economic profit is often referred to as Economic
Value Added (E V A), which is a trademark of Stern Stewart
and Company

72. Timothy R. Mayes, Financial Analysis with Microsoft Excel,
9th Edition. © 2021 Cengage. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Red Company HomeworkEnter your answers below - numbers
only with20172016EX2-1% of net sales% of net sales1Cost of
Sales63.20%63.40%2Gross profit36.70%36.50%3selling,
general, and admin expense22.50%22.50%4operating
earnings14.17%13.97%5net earnings10.60%9.65%B. Discuss
which line item (Cost of sales or selling, general and
administrative expense) helped to increase the operating
earnings and net earnings as a % of Net Sales from 2016 to
2017This helped operating earnings and net earnings as a
percent of sales go up from 2016 to 2017, because the cost of
sales was a little less in 2017. This helped.20172016EX 2-2% of
net sales% of net sales1Total receivables,
net12.25%11.79%2Inventories, net22%22.17%3Accounts
payable14.17%13.61%4Retained earnings7.50%7.88%5Total
stockholders' equity41.31%39.72%B.Did liabilities or equity
finance more of Toro's Total assets in
2017?liabilities20172016EX-2-3% of net sales% of net
sales1Net sales4.72%0.05%2Cost of sales4.21%2.40%3Gross
profit5.28%4.69%4selling, general, and admin
expense4.72%0.62%5net earnings18.89%14.58%B.Coment on
the percent change in gross profit from 2016 to 2017 compared
to the percent change in net sales from 2016 to 2017It is the
percentage change in net sales from 2016 to 2017. Even though
net sales have gone up a lot from last year compared to gross
profit.20172016EX2-4% of net sales% of net sales1Total
receivables, net$19,80812.13%2Inventories,
net$21,9587.15%3Accounts payable$37,08421.23%4Retained
Earnings$54,28511.30%B.Comment on the percent change in
inventory from 2016 to 2017 compared to the percent change in
cost of sales from 2016 to 2017When you compare the

73. percentage changes in inventory from 2016 to 2017 to the
percentage changes in cost of sales from 2016 to 2017, you see
that inventory changed more than cost of sales changed.
Internet ExerciseBig RockCandy Mountain Mining Co.Income
StatementFor the Year Ended Dec.
31,202020202019Sales412,500398,600Cost of Goods
Sold318,786315,300Gross Profit93,71483,300=B5-B6Selling
and G&A Expenses26,25024,550Other
Expenses1,2101,245Depreciation
Expense29,80029,652EBIT36,45427,853=B7-
SUM(B8:B10)Interest Expense8,5828,457Earnings Before
Taxes27,87219,396=B11-
B12Taxes6,9684,849=B13*B18Netlncome20,90414,547=B13-
B14Notes:Tax
Rate0.250.25Shares52,10052,100EPS$0.40$0.40Big Rock
Candy Mountain Mining Co.Balance SheetAs of Dec.
31,2020Assets20202019Cash16,43511,596Accounts
Receivable45,89647,404Marketable
Securities3,656619Inventory52,39754,599Total Current
Assets118,384114,218=SUM(B5:B8)Gross Fixed
Assets436,573397,023Accumulated
Depreciation87,45057,650Net Plant &
Equipment349,123339,373=B10-B11Total
Assets467,507453,591=B9+B12Liabilities and Owner's
EquityAccounts Payable37,75236,819Accured
Expenses3,1833,085Total Current
Liabilities40,93539,904=SUM(B15:B16)Long-term
Debt170,562178,581Total
Liabilities211,497218,485=B17+B18Common
Stock58,66458,664Additional Paid-In-
Capital136,807136,807Retained Earnings60,53939,635Total
Shareholder's Equity256,010235,106=SUM(B20:B22)Total
Liabilities and Owner's Equity467,507453,591=B19+B23Big
Rock Candy Mountain Mining Co.Common Size Income
StatementFor the years 2019 and 2020Income
StatementCommon Size Income

74. Statement2020201920202019Sales412,500.00398,600.00100.00
%100.00%Cost of
Goods318,786.00315,300.0077.28%79.10%Gross
Profit93,714.0083,300.0022.72%20.90%Depreciation29,800.002
9,652.007.22%7.44%Selling & Admin.
Expense26,250.0024,550.006.36%6.16%Other Operating
Expense ___1,210.001,245.000.29%0.31%Net Operating
Income36,454.0027,853.008.84%6.99%Interest
Expense8,582.008,457.002.08%2.12%Earnings Before
Taxes27,872.0019,396.006.76%4.87%Taxes6,968.004,849.001.6
9%1.22%Net Income20,904.0014,547.005.07%3.65%New
Smyrna Surf ShopStatement of Cash FlowsFor the Year
2020Cash Flows from OperationsNet
Income120.540.00Depreciation Expense7,148Change in
Accounts Receivable(11,248)Change in
Inventories(8,276)Change in Accounts Payable1,589Total Cash
Flows from Operations109,753.00Cash Flows from
InvestingChange in fixed assets(41,704)Total Cash Flows from
InvestingS (41,704)Cash Flows from FinancingChange in Notes
Payable(3,025)Change in Long-Term Debt755Change in
Common Stock-Change in Paid-In Capital-Cash
Dividends(60,000)Total Cash Flows from
Financing(62,270.00)Net Change in Cash
Balance5,779.00Check answer against Balance SheetBeginning
Cash From Balance Sheet15,187Ending Cash From Balance
Sheet20,966Net Change in Cash Balance5,779.00