Rev. 6/27/2023
BUS 5601 Essentials of Business Development 1
Accounting Project: Part 3 – Ratio and Investment Analysis Instructions
Due Date: [End of Week 3, by 11:59pm ET]
EXAMPLES OF HORIZONTAL AND VERTICAL ANALYSES:
Horizontal Analysis Example (same method for all financial statements)
|
|
2020 |
Difference between ‘20 and ‘19 |
% Difference between ‘20 and ‘19 |
2019 |
Difference between ‘19 |
% Difference between ‘19 and ‘18 |
2018 Use oldest year as base year |
Difference between ‘20 |
% between ‘20 |
|
Cash |
$20,000 |
$2,000 |
11.1% 2,000 / 18,000 |
$18,000 |
$3,000
|
20% 3,000 / 15,000 |
$15,000 |
$5,000
|
33.3% 5,000/15,000 |
Vertical Analysis Example: Balance sheet
|
|
2020 |
Percent of Total assets |
2019 |
Percent of Total assets |
2018 |
Percent of Total assets |
|
Assets Cash Etc. |
$20,000 — |
8% |
$18,000 |
5.6% |
$15,000 |
5.0% |
|
Total Assets Largest number on B.S. |
$250,000 |
100% |
$320,000 |
100% |
$300,000 |
100% |
|
Liabilities Acct. Payable Etc. St. Equity — Ret. Earnings |
$40,000 —
— 120,000 |
16% —
— 48% |
$45,000 —
— 110,000 |
14.1%
34.4% |
$50,000 —
— 130,000 |
16.7%
43.3% |
|
Total Liab. & SE Largest number on B.S. is the 100% |
$250,000 |
100% |
$320,000 |
100% |
$300,000 |
100% |
Vertical Analysis Example: Income statement
|
|
2020 |
Percent of Sales |
2019 |
Percent of Sales |
2018 |
Percent of Sales |
|
Sales Largest number on income |
$430,000 |
100% |
$400,000 |
100% |
$350,000 |
100% |
|
Expenses |
422,000 |
98.1% |
390,000 |
97.5% |
330,000 |
94.3% |
|
Net Income |
$8,000 |
1.9% |
$10,000 |
2.5% |
$20,000 |
5.7% |
TASK #1: Requirements 1 through 4 can be done in Word or Excel.
- Horizontal and vertical analyses. Perform the following:
- Perform and submit horizontal and vertical analyses on your company for the 3 most recent years.
- In your opinion, for the horizontal analysis, is the company’s financial position showing a better or worse trend from the oldest to the most recent period? Why? (Remember, when determining percentage changes, the “denominator” in the formula is the value for the oldest year.)
- What inefficiencies do you note in the vertical analysis? Does your opinion of the company’s financial position change from what you entered in 1b.? Why?
- For the most recent year of your company, locate the “Ratios” in the Mergent Database, under the “Company Financials” tab, and list in a 2-column table (Column 1: Name of Ratio and Column 2: Value of Ratio) between 5-to-10 ratios.
- Go to https://www.readyratios.com/sec/industry (or copy and paste this web address in a browser’s address bar) and click on “All Industries”, and select the industry applicable for your company. Compare the ratios obtained from Requirement #2 above with the industry average ratios that are available. Note that you may not be able to identify some industry average ratios to compare against your company ratios, and vice versa. Present the ratios for your company and its industry in a table with the following four columns: Ratio Name, Your Company’s Ratio Value, the Industry Average Ratio Value, and Your Assessment and Interpretation of the Ratio. Note: For the ratio assessment and interpretation, you will need to refer to your text and/or notes regarding the nature, purpose, and objective of the ratio.
- Compute the Altman Z-Score: The Z-Score can be characterized as a linear combination of 4-5 common business ratios. These ratios are weighted by coefficients which are estimated by spotting a set of firms which had declared a bankruptcy. Thereafter, a matched sample of firms is collected for the surviving firms, with matching by industry and estimated assets. The formula for Z-Score and prediction of bankruptcy was given by Edward I. Altman in 1968. This formula for Altman Z-Score is helpful in calculating and predicting the probability that a company will go into bankruptcy within two years.
5-factor model formula of the Altman Z-score:
Z-score = 0.717T1 + 0.847T2 + 3.107T3 + 0.42T4 + 0.998T5
where,
T1 = Working Capital / Total Assets
T2 = Retained Earnings / Total Assets
T3 = Earnings Before Interest and Taxes / Total Assets
T4 = Equity / Total Liabilities
T5 = Sales / Total Assets
Zones of Discrimination:
· 1.23 or less – “Distress” Zone
· from 1.23 to 2.9 – “Grey” Zone
· 2.9 or more – “Safe” Zone
Interpretation of the Altman Z-Score (Zones of Discrimination) – The Z-Scores are helpful in predicting corporate defaults as well as an easy-to-calculate measure of control for financial distress status of companies in academic studies. A Z-Score of 2.9 and above is indication of a healthy company or one that is in the “safe” zone. A “safe” zone implies that such a company is not likely to enter bankruptcy. Companies with Z-Scores ranging between 1.23 – 2.9 lie in the “grey” area. Companies with a Z-Score or 1.23 or less lie in the “distress” zone and may face potential disruptions or even enter into bankruptcy.
Accuracy and Effectiveness – In the initial stages, the Altman Z-Score was found to be 72% exact in predicting bankruptcy two years preceding the event, including a Type II error (false positives) of 6%. However, the model was found to be about 80% – 90% accurate in the process of predicting bankruptcy one year preceding the event, in a series of ensuing tests including three distinctive time periods over the next 31 years. However, a type II error, classifying the company as bankrupt while it is not going so, of 15% – 20% was also included in these tests.
Required: Present the following information in a table with 8 columns:
Column 1: T1 most current year
Column 2: T2 most current year
Column 3: T3 most current year
Column 4: T4 most current year
Column 5: T5 most current year
Column 6: Z-score (calculated on the 5-factor model) for the most current year
Column 7: Distress, Gray, Safe
Column 8: Your opinion on the Altman Z-Score Interpretation (Column 7): Agree, Disagree, or Unsure? Why?
TASK #2: Requirement 5 should be done in a Word document.
- Investment Decision: In no more than two typed pages (double line spacing, 1” margins, and font Times New Roman, size 12), provide a statement of your decision to invest or not invest in your selected company’s stock based on your interpretation of the company’s long-term prospects (i.e., long-term viability and growth). Research this as you would if you were considering investing $50,000 your own cash in the stock of this company. You are expected to integrate your conclusions from the ratio analyses performed above; however, this is not to be your only source of information for the investment decision. You may use articles about you company found in publications or financial analyst reports to support your decision. Use the library academic databases (i.e., Proquest), the Internet, and Mergent Online news to search for information on your company and/or the industry. Provide a reference list for any sources cited in support of your statement. Please be sure to provide a clear conclusion on your decision to invest or not invest in this company’s stock.
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