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ers™ equity) from last year to this year.
The percentage change in each stockholders™ equity item
s

(as a percentage of liabilities and stockholders™ equity) from
last year to this year.
The Income Statement. Figure 5-1 on the next page shows
a vertical analysis for A.I.™s income statement for this year and
last year, using net sales as a base (100 percent). All those inter-
ested folks you read about in chapter one can compare the change
in percentages between years to see what™s gone up or down, by
how much, and which items accounted for the difference, and
whether it™s good (yea!) or bad (boo!).
Notice that net income as a percentage of net sales is 1.3
percent lower this year than last. That was caused by a combina-
tion of three factors. Cost of goods sold increased 6.5 percent,
which is not good news. That automatically lowered gross profit
by the same percentage.
Total expenses were down this year by 4.3 percent, and in-
come tax was down by .9 percent, but that wasn™t enough to
offset that 6.5 percent increase in cost of goods sold. So net
62 THE AGILE MANAGER™S GUIDE TO UNDERSTANDING FINANCIAL STATEMENTS


Figure 5-1 Avaricious Industries
Consolidated Earnings Statement
(Note: Comparative statements are condensed to key amounts)

This Year Last Year
Amount Percent Amount Percent
Net sales $38,028,500 100.0% $26,315,420 100.00%
Cost of goods sold 26,358,500 69.3% 16,526,084 62.80%
Gross profit 11,670,000 30.7% 9,789,336 37.20%
Variable and
selling expenses 6,910,605 18.2% 6,157,808 23.40%
General and admini-
strative expenses 2,324,555 6.1% 1,368,402 5.20%
Total operating
expenses 9,235,160 24.3% 7,526,210 28.60%
Earnings before
income tax 2,434,840 6.4% 2,263,126 8.60%
Income tax 925,239 2.4% 868,409 3.30%
Net income $1,509,601 4.0% $1,394,717 5.30%

Common stock shares
outstanding 2,500,000 2,498,750
Earnings per share
of common stock 0.60 0.56


income, expressed as a percentage of net sales, decreased 1.3
percent, and the higher cost of goods sold was the root cause.
The Balance Sheet. Shifting to A.I.™s balance sheet, Figure
5-2 expresses key assets as a percentage of total assets for the past
two years. Some changes are obvious. As with the income state-
ment, liabilities and stockholders™ equity are expressed as a per-
centage of their total (percentage amounts may vary because of
rounding).
First, take a look at the company™s assets. Notice that cash is a
higher percentage of assets this year than last year (6.51 percent
vs. 3.82 percent). Accounts receivable are also a higher percent-
age of assets, but notes receivable dropped slightly. Merchandise
inventory was lower than last year (which implies more careful
Financial Analysis: Number-Crunching for Profit 63


Figure 5-2 Avaricious Industries
Balance Sheet
December 31, 19XX

ASSETS This Year Last Year
Current assets Amount Percent Amount Percent
Cash and cash
equivalents $1,271,231 6.51% $677,600 3.82%
Accounts
receivable (net) 994,409 5.09% 773,134 4.35%
Notes receivable 350,000 1.79% 320,000 1.80%
Merchandise
inventories 3,250,000 16.64% 4,190,000 23.59%
Total
current assets 5,865,640 30.03% 5,960,734 33.56%
Property and
equipment (net) 13,668,850 69.97% 11,798,155 66.44%
TOTAL ASSETS $19,534,490 100% $17,758,889 100%


inventory management) and net property and equipment in-
creased, because management bought some new items and un-
loaded some obsolete ones (which was shown on the cash flow
statement).
Moving to liabilities (next page), you™ll see that accounts pay-
able is a smaller percentage of total liabilities and stockholders™
equity this year than last. Income taxes payable are somewhat
higher, but other accrued expenses (“accrued,” recall, means owed
but not yet paid on the balance sheet date) are considerably
lower. Looking at the two major liability categories, current liabili-
ties are up .21 percent over last year, but long-term liabilities are
1.34 percent below last year™s percentage. The net result? Total li-
abilities are 1.15 percent lower this year. So creditors have less of a
stake in the company this year than they had last year. Cheers!
Stockholders™ equity is up 1.15 percent, which is logical, be-
cause debts went down 1.15 percent. The decrease in the credi-
tors™ claims naturally shifted down to (and increased) the stock-
holders™ claims.
64 THE AGILE MANAGER™S GUIDE TO UNDERSTANDING FINANCIAL STATEMENTS



Figure 5-2, continued
LIABILITIES
This Year Last Year
Amount Percent Amount Percent
Current liabilities
Accounts payable 1,275,300 6.53% 1,477,800 8.32%
Salaries payable 330,000 1.69% 245,200 1.38%
Income taxes
payable 925,239 4.74% 500,200 2.82%
Other accrued
expenses 8,000 0.04% 48,339 0.27%
Total
current liabilities 2,538,539 13.00% 2,271,539 12.79%
Long-term liabilities
Mortgage payable 500,000 2.56% 536,000 3.02%
Bonds payable 2,400,000 12.29% 2,340,000 13.18%
Total long-term
liabilities 2,900,000 14.85% 2,876,000 16.19%
TOTAL
LIABILITIES 5,438,539 27.84% 5,147,539 28.99%

