CHAPTER 13 Analyzing Financial Statements: A Managerial Perspective Analyzing Financial Statements: A Managerial Perspective

Why Managers Analyze Financial Statements  Control of operations  Assess the financial stability of vendors, customers, and other business partners  Assess the appearance of the company to investors and creditors

Control of Operations  Analysis of financial statements help management gain insight into whether their goals have been achieved  Assume successful implementation of plan will be reflected in financial information  If financial information is inconsistent with a successful implementation an investigation will be launched

Assessment of Vendors, Customers, and Other Partners  Management takes same approach to review the financial stability of vendors, customers, and other strategic partners  Used to identify, qualify, and monitor potential partners  Important when developing relationships that the vendor or customer’s business is viable and will continue operations

Assessment of Appearance to Investors and Creditors  Accrual income v. cash flows  Will help describe the differences between net income and cash flow from operating activities  Notes to the Financial Statements  Need to be prepared in order to answer questions from potential investors and creditors

Review the Three Basic Financial Statements  Balance Sheet  Income Statement  Statement of Cash Flows

Balance Sheet  Snapshot at a given point in time  Assets = Liabilities + Shareholders’ Equity  Current and Noncurrent Assets and Liabilities

Income Statement  Statement of operations or performance over a given period of time  Format of Income Statement Sales -Cost of Goods Sold -Operating Expenses +/- Non-operating Income/(Expense) -Income Taxes =Net Income / (Net Loss)

Statement of Cash Flows  Shows how the firm generated and used cash for a period of time  Related to 3 Types of Activities  Operating Activities  Buying and selling merchandise and services (core business activities)  Investing Activities  Buying and selling long-term assets  Financing Activities  Acquiring capital, re-paying debt, and paying investors through dividends

Horizontal Analysis  Analysis of dollar value and year-to- year percentage of change  Over a period of time (left to right)  Sometimes referred to as a trend 12/31/07 $ Change % Change Accounts Receivable $70,150$59,287$+10, %

Vertical Analysis  Analysis of dollar amounts relative to a common base (i.e. sales or total assets)  Top to Bottom  Sometimes referred to as Common Size Statement Analysis Year-end 12/31/08 Percent of Sales Year end 12/31/07 Percent of Sales Sales$2,766,425100%$1,940,917100% COGS$1,942, %$1,364, % Gross Margin $823, %$576, %

Analysis of the Balance Sheet  Horizontal Analysis  How have the elements changed over time?  Dollar change  Percentage change  Vertical Analysis  Express all asset accounts as a percentage of total assets  Express all liability and equity accounts as a percentage of total liabilities & equity

Analysis of Income Statement  Horizontal Analysis  How have the elements changed over time?  Dollar change  Percentage change  Vertical Analysis  Express all income statement accounts as a percentage of sales

Cash Flow Versus Earnings

Other Sources of Financial Performance  Management Discussion and Analysis  Management provides financial statement users with explanations of financial results  Credit Reports  Provides information on a company’s credit history  News Articles  Includes announcements regarding major company changes which may indicate problems  Many on-line services are available in which to conduct a search of news articles

Study Break #1 Why do managers analyze financial statements? a.To evaluate and control operations b.To evaluate vendors and customers c.To anticipate questions from shareholders and creditors d.All of the above Answer: d. All of the above

Study Break #2 Horizontal analysis analyzes: a.Comparable companies b.Changes in expenses as a percentage of sales c.Changes in expenses as a percent of total assets d.Changes in balances from one year to another Answer: d. Changes in balances from one year to another

Study Break #3 In connection with a company’s annual report, MD&A stands for: a.Management discussion and analysis b.More depreciation and amortization c.Monthly depreciation and amortization d.Monthly discounts and advertising Answer: a. Management discussion and analysis

Ratio Analysis  Profitability Ratios  Reveals a company’s ability to generate profits  Turnover Ratios  Reveals the company’s efficiency with regard to the use of its assets  Debt-Related Ratios  Reveals a company’s ability to re-pay its obligations

Profitability Ratios  Earnings Per Share (EPS)  Measures the earnings per each share of common stock outstanding  Price-Earnings Ratio (PE)  Measures an investor’s expectations of future profitability  Gross Margin Percentage  Estimates the incremental profit generated by each dollar of sales  Return on Total Assets  Measures the net income generated for each dollar invested in assets  Return on Common Stockholders’ Equity  Measures the net income generated for each dollar invested by the shareholders

Profitability Ratio Formulas

Turnover Ratios  Asset Turnover  Measures how efficiently assets are utilized  Accounts Receivable Turnover  Measures the number of times each year receivables are collected  Days’ Sales in Receivables  Measures the average number of days necessary to collect credit sales  Inventory Turnover  Measures the number of times each year inventory is sold  Days’ Sales in Inventory  Measures the average number of days necessary to sell all inventory

Turnover Ratio Formulas

Ratio – Too High or Low?

Debt-Related Ratios  Current Ratio  Measures a company’s ability to meet short- term obligations  Acid-Test Ratio (Quick Ratio)  More stringent measure of the current ratio  Debt-to-Equity Ratio  Assesses the company’s debt position  Times Interest Earned  Measures a company’s ability to re-pay long- term debt

Debt-Related Ratios

Comparative Ratio Data

Summary of Ratio Formulas

Study Break #4 The ratio times interest earned can be used to evaluate: a.The amount of debt versus equity financing b.The extent to which interest income exceeds interest expense c.The extent to which interest expense exceeds interest income d.The likelihood that a company will be able to make required interest payments Answer: d. The likelihood that a company will be able to make required interest payments

Study Break #5 The efficient use of assets is indicated by: a.Turnover ratios b.Debt-related ratios c.The ratio of debt to equity d.The ratio of current assets to current liabilities Answer: a. Turnover ratios

“Strategic Partners”

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