(shail) analysis
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17-1
ANALYSIS ANDINTERPRETATION OF
FINANCIAL STATEMENTS
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
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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
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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
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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
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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
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Horizontal Analysis
Vertical Analysis
Common-Size Statements
Trend Percentages
Ratio Analysis
Methods ofMethods ofFinancial Statement AnalysisFinancial Statement Analysis
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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
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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
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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)
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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)
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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 analysis horizontal analysis on the information.
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Calculating Change as a Percentage
PercentageChange
Dollar Change Base Year Figure
100%= ×
Horizontal Analysis ExampleHorizontal Analysis Example
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Calculating Change in Dollar Amounts
DollarChange
Current YearFigure
Base YearFigure
= –
Horizontal Analysis ExampleHorizontal Analysis Example
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$12,000 – $23,500 = $(11,500)
Horizontal Analysis ExampleHorizontal Analysis Example
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($11,500 ÷ $23,500) × 100% = 48.9%
Horizontal Analysis ExampleHorizontal Analysis Example
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Horizontal Analysis ExampleHorizontal Analysis Example
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Let’s apply the sameprocedures to the
liability and stockholders’equity sections of the
balance sheet.
Horizontal Analysis ExampleHorizontal Analysis Example
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CLOVER CORPORATIONComparative Balance SheetsDecember 31, 1999 and 1998
Increase (Decrease)1999 1998 Amount %
Liabilities and Stockholders' EquityCurrent liabilities: Accounts payable 67,000$ 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 40.0Long-term liabilities: Bonds payable, 8% 75,000 80,000 (5,000) (6.3) Total liabilities 145,000 130,000 15,000 11.5Stockholders' 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 - 0.0Retained earnings 80,000 69,700 10,300 14.8 Total stockholders' equity 170,000 159,700 10,300 6.4Total liabilities and stockholders' equity 315,000$ 289,700$ 25,300$ 8.7
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Now, let’s apply the procedures to theincome statement.
Horizontal Analysis ExampleHorizontal Analysis Example
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CLOVER CORPORATIONComparative Income Statements
For the Years Ended December 31, 1999 and 1998Increase (Decrease)
1999 1998 Amount %Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net 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)
17-23
CLOVER CORPORATIONComparative Income Statements
For the Years Ended December 31, 1999 and 1998Increase (Decrease)
1999 1998 Amount %Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net 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%.
17-24
CLOVER CORPORATIONComparative Income Statements
For the Years Ended December 31, 1999 and 1998Increase (Decrease)
1999 1998 Amount %Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net 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.
17-25
Vertical Analysis ExampleVertical Analysis Example
The management of Sample Company asks you to prepare a vertical analysis vertical analysis for the
comparative balance sheets of the company.
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Vertical Analysis ExampleVertical Analysis Example
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Vertical Analysis ExampleVertical Analysis Example
$82,000 ÷ $483,000 = 17% rounded$30,000 ÷ $387,000 = 8% rounded
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Vertical Analysis ExampleVertical Analysis Example
$76,000 ÷ $483,000 = 16% rounded
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Trend Percentages ExampleTrend Percentages Example
Wheeler, Inc. provides you with the following operating data and asks that
you prepare a trend analysis.
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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
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
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Trend linefor Sales
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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
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Categories of RatiosCategories of Ratios
Liquidity RatiosIndicate a company’s short-term debt-paying ability
Equity (Long-Term Solvency) RatiosShow relationship between debt and equity financing in a company
Profitability TestsRelate income to other variables
Market TestsHelp assess relative merits of stocks in the marketplace
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Liquidity RatiosCurrent (working capital) ratioAcid-test (quick) ratio Cash flow liquidity ratioAccounts receivable turnoverNumber of days’ sales in accounts
receivableInventory turnover Total assets turnover
651
10 Ratios You Must Know10 Ratios You Must Know
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Equity (Long-Term Solvency) RatiosEquity (stockholders’ equity) ratio Equity to debt
10 Ratios You Must Know10 Ratios You Must Know
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Profitability Tests Return on operating assetsNet income to net sales (return on
sales or “profit margin”“profit margin”)Return on average common
stockholders’ equity (ROEROE) Cash flow marginEarnings per share Times interest earned Times preferred dividends earned
$
10 Ratios You Must Know10 Ratios You Must Know
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Market Tests Earnings yield on common stockPrice-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
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Now, let’s look at Norton
Corporation’s 1999 and 1998 financial
statements.
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Now, let’s calculate the 10 ratios based
on Norton’s financial statements.
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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
informationto calculatethe liquidity
ratios for Norton.
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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.
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Current (Working Capital) RatioCurrent (Working Capital) Ratio
CurrentRatio
$65,000 $42,000
= = 1.55 : 1
Measures the abilityof the company to pay current
debts as they become due.
CurrentRatio
Current Assets Current Liabilities
=
#1#1
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Acid-Test (Quick) RatioAcid-Test (Quick) Ratio
Quick Assets Current Liabilities
=Acid-Test
Ratio
Quick assets are Cash,Marketable Securities,
Accounts Receivable (net) andcurrent Notes Receivable.
#2#2
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Quick Assets Current Liabilities
=Acid-Test
Ratio
Norton Corporation’s quick assets consist of cash of
$30,000 and accounts receivable of $20,000.