STOCKHOLDERS™ EQUITY
Common stock, 2,500,000 shares
at $1 par value
per share 2,500,000 12.80% 2,498,750 14.07%
Capital in excess of
par value 1,750,000 8.96% 1,726,250 9.72%
Retained earnings,
January 1, 19XX 8,386,350 42.93% 6,991,633 39.37%
Net income
for year 1,509,601 7.73% 1,424,717 8.02%
Less dividends (50,000) -0.26% (30,000) -0.17%
Retained earnings,
Dec. 31, 19XX 9,845,951 50.40% 8,386,350 47.22%
TOTAL STOCKHOLDERS™
EQUITY 14,095,951 72.16% 12,611,350 71.01%
TOTAL LIABILITIES AND
STOCKHOLDERS™
EQUITY $19,534,490 100.00% $17,758,889 100.00%
Financial Analysis: Number-Crunching for Profit 65



The Agile Manager™s Checklist
Look at the organization™s finances from several angles.
Some indicators may show it™s doing fine, while others
may show it™s doing poorly.
Find an industry comparison for all your figures. When
in doubt, try the Robert Morris Annual Statement Studies.
(You™ll find it in most good libraries.)
A healthy current ratio is $2 : $1 (current assets vs.
current liabilities).
The acid-test ratio (cash and accounts receivable vs.
current liabilities) should be around $1 : $1.
Return on stockholders™ equity (net income divided by
stockholders™ equity) should at least match the return
investors could get elsewhere.
Many companies live or die based on how fast they turn
over inventory.
Chapter Six


Inventory Valuation
(Or, What™s It Worth?)




“Bankrupt companies value their inventory with a method
called FISH. That stands for First In, Still Here.”
ANONYMOUS


As the Agile Manager jotted down a few notes about valuing
inventory for his meeting with Steve, he recalled meeting with a
small vendor when that very subject came up.
He™d just about wrapped up the visit with the company™s presi-
dent when the president took a phone call. The Agile Manager
cursed himself for not getting out of there a hair sooner”especially
when the president began shouting at his caller.
“LIFO Schmifo! I just want you to get that bottom line down!”
The man™s bald head turned purple.
Wow, thought the Agile Manager. Do people like this still exist
in this industry?
“Don™t give me that crap”I pay you to keep my books, not tell
me what to do. Now go back at it and don™t call me until you have
the bottom line in six figures.” With that he slammed down the


67
68 THE AGILE MANAGER™S GUIDE TO UNDERSTANDING FINANCIAL STATEMENTS


phone, mopped his brow, and became remarkably composed in
just a few seconds.
“Damn accountant,” he said to the Agile Manager. “Tells me I
can™t change inventory valuation methods every year to suit my
needs. But I tell you,” he hissed through gritted teeth, “I can™t afford
to give the government half my profits!” His head purpled again
briefly. “Well,” he said, smiling broadly and sticking out his hand.
“Pleasure meeting you finally. Next time let™s do it over lunch.”

Companies have a number of methods at hand to figure out
the value of their year-end inventory, and each one produces a
different value for the same goods.
The ending inventory™s value, as you saw in chapters two and
three (we™ve come a long way, baby!), shows up on both the
income statement and the balance sheet. The method a com-
pany picks to assign a value to that inventory will alter the value
of its assets (because inventory is an asset) as well as the cost of
goods sold”which also affects, in domino fashion, gross profit
and net income, and ultimately stockholders™ equity.
Major Inventory Valuation Methods
The philosophical question, “What™s in a name?” might be
changed to read, “What™s an inventory worth?” Fiscal philoso-
phers and monetary mavens can answer that question four dif-
ferent ways.
Specific invoice prices. This valuation method is pretty un-
usual. It only works when a company™s records allow it to track
each item in its ending inventory to the specific invoice on which
the item was bought.
Specific invoice prices would be practical for auto dealerships
or businesses that sell heavy equipment, because their ending
inventory would be made up of big-ticket, easily identified prod-
ucts. All you need to do is walk out on the lot and check the
serial numbers on the cars or bulldozers, look them up in the
invoices in the file, and jot down each one™s cost.
FIFO. No, we™re not talking about somebody™s pet poodle.
69
Inventory Valuation


FIFO stands for First In, First Out, and it refers to how the units
in the company™s inventory flowed through the warehouse from
when they arrived until the time they were sold. Most products
move through a business in FIFO fashion. The first ones re-
ceived are the first ones sold over the counter to customers.
Now if you assume this sequence reflects reality, it stands to
reason that the ending inventory (the goods that are sitting in
the warehouse on the last day of the year) are the ones that were
bought most recently. Very good! The cost of the goods that
were sold, then, would be the total of the beginning inventory
and the earliest purchases.
Look at Figure 6-1, which shows information about Avari-
cious Industries™ beginning inventory and the purchases it made

Figure 6-1 Units Cost per unit Total cost

Beginning inventory 274,754 $15.25 $4,190,000
February purchase 313,036 $12.18 $3,812,775
April purchase 559,386 $11.36 $6,354,625
June purchase 421,884 $12.05 $5,083,700
September purchase 762,555 $10.00 $7,625,550
November purchase 203,348 $12.50 $2,541,850
TOTAL UNITS 2,534,963
TOTAL PURCHASES $25,418,500
Goods available for sale $29,608,500
Weighted average cost per unit $11.68
If ending inventory is 274,163 units:
Value under FIFO: 203,348 @ $12.50 2,541,850
70,815 @ $10.00 708,150
$3,250,000

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