Chapter 3 Accrual Accounting Concepts 121
a common basis. Without a common basis, it is difficult to compare companies. For ex-
ample, Wendy’s total operating expenses are $3,408,834,000 compared to McDonald’s
$15,524,200,000. So, does this mean that Wendy’s has an advantage because of its lower
total operating expenses? Exhibit 9 reveals that this is not the case. In fact, Wendy’s
operating expenses are 93.8% of sales in comparison to 81.4% for McDonald’s. As a re-
sult, Wendy’s operating income is significantly less as a percent of sales, 6.2%, com-
pared to McDonald’s 18.6%.
Based upon Exhibit 9, further analyses are called for to determine why Wendy’s
operating expenses as a percent of sales are significantly higher than McDonald’s. For
example, the higher operating expenses may be related to the fact that 19.2% of
Wendy’s revenues come from its franchise restaurants, while 25.4% of McDonald’s
revenues come from franchise restaurants.
Exhibit 9 also reports common-sized balance sheet information for Wendy’s and
McDonald’s. The balance sheet data are expressed as a percentage of total assets. The
common-sized balance sheets provide information about the relative composition of
balance sheet categories to the total. Exhibit 9 indicates that Wendy’s keeps a higher
percent of its assets in the form of current assets, 14.3%, as compared to 10.3% for
McDonald’s. This can mostly be explained by Wendy’s higher percent of receivables
and inventory compared to McDonald’s. The percent of property and equipment is
nearly the same, while other assets are 12.2% of total assets compared to McDonald’s
15.4%. Exhibit 9 also reveals that Wendy’s finances more of its operations through
stockholders’ equity, 53.7%, than does McDonald’s, 51.1%. In addition, the relative
composition of their liabilities is quite different. Wendy’s has current and long-term
liabilities representing 21.5% and 24.8% of total assets, while McDonald’s is 12.6% and
36.3%, respectively. McDonald’s appears to require less relative current liabilities but
more long-term debt to support its operations than does Wendy’s.
As Exhibit 9 shows, common-sized financial statements facilitate company com-
parisons and analyses. Such statements are often a starting point for further investiga-
tion and analyses of major differences between companies in similar industries. For
example, based upon the preceding comparison, further inquiries might be made into
why Wendy’s operating expenses are a higher percent of sales and why Wendy’s
maintains a higher percent of its total assets in accounts receivable and inventory than
does McDonald’s.
APPENDIX
Reconciliation: Net Cash Flows from Operations
and Net Income^4
In Chapter 2, we illustrated financial statements for Family Health Care for September
and October 2007. Because all the September and October transactions were cash trans-
actions, the net cash flows from operating activities shown on the statement of cash
flows equals the net income shown in the income statements. For example, Exhibits 4
and 7 in Chapter 2 report net cash flows from operating activities and net income of
$2,600 and $3,220 for September and October. When all of an entity’s transactions have
cash transactions or when an entity uses the cash basis of accounting, net cash flows
from operating activities will always equal net income. This is not true, however, un-
der the accrual basis of accounting.
4 In a later chapter, this reconciliation will be referred to as the indirect method of reporting cash flows
from operations.