Acid-Test (Quick) RatioAcid-Test (Quick) Ratio
#2#2
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Quick Assets Current Liabilities
=Acid-Test
Ratio
$50,000 $42,000
= 1.19 : 1=Acid-Test
Ratio
Acid-Test (Quick) RatioAcid-Test (Quick) Ratio
#2#2
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Sales on Account Average Accounts Receivable
Accounts ReceivableTurnover
=
Accounts Receivable TurnoverAccounts Receivable Turnover
= 26.70 times $494,000 ($17,000 + $20,000) ÷ 2
Accounts ReceivableTurnover
=
This ratio measures how many times a company converts its
receivables into cash each year.
#3#3 Average, net accounts receivable
Net, credit sales
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Number of Days’ SalesNumber of Days’ Salesin Accounts Receivablein Accounts Receivable
Measures, on average, how many days it takes to collect an
account receivable.
Days’ Salesin AccountsReceivables
= 365 Days Accounts Receivable Turnover
= 13.67 days= 365 Days 26.70 Times
Days’ Salesin AccountsReceivables
#4#4
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Number of Days’ SalesNumber of Days’ Salesin Accounts Receivablein Accounts Receivable
In practice, would 45 days be a desirable number of days in
receivables?
#4#4Days’ Salesin AccountsReceivables
= 365 Days Accounts Receivable Turnover
= 13.67 days= 365 Days 26.70 Times
Days’ Salesin AccountsReceivables
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Inventory TurnoverInventory Turnover
Cost of Goods Sold Average Inventory
InventoryTurnover
=
Measures the number of timesinventory is sold and
replaced during the year.
= 12.73 times $140,000 ($10,000 + $12,000) ÷ 2
InventoryTurnover
=
#5#5
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Inventory TurnoverInventory Turnover
Cost of Goods Sold Average Inventory
InventoryTurnover
=
Would 5 be a desirable number of times for inventory to turnover?
= 12.73 times $140,000 ($10,000 + $12,000) ÷ 2
InventoryTurnover
=
#5#5
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Equity, or Long–TermEquity, or Long–TermSolvency RatiosSolvency Ratios
This is part of the information to calculate the equity, or long-term
solvency ratios of Norton Corporation.
NORTON CORPORATION
1999
Net operating income 84,000$ Net sales 494,000 Interest expense 7,300 Total stockholders' equity 234,390
17-56NORTON 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 therest of the
informationwe will
use.
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Equity RatioEquity Ratio
EquityRatio
= Stockholders’ Equity Total Assets
EquityRatio
= $234,390 $346,390
67.7%=
Measures the proportionof total assets provided by
stockholders.
#6#6
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Net Income to Net SalesNet Income to Net SalesA/K/A Return on Sales or Profit MarginA/K/A Return on Sales or Profit Margin
Net Incometo
Net Sales=
Net Income Net Sales
Net Incometo
Net Sales=
$53,690 $494,000
= 10.9%
Measures the proportion of the sales dollarwhich is retained as profit.
#7#7
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Net Income to Net SalesNet Income to Net SalesA/K/A Return on Sales or Profit MarginA/K/A Return on Sales or Profit Margin
Net Incometo
Net Sales=
Net Income Net Sales
Net Incometo
Net Sales=
$53,690 $494,000
= 10.9%
Would a 1% return on sales be good?
#7#7
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Return on Average Common Return on Average Common Stockholders’ Equity (ROE)Stockholders’ Equity (ROE)
Return onStockholders’
Equity=
Net Income Average Common
Stockholders’ Equity
= $53,690 ($180,000 + $234,390) ÷ 2
= 25.9%Return on
Stockholders’Equity
Important measure of theincome-producing ability
of a company.
#8#8
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Earningsper Share
Earnings Available to Common StockholdersWeighted-Average Number of Common
Shares Outstanding=
Earningsper Share
$53,690 (17,000 + 27,400) ÷ 2
= = $2.42
The financial press regularly publishesactual and forecasted EPS amounts.
#9#9
Earnings Per ShareEarnings Per Share
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What’s new from Chap. 15? Weighted-average calculation
EPS of common stock = _______________________Earnings available tocommon stockholders
Weighted-average number ofcommon shares outstanding
644
Three alternatives for calculating weighted-average number of shares
Earnings Per ShareEarnings Per Share
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EPS of common stock = _______________________Earnings available tocommon stockholders
Weighted-average number ofcommon shares outstanding
645
Alternate #1
Earnings Per ShareEarnings Per Share
What’s new from Chap. 15? Weighted-average calculation
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Alternate #3
Alternate #2
645
Earnings Per ShareEarnings Per Share
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¶ EPS and Stock Dividends or SplitsWhy 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 EPSAPB Opinion No. 15
I mentioned this 17-page pronouncement that required a 100-page explanation in the lecture for chapter 13.
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Price-Earnings RatioPrice-Earnings RatioA/K/A P/E MultipleA/K/A P/E Multiple
Price-EarningsRatio
Market Price Per Share EPS
=
Price-EarningsRatio
= $20.00
$ 2.42= 8.3 : 1
#10#10
Provides some measure of whether the stock is under or overpriced.
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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
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
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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 ofliquidity, but is computed by
dividing currentcurrent assets bycurrentcurrent liabilities
The current ratio is a measure ofliquidity, but is computed by
dividing currentcurrent assets bycurrentcurrent liabilities
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
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
17-72
No more ratios, please!
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About Test #1About Test #1
Will be challenging because the material covered is challenging
All questions are T/F or M/CQuestions are 5-pt., 3-pt. & 1-pt.
No tricks such as patterns in answersOrder of answers is random
Coverage is even over the 4 chapters Time allowed: 75 minutes
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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
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