Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Prepared by: Debbie Musil Kwantlen Polytechnic University Chapter 18 Financial Statement Analysis Chapter 18 Financial Statement Analysis

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Financial Statement Analysis Basics of financial statement analysis Basics of financial statement analysis Horizontal analysis Horizontal analysis Balance sheetBalance sheet Income statementIncome statement Vertical analysis Vertical analysis Balance sheetBalance sheet Income statementIncome statement Intercompany comparisonsIntercompany comparisons Ratio analysis Ratio analysis Liquidity, solvency and profitability ratiosLiquidity, solvency and profitability ratios Limitations of financial statement analysis Limitations of financial statement analysis

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Basics of Financial Statement Analysis Comparing financial statement information of a company can be done: Comparing financial statement information of a company can be done: On an intracompany basis: compare current year with prior yearsOn an intracompany basis: compare current year with prior years On an intercompany basis: with other competing companiesOn an intercompany basis: with other competing companies Based on industry averagesBased on industry averages Important to also review other financial and non-financial information Important to also review other financial and non-financial information

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Basics of Financial Statement Analysis 2 Commonly used tools to evaluate financial data: Commonly used tools to evaluate financial data: Horizontal analysis: evaluate a series of data over a period of timeHorizontal analysis: evaluate a series of data over a period of time Vertical analysis: evaluate data as a percentage of a base amountVertical analysis: evaluate data as a percentage of a base amount Ratio analysis: expresses the relationship among selected financial dataRatio analysis: expresses the relationship among selected financial data

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Horizontal Analysis (Trend Analysis) Compares a series of financial data Compares a series of financial data To determine the increase or decrease over timeTo determine the increase or decrease over time Horizontal percentage of base-period amount Horizontal percentage of base-period amount Expresses specified amount as a percent of a base yearExpresses specified amount as a percent of a base year Horizontal percentage change for period Horizontal percentage change for period Measures change in any one specific periodMeasures change in any one specific period = ÷ Analysis-Period Amount Horizontal Percentage of Base- Period Amount Base-Period Amount = - Analysis-Period Amount Horizontal Percentage Change for Period Base-Period Amount

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Horizontal Analysis Balance Sheet

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Horizontal Analysis Income Statement

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Vertical Analysis (Common Size Analysis) Expresses financial statement data as a percentage of a base amount Expresses financial statement data as a percentage of a base amount Commonly used base amounts are: Commonly used base amounts are: Balance sheet: total assets; total liabilities and shareholders’ equityBalance sheet: total assets; total liabilities and shareholders’ equity Income statement: net salesIncome statement: net sales Useful for intracompany and intercompany comparisons Useful for intracompany and intercompany comparisons = ÷ Analysis Amount Vertical Percentage Base Amount

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Vertical Analysis Balance Sheet

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Vertical Analysis Income Statement

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Ratio Analysis Expresses the relationship between selected financial statement items Expresses the relationship between selected financial statement items Classified into: Classified into: Liquidity ratios: measure short-term ability to meet obligations and unexpected cash needsLiquidity ratios: measure short-term ability to meet obligations and unexpected cash needs Solvency ratios: measure ability to survive over long periods of timeSolvency ratios: measure ability to survive over long periods of time Profitability ratios: measure operating success for a specific time periodProfitability ratios: measure operating success for a specific time period

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Ratio Analysis Liquidity Ratios

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Ratio Analysis Solvency Ratios

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Ratio Analysis Profitability Ratios

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Limitations of Financial Analysis Alternative accounting principles: reduces intercompany comparability Alternative accounting principles: reduces intercompany comparability Other Comprehensive income: generally excluded from analysis, should be assessed if significant Other Comprehensive income: generally excluded from analysis, should be assessed if significant Diversification: affects classification and intercompany comparability Diversification: affects classification and intercompany comparability Quality of information: full and transparent reporting aids in accurate financial analysis Quality of information: full and transparent reporting aids in accurate financial analysis Inflation: ignored in intracompany comparisons Inflation: ignored in intracompany comparisons Economic factors: Economic factors: Irregular items (e.g. – discontinued operations) must be excludedIrregular items (e.g. – discontinued operations) must be excluded Losses make it difficult to calculate and interpret ratiosLosses make it difficult to calculate and interpret ratios

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