Principles of Managerial Finance

CHAPTER 2 Financial Statements and Analysis 61

common-size income statement
An income statement in which
each item is expressed as a
percentage of sales.

15. This statement is sometimes called a percent income statement.The same treatment is often applied to the firm’s
    balance sheet to make it easier to evaluate changes in the asset and financial structures of the firm. In addition to
    measuring profitability, these statements in effect can be used as an alternative or supplement to liquidity, activity,
    and debt-ratio analysis.

LG5

tax values of all other terms. Applying the formula to Bartlett Company’s 2003

data yields

Fixed-payment

coverage ratio

1.9

Because the earnings available are nearly twice as large as its fixed-payment

obligations, the firm appears safely able to meet the latter.

Like the times interest earned ratio, the fixed-payment coverage ratio mea-

sures risk. The lower the ratio, the greater the risk to both lenders and owners;

the greater the ratio, the lower the risk. This ratio allows interested parties to

assess the firm’s ability to meet additional fixed-payment obligations without

being driven into bankruptcy.

Review Questions

2–10 What is financial leverage?

2–11 What ratio measures the firm’s degree of indebtedness? What ratios assess

the firm’s ability to service debts?

2.6 Profitability Ratios

There are many measures of profitability. As a group, these measures enable the

analyst to evaluate the firm’s profits with respect to a given level of sales, a cer-

tain level of assets, or the owners’ investment. Without profits, a firm could not

attract outside capital. Owners, creditors, and management pay close attention to

boosting profits because of the great importance placed on earnings in the

marketplace.

Common-Size Income Statements

A popular tool for evaluating profitability in relation to sales is the common-size

income statement.^15 Each item on this statement is expressed as a percentage of

sales. Common-size income statements are especially useful in comparing perfor-

mance across years. Three frequently cited ratios of profitability that can be read

directly from the common-size income statement are (1) the gross profit margin,

(2) the operating profit margin, and (3) the net profit margin.

Common-size income statements for 2003 and 2002 for Bartlett Company

are presented and evaluated in Table 2.7. These statements reveal that the firm’s

$453,000



$242,000

$418,000$35,000



$93,000$35,000{($71,000$10,000)[1/(10.29)]}