Prepared by: Keri Norrie, Camosun College ACCOUNTING PRINCIPLES Third Canadian Edition Prepared by: Keri Norrie, Camosun College

FINANCIAL STATEMENT ANALYSIS CHAPTER 18 FINANCIAL STATEMENT ANALYSIS

COMPARATIVE ANALYSIS Three types of comparisons: Intracompany basis PowerPoint Slides COMPARATIVE ANALYSIS Three types of comparisons: Intracompany basis Intercompany basis Industry averages 30

COMPARATIVE ANALYSIS Three tools: Horizontal analysis PowerPoint Slides COMPARATIVE ANALYSIS Three tools: Horizontal analysis Vertical analysis Ratio analysis 34

Percentage change since base period Dollar amount of change HORIZONTAL ANALYSIS Percentage change since base period Dollar amