2. 17-2
It looks at accounting information from users’
perspective
What is financial statement analysis?
”Tearing apart” the financial statements
and looking at the relationships
Financial Statement AnalysisFinancial Statement Analysis
3. 17-3
Who need results of financial statement
Analysis?
Internal users (i.e., management)
External users (emphasis of chapter)
Examples?
Investors, creditors, regulatory agencies & …
stock market analysts and
auditors
Financial Statement AnalysisFinancial Statement Analysis
4. 17-4
What do internal users use it for?
Planning, evaluating and controlling
company operations
What do external users use it for?
Assessing past performance and current
financial position and making predictions
about the future profitability and solvency
of the company as well as evaluating the
effectiveness of management
Financial Statement AnalysisFinancial Statement Analysis
5. 17-5
Information is available from
Published annual reports
(1) Financial statements
(2) Notes to financial statements
(3) Letters to stockholders
(4) Auditor’s report (Independent
accountants)
(5) Management’s discussion and
analysis
Reports filed with the government
627 628
Financial Statement AnalysisFinancial Statement Analysis
6. 17-6
Information is available from
Other sources
(1) Newspapers
(2) Periodicals
(3) Financial information
organizations such
as: AIFI
(4) Other business publications
627 628
Financial Statement AnalysisFinancial Statement Analysis
8. 17-8
Horizontal AnalysisHorizontal Analysis
Using comparative financial
statements to calculate rupee
or percentage changes in a
financial statement item from
one period to the next
Using comparative financial
statements to calculate rupee
or percentage changes in a
financial statement item from
one period to the next
9. 17-9
Vertical AnalysisVertical Analysis
For a single financial
statement, each item
is expressed as a
percentage of a
significant total,
e.g., all income
statement items are
expressed as a
percentage of sales
For a single financial
statement, each item
is expressed as a
percentage of a
significant total,
e.g., all income
statement items are
expressed as a
percentage of sales
10. 17-10
Trend PercentagesTrend Percentages
Show changes over time in
given financial statement items
(can help evaluate financial
information of several years)
Show changes over time in
given financial statement items
(can help evaluate financial
information of several years)
11. 17-11
Ratio AnalysisRatio Analysis
Expression of logical relationships
between items in a financial
statement of a single period
(e.g., percentage relationship
between revenue and net income)
Expression of logical relationships
between items in a financial
statement of a single period
(e.g., percentage relationship
between revenue and net income)
12. 17-12
Horizontal Analysis ExampleHorizontal Analysis Example
The management of Clover Company
provides you with comparative balance
sheets of the years ended December 31,
1999 and 1998. Management asks you to
prepare a horizontal analysishorizontal analysis on the
information.
13. 17-13
Calculating Change as a Percentage
Percentage
Change
Dollar Change
Base Year Figure
100%= ×
Horizontal Analysis ExampleHorizontal Analysis Example
15. 17-15
Calculating Change in Dollar Amounts
Dollar
Change
Current Year
Figure
Base Year
Figure
= –
Horizontal Analysis ExampleHorizontal Analysis Example
19. 17-19
Let’s apply the same
procedures to the
liability and stockholders’
equity sections of the
balance sheet.
Horizontal Analysis ExampleHorizontal Analysis Example
20. 17-20
CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable 67,000$ 44,000$ 23,000$ 52.3
Notes payable 3,000 6,000 (3,000) (50.0)
Total current liabilities 70,000 50,000 20,000 40.0
Long-term liabilities:
Bonds payable, 8% 75,000 80,000 (5,000) (6.3)
Total liabilities 145,000 130,000 15,000 11.5
Stockholders' equity:
Preferred stock 20,000 20,000 - 0.0
Common stock 60,000 60,000 - 0.0
Additional paid-in capital 10,000 10,000 - 0.0
Total paid-in capital 90,000 90,000 - 0.0
Retained earnings 80,000 69,700 10,300 14.8
Total stockholders' equity 170,000 159,700 10,300 6.4
Total liabilities and stockholders' equity 315,000$ 289,700$ 25,300$ 8.7
21. 17-21
Now, let’s apply the
procedures to the
income statement.
Horizontal Analysis ExampleHorizontal Analysis Example
22. 17-22
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Net sales 520,000$ 480,000$ 40,000$ 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income 17,500$ 22,400$ (4,900)$ (21.9)
23. 17-23
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Net sales 520,000$ 480,000$ 40,000$ 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income 17,500$ 22,400$ (4,900)$ (21.9)
Sales increased by 8.3% while net
income decreased by 21.9%.
24. 17-24
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Net sales 520,000$ 480,000$ 40,000$ 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income 17,500$ 22,400$ (4,900)$ (21.9)
There were increases in both cost of goods
sold (14.3%) and operating expenses (2.1%).
These increased costs more than offset the
increase in sales, yielding an overall
decrease in net income.
25. 17-25
Vertical Analysis ExampleVertical Analysis Example
The management of Sample Company asks
you to prepare a vertical analysisvertical analysis for the
comparative balance sheets of the
company.
29. 17-29
Trend Percentages ExampleTrend Percentages Example
Wheeler, Inc. provides you with the
following operating data and asks that
you prepare a trend analysis.
30. 17-30
Trend Percentages ExampleTrend Percentages Example
Wheeler, Inc. provides you with the
following operating data and asks that
you prepare a trend analysis.
$1,991 - $1,820 = $171$1,991 - $1,820 = $171
31. 17-31
Trend Percentages ExampleTrend Percentages Example
Using 1995 as the base year, we develop
the following percentage relationships.
$1,991 - $1,820 = $171$1,991 - $1,820 = $171
$171 ÷ $1,820 = 9% rounded$171 ÷ $1,820 = 9% rounded
33. 17-33
Ratios can be expressed in three
different ways:
1. Ratio (e.g., current ratio of 2:1)
2. % (e.g., profit margin of 2%)
3. Rs. (e.g., EPS of Rs.2.25)
CAUTION!
“Using ratios and percentages without
considering the underlying causes may
lead to incorrect conclusions.”
RatiosRatios
34. 17-34
Categories of RatiosCategories of Ratios
Liquidity Ratios
Indicate a company’s short-term
debt-paying ability
Equity (Long-Term Solvency) Ratios
Show relationship between debt and
equity financing in a company
Profitability Tests
Relate income to other variables
Market Tests
Help assess relative merits of stocks in
the marketplace
35. 17-35
Liquidity Ratios
Current (working capital) ratio
Acid-test (quick) ratio
Cash flow liquidity ratio
Accounts receivable turnover
Number of days’ sales in accounts
receivable
Inventory turnover
Total assets turnover
651
10 Ratios You Must Know10 Ratios You Must Know
36. 17-36
Equity (Long-Term Solvency) Ratios
Equity (stockholders’ equity) ratio
Equity to debt
10 Ratios You Must Know10 Ratios You Must Know
37. 17-37
Profitability Tests
Return on operating assets
Net income to net sales (return on
sales or “profit margin”“profit margin”)
Return on average common
stockholders’ equity (ROEROE)
Cash flow margin
Earnings per share
Times interest earned
Times preferred dividends earned
$
10 Ratios You Must Know10 Ratios You Must Know
38. 17-38
Market Tests
Earnings yield on common stock
Price-earnings ratio
Payout ratio on common stock
Dividend yield on common stock
Dividend yield on preferred stock
Cash flow per share of common
stock
10 Ratios You Must Know10 Ratios You Must Know
44. 17-44
NORTON CORPORATION
1999
Cash 30,000$
Accounts receivable, net
Beginning of year 17,000
End of year 20,000
Inventory
Beginning of year 10,000
End of year 12,000
Total current assets 65,000
Total current liabilities 42,000
Sales on account 494,000
Cost of goods sold 140,000
We will
use this
information
to calculate
the liquidity
ratios for
Norton.
45. 17-45
Working Capital*Working Capital*
12/31/99
Current assets 65,000$
Current liabilities (42,000)
Working capital 23,000$
The excess of current assets over
current liabilities.
* While this is not a ratio, it does give an
indication of a company’s liquidity.
46. 17-46
Current (Working Capital) RatioCurrent (Working Capital) Ratio
Current
Ratio
$65,000
$42,000
= = 1.55 : 1
Measures the ability
of the company to pay current
debts as they become due.
Current
Ratio
Current Assets
Current Liabilities
=
#1#1
47. 17-47
Acid-Test (Quick) RatioAcid-Test (Quick) Ratio
Quick Assets
Current Liabilities
=
Acid-Test
Ratio
Quick assets are Cash,
Marketable Securities,
Accounts Receivable (net) and
current Notes Receivable.
#2#2
50. 17-50
Sales on Account
Average Accounts Receivable
Accounts
Receivable
Turnover
=
Accounts Receivable TurnoverAccounts Receivable Turnover
= 26.70 times
$494,000
($17,000 + $20,000) ÷ 2
Accounts
Receivable
Turnover
=
This ratio measures how many
times a company converts its
receivables into cash each year.
#3#3 Average, net accounts
receivable
Net, credit sales
51. 17-51
Number of Days’ SalesNumber of Days’ Sales
in Accounts Receivablein Accounts Receivable
Measures, on average, how many
days it takes to collect an
account receivable.
Days’ Sales
in Accounts
Receivables
=
365 Days
Accounts Receivable Turnover
= 13.67 days=
365 Days
26.70 Times
Days’ Sales
in Accounts
Receivables
#4#4
52. 17-52
Number of Days’ SalesNumber of Days’ Sales
in Accounts Receivablein Accounts Receivable
In practice, would 45 days be a
desirable number of days in
receivables?
#4#4
Days’ Sales
in Accounts
Receivables
=
365 Days
Accounts Receivable Turnover
= 13.67 days=
365 Days
26.70 Times
Days’ Sales
in Accounts
Receivables
53. 17-53
Inventory TurnoverInventory Turnover
Cost of Goods Sold
Average Inventory
Inventory
Turnover
=
Measures the number of times
inventory is sold and
replaced during the year.
= 12.73 times
$140,000
($10,000 + $12,000) ÷ 2
Inventory
Turnover
=
#5#5
54. 17-54
Inventory TurnoverInventory Turnover
Cost of Goods Sold
Average Inventory
Inventory
Turnover
=
Would 5 be a
desirable number of times
for inventory to turnover?
= 12.73 times
$140,000
($10,000 + $12,000) ÷ 2
Inventory
Turnover
=
#5#5
55. 17-55
Equity, or Long–TermEquity, or Long–Term
Solvency RatiosSolvency Ratios
This is part of the information to
calculate the equity, or long-term
solvency ratios of Norton Corporation.
NORTON CORPORATION
1999
Net operating income 84,000$
Net sales 494,000
Interest expense 7,300
Total stockholders' equity 234,390
56. 17-56
NORTON CORPORATION
1999
Common shares outstanding
Beginning of year 17,000
End of year 27,400
Net income 53,690$
Stockholders' equity
Beginning of year 180,000
End of year 234,390
Dividends per share 2
Dec. 31 market price/share 20
Interest expense 7,300
Total assets
Beginning of year 300,000
End of year 346,390
Here is the
rest of the
information
we will
use.
58. 17-58
Net Income to Net SalesNet Income to Net Sales
A/K/A Return on Sales or Profit MarginA/K/A Return on Sales or Profit Margin
Net Income
to
Net Sales
=
Net Income
Net Sales
Net Income
to
Net Sales
=
$53,690
$494,000
= 10.9%
Measures the proportion of the sales dollar
which is retained as profit.
#7#7
59. 17-59
Net Income to Net SalesNet Income to Net Sales
A/K/A Return on Sales or Profit MarginA/K/A Return on Sales or Profit Margin
Net Income
to
Net Sales
=
Net Income
Net Sales
Net Income
to
Net Sales
=
$53,690
$494,000
= 10.9%
Would a 1% return on sales be good?
#7#7
60. 17-60
Return on Average CommonReturn on Average Common
Stockholders’ Equity (ROE)Stockholders’ Equity (ROE)
Return on
Stockholders’
Equity
=
Net Income
Average Common
Stockholders’ Equity
=
$53,690
($180,000 + $234,390) ÷ 2
= 25.9%
Return on
Stockholders’
Equity
Important measure of the
income-producing ability
of a company.
#8#8
61. 17-61
Earnings
per Share
Earnings Available to Common Stockholders
Weighted-Average Number of Common
Shares Outstanding
=
Earnings
per Share
$53,690
(17,000 + 27,400) ÷ 2
= = $2.42
The financial press regularly publishes
actual and forecasted EPS amounts.
#9#9
Earnings Per ShareEarnings Per Share
62. 17-62
What’s new from Chap. 15?
Weighted-average calculation
EPS of common stock = _______________________
Earnings available to
common stockholders
Weighted-average number of
common shares outstanding
644
Three alternatives for calculating
weighted-average number of shares
Earnings Per ShareEarnings Per Share
63. 17-63
EPS of common stock = _______________________
Earnings available to
common stockholders
Weighted-average number of
common shares outstanding
645
Alternate #1
Earnings Per ShareEarnings Per Share
What’s new from Chap. 15?
Weighted-average calculation
65. 17-65
¶ EPS and Stock Dividends or Splits
Why restate all prior calculations of EPS?
Comparability - i.e., no additional capital was
generated by the dividend or split
646
Earnings Per ShareEarnings Per Share
¶ Primary EPS and Fully Diluted EPS
APB Opinion No. 15
I mentioned this 17-page pronouncement that
required a 100-page explanation in the lecture
for chapter 13.
66. 17-66
Price-Earnings RatioPrice-Earnings Ratio
A/K/A P/E MultipleA/K/A P/E Multiple
Price-Earnings
Ratio
Market Price Per Share
EPS
=
Price-Earnings
Ratio
=
$20.00
$ 2.42
= 8.3 : 1
#10#10
Provides some measure of whether the
stock is under or overpriced.
67. 17-67
Important ConsiderationsImportant Considerations
Need for comparable data
Data is provided by Dun &
Bradstreet, Standard & Poor’s etc.
Must compare by industry
Is EPS comparable?
Influence of external factors
General business conditions
Seasonal nature of business operations
Impact of inflation
68. 17-68
QuestionQuestion
The current ratio is a measure of
liquidity that is computed by dividing
total assets by total liabilities.
a. True
b. False
The current ratio is a measure of
liquidity that is computed by dividing
total assets by total liabilities.
a. True
b. False
69. 17-69
The current ratio is a measure of
liquidity that is computed by dividing
total assets by total liabilities.
a. True
b. False
The current ratio is a measure of
liquidity that is computed by dividing
total assets by total liabilities.
a. True
b. False
QuestionQuestion
The current ratio is a measure of
liquidity, but is computed by
dividing currentcurrent assets by
currentcurrent liabilities
The current ratio is a measure of
liquidity, but is computed by
dividing currentcurrent assets by
currentcurrent liabilities
70. 17-70
QuestionQuestion
Quick assets are defined as Cash,
Marketable Securities and net
receivables.
a. True
b. False
Quick assets are defined as Cash,
Marketable Securities and net
receivables.
a. True
b. False
71. 17-71
Quick assets are defined as Cash,
Marketable Securities and net
receivables.
a. True
b. False
Quick assets are defined as Cash,
Marketable Securities and net
receivables.
a. True
b. False
QuestionQuestion
73. 17-73
About Test #1About Test #1
Will be challenging because the
material covered is challenging
All questions are T/F or M/C
Questions are 5-pt., 3-pt. & 1-pt.
No tricks such as patterns in answers
Order of answers is random
Coverage is even over the 4 chapters
Time allowed: 75 minutes
74. 17-74
About Test #1About Test #1
Best way to study
Notes first
Study guide and/or Hermanson tutorials
Calculators will be provided
Must wait outside classroom
Have your questions ready for next
actual class
See course home page for office hours
