6.2 FINANCIAL STATEMENT ANALYSIS

Question 1

OPERATING PROFIT MARGIN

Answer 1

Operating profit margin = EBIT / Net sales.

Question 2

DEBT TO EQUITY RATIO

Answer 2

the accounts payable is not a debt

Question 3

An investment firm’s research wing has developed a spread sheet model using macros to do stock valuation. In the current year, the Vice President of the firm plans to develop the model further and the company has spent $275,000 for the development of the software. Currently, the firm considers to sell it as a sophisticated valuation model. As a result, what will be effect of planning to sell it as a product against using it for internal purposes only?

Answer 3

This is a case where the internally developed software was fisrt classified as “for internal use” and then later it was decided to sell the software. When it was classified as “for internal use” the cost incurred after the prelimnary stage would have been capitalized and an amortization for the same would be recognized in the income statement. Then, later when the company classifies the software as a product for sales, It would record the software in the balance sheet as inventory and there wouldn’t be any amortization. This would increase the income in the income statement. Further revenue for the sale of the software can be recognized only when the revenue exceeds the carrying value of the software. [Net profit margin = Net profit / revenue].
Thus, the net profit margin will increase.

Question 4

RETURN ON EQUITY

Answer 4

Return on equity = Net profit / Equity. A variation of the return of equity formula is: (Net profit / Net sales) x (Net sales / Assets) x (Assets / Equity) which measures the operating efficiency, asset use efficiency and financial leverage respectively.