Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 14 Financial Statement Analysis 683

Assume that the president of Crest Brewery made the following statement to shareholders in

Crest’s most recent annual report:

“The founding family and majority shareholders of the company do not believe in

using debt to finance future growth. The founding family learned from hard experience

during Prohibition and the Great Depression that debt can cause loss of flexibility and

eventual loss of corporate control. The company will not place itself at such risk. As

such, all future growth will be financed either by stock sales to the public or by inter-

nally generated resources.”

As a public shareholder of this company, how would you respond to this policy?

Micro-Tek Company completed its fiscal year on December 31, 2007. The auditor, Ashley Blake,

has approached the CFO, Gwen Williams, regarding the year-end receivables and inventory levels

of Micro-Tek. The following conversation takes place:

Ashley:We are beginning our audit of Micro-Tek and have prepared ratio analyses to deter-

mine if there have been significant changes in operations or financial position. This helps

us guide the audit process. This analysis indicates that the inventory turnover has de-

creased from 15 to 8.5, while the accounts receivable turnover has decreased from 12 to 8.

I was wondering if you could explain this change in operations.

Gwen:There is little need for concern. The inventory represents computers that we were un-

able to sell during the holiday buying season. We are confident, however, that we will be

able to sell these computers as we move into the next fiscal year.

Ashley:What gives you this confidence?

Gwen:We will increase our advertising and provide some very attractive price concessions to

move these machines. We have no choice. Newer technology is already out there, and we

have to unload this inventory.

Ashley:... and the receivables?

Gwen:As you may be aware, the company is under tremendous pressure to expand sales and

profits. As a result, we lowered our credit standards to our commercial customers so that

we would be able to sell products to a broader customer base. As a result of this policy

change, we have been able to expand sales by 35%.

Ashley:Your responses have not been reassuring to me.

Gwen:I’m a little confused. Assets are good, right? Why don’t you look at our current ratio? It

has improved, hasn’t it? I would think that you would view that very favorably.

Why is Ashley concerned about the inventory and accounts receivable turnover ratios and

Gwen’s responses to them? What action may Ashley need to take? How would you respond to

Gwen’s last comment?

Warren Buffet, one of the most successful investors in the world, made the following comment

about his investment emphasis: “We simply attempt to be fearful when others are greedy and

to be greedy only when others are fearful.”

What does Buffet mean by this quote?

Use the Internet to research the difference between the following three popular investing strategies:

1. Value investing


2. Growth investing


3. Technical investing (or analysis)

Provide a brief paragraph explaining each investment approach.

Activity 14-2

Analysis of financing corpo-
rate growth

Activity 14-3

Receivables and inventory
turnover

Activity 14-4

Warren Buffet on investing

Activity 14-5

Investing strategies