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GLENCOE / McGraw-Hill

GLENCOE / McGraw-Hill. Statement Analysis: Measuring Profitability, Financial Strength, and Liquidity. Ratios Measuring Financial Strength. Section Objective. Compute and interpret financial ratios that measure financial strength. Number of times bond interest earned

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GLENCOE / McGraw-Hill

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  1. GLENCOE / McGraw-Hill

  2. Statement Analysis: Measuring Profitability, Financial Strength, and Liquidity

  3. Ratios Measuring Financial Strength Section Objective • Compute and interpret financial ratios that measure financial strength.

  4. Number of times bond interest earned Ratio of stockholders’ equity to total equities Ratio of stockholders’ equity to total liabilities Book value per share of stock Page 885 Ratios Measuring Financial Strength

  5. Measures the ability of net income to cover the required bond interest payments Formula: Income before bond interest and income taxes Bond interest cash requirement Times bond interest earned = Page 885 Number of Times Bond Interest Earned • Procedure: • Step 1: Compute the income before bond interest and income taxes. • Step 2: Compute the cash required to pay bond interest. • Step 3: Compute the ratio.

  6. Step 1: Compute income before bond interest and income taxes. Add bond interest expense 5,908 Available for bond interest $202,302 Page 885 Number of Times Bond Interest Earned Income before tax $196,394

  7. Step 1: Income before bond interest and income taxes = $202,302 $70,000 x 0.10 $ 7,000 Page 885 Number of Times Bond Interest Earned • Step 2: Compute the cash required to pay bond interest.

  8. Step 1: Income before bond interest and income taxes = $202,302 Step 2: Cash required to pay bond interest = $7,000 $202,302 $ 7,000 = 28.9 times Page 885 Number of Times Bond Interest Earned • Step 3: Compute the ratio. The income of Carolina Creations, Inc. easily covers required bond payments.

  9. Measures the portion of total capital provided by the stockholders and indicates the protection afforded creditors against possible losses. Formula: Stockholders’ equity Total equities Ratio of stockholders’ equity to total equities = $328,510 $480,059 = 0.68 to 1 Page 885 Ratio of Stockholders’ Equity to Total Equities • Example: A comparison with the industry average is important in determining a desirable ratio for a particular business.

  10. Stockholders’ equity Total liabilities Ratio of stockholders’ equity to total liabilities = $328,510 $151,549 2.17 to 1 = Page 886 Ratio of Stockholders’ Equity to Total Liabilities • Also known as the ratio of owned capital to borrowed capital • Formula: • Example:

  11. Measures the financial strength underlying each share of stock Formula: Common stockholders’ equity Number of common shares Book value per share of stock = Page 887 Book Value per Share of Stock • Procedure: Step 1: Compute the claims of preferred shareholders. Step 2: Compute the claims of common stockholders. Step 3: Divide the total claims of common stockholders by the number of shares outstanding.

  12. Step 1: Compute the claims of preferred stockholders. $ 100 x 500 shares outstanding $50,000 Page 887 Book Value per Share of Stock For Carolina Creations, Inc. the book value of preferred stock is the same as the par value, $100 per share.

  13. Step 1: Claims of preferred stockholders = $50,000 Less preferred stock equity 50,000 Claims of common stockholders $278,510 Page 887 Book Value per Share of Stock • Step 2: Compute the claims of common stockholders. Stockholders’ equity $328,510

  14. Step 1: Claims of preferred stockholders = $50,000 Step 2: Claims of common stockholders = $278,510 $63.30 = $278,510 4,400 shares Page 887 Book Value per Share of Stock • Step 3: Divide the total claims of common stockholders by the number of shares outstanding.

  15. Book value and fair market value often are quite different. Book value per share does not indicate how much the stockholder would receive if the assets were sold and the corporation liquidated. Page 886 Book Value per Share

  16. R E V I E W Complete the following sentences: The number of times bond interest earned measures the ability of __________ to cover required _____________________. net income bond interest payments stockholders’ equity to total The ratio of ________________________ _______ is an indication of the protection afforded creditors against possible losses. equities The ratio of owned capital to borrowed capital is the ________________________ _______________. ratio of stockholders’ equity to total liabilities

  17. R E V I E W Complete the following sentences: book value per share of stock The __________________________ measures the financial strength underlying each share of stock. The formula for book value per share of stock is __________________________ divided by _______________________. common stockholders’ equity number of common shares Book value per share does not indicate how much the stockholder would receive if the assets were sold and the corporation _________. liquidated

  18. Thank You for using College Accounting, Tenth Edition Price • Haddock • Brock

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