AP Business with Personal Finance · Free-response skill

Work from the financial statements

The move. Pull the right figures from a business's statements, work out net income, a margin and owner's equity, and say what a liquidity figure shows about the business.

How to do it

  1. Write the formula in words first, then put in the numbers: net income = revenue - cost of goods sold - operating expenses - interest - taxes.
  2. A margin is a profit line divided by revenue. Say which profit line you used, and give the answer as a percent.
  3. For owner's equity, add up every asset, add up every liability, and subtract. For bills due soon, use only current assets and current liabilities.
  4. End each calculation with a short sentence that says what the number means for this business, using the words of the question.

Practice prompt Try it

Juniper Lane Outfitters is a fictional outdoor-gear store. Its owner wants a bank loan to open a second store and has prepared the figures below: the income statement for last year and the balance sheet on December 31.

Juniper Lane Outfitters (fictional): income statement for the year and balance sheet on December 31

StatementItemAmount (dollars)
Income statementRevenue200,000
Income statementCost of goods sold80,000
Income statementOperating expenses86,000
Income statementInterest expense4,000
Income statementIncome taxes6,000
Balance sheetCash (current asset)14,000
Balance sheetAccounts receivable (current asset)6,000
Balance sheetInventory (current asset)10,000
Balance sheetEquipment and fixtures (long-term asset)70,000
Balance sheetAccounts payable (current liability)9,000
Balance sheetShort-term loan (current liability)3,000
Balance sheetLong-term loan (long-term liability)48,000

Use the figures in the table to answer each part.

  1. Work out the store's net income for the year.
  2. Work out the store's net profit margin, as a percent of revenue.
  3. Work out the owner's equity (the store's net worth) on December 31.
  4. The bank wants to know whether the store can pay the bills it owes within the next year. Work out one figure from the balance sheet that answers this, and say what that figure shows.

Write each part, then check yourself against the checklist. Nothing you type here is saved or graded.

Check yourself and see a model answer

Checklist

Our own checklist of what a full answer does, one line per point. Tick each one your response earns.

0 of 5 points

Model answer, annotated

(a) Net income = 200,000 - 80,000 - 86,000 - 4,000 - 6,000 = 24,000 dollars. (Gross profit is 120,000 dollars and operating income is 34,000 dollars along the way.)

  • Point 1 Subtracts every cost line from revenue and reaches the bottom line, 24,000 dollars.

(b) Net profit margin = net income / revenue = 24,000 / 200,000 = 0.12, or 12 percent. The store keeps 12 cents of profit from each dollar of sales.

  • Point 2 Uses net income, not gross profit, over revenue and gives the answer as a percent.

(c) Total assets are 14,000 + 6,000 + 10,000 + 70,000 = 100,000 dollars. Total liabilities are 9,000 + 3,000 + 48,000 = 60,000 dollars. Owner's equity = 100,000 - 60,000 = 40,000 dollars.

  • Point 3 Adds every asset and every liability, including the long-term loan, before subtracting.

(d) Working capital = current assets - current liabilities = (14,000 + 6,000 + 10,000) - (9,000 + 3,000) = 30,000 - 12,000 = 18,000 dollars. Because it is positive, the store has 18,000 dollars more in current assets than it owes within the next year, so it can pay those bills. (The current ratio, 30,000 / 12,000 = 2.5, says the same thing.)

  • Point 4 Uses only the current items and gets 18,000 dollars (with the 2.5 current ratio as a check).
  • Point 5 Says what the figure means for the bank's question: current assets cover the bills due within a year.