Question

1) Prepare an income statement from the following information. Sales: $600,000 Cost of Goods Sold: $300,000 Administrative expenses: $50,000 Depreciation expenses: $10,000 Interest expense: $15,000 Tax rate: 20% 2) Prepare a balance sheet from the following information Cash $110,000 Accounts receivable: $50,000 Accounts payable: $40,000 Notes payable (short term $120,000 Inventories: $70,000 Gross fixed assets: $175,000 Other assets: $15,000 Retained earnings: $15,000 Accumulated depreciation: $20,000 Long term banknote: $105,000 Other long-term debt: $20,000 Common stock $100,000 3) Prepare a statement of cash flows using the following information. Increase in accounts receivable: 5600 Increase in inventories: $160 Increase in long term debt: $160 Beginning cash: $6,000 Increase in accounts payable: $120 Increase in other current assets: $300 Dividends: $80 Increase in common stock: $20 Increase in gross fixed assets: $100 Depreciation expense: 3,000 Net income: $1,000 4 When will afirm's ROE and ROE be equal to one each other? 5) What are the limitations of financial ratios?

Answer 1

(1): Income statement:

Sales	600,000
less: cost of goods sold	300,000
Gross profit	300,000
less: other expenses
Administrative expenses	50,000
EBITDA	250,000
less: depreciation	10,000
EBIT	240,000
less: Interest expense	15,000
Profit before tax	225,000
less: tax @ 20%	45,000
Net income	180,000

(2): Balance sheet:

Assets		Liabilities
Current assets:		Current liabilities:
Cash	110,000	Accounts payable	40,000
Accounts receivable	50,000	Notes payable	120,000
Inventories	70,000	Total current liabilities	160,000
Total current assets	230,000	Long term bank note	105,000
Gross fixed assets	175,000	Other long term debt	20,000
less: accumulated depreciation	20,000	Total liabilities	285,000
Net fixed assets	155,000	Common stock	100,000
Other assets	15,000	Add: retained earnings	15,000
		Total equity	115,000
Total assets	400,000	Total liabilities and equity	400,000

(3): Cash flow statement:

Operating activities:
Net income	1,000
Add: depreciation expense	3,000
Changes in operating assets and liabilities:
Increase in accounts receivable	-          600
Increase in inventories	-          160
Increase in other current assets	-          300
Increase in accounts payable	120
Net cash provided by operating activities	3,060
Investing activities:
Increase in gross fixed assets	-          100
Net cash used in investing activities	-          100
Financing activities:
Increase in long term debt	160
Dividends	-            80
Increase in common stock	20
Net cash provided by financing activities	100
Net increase/(decrease) in cash	3,060
Cash at the beginning of the year	6,000
Cash at the end of the year	9,060

(4): The question states when will ‘ROE and ROE be equal’. As both are same I am assuming the question is when ROE will be equal to ROA. This will happen when assets = equity. In other words this will happen when there are no liabilities and so the equation ASSETS = LIABILITIES + EQUITY will become ASSETS = EQUITY.

(5): The limitations of financial ratios are that they fail to represent the future financial performance of a company in a proper manner. The financial ratio computations are based on past and we can determine the trend but still it is will be difficult to properly determine a company’s future performance based on its financial ratios. Secondly any changes in accounting policies will make the financial ratios not comparable. Thirdly ratio analysis fails to consider seasonal effects. Lastly if there are any operational changes, change in strategy or supply chain changes then financial ratios will become incomparable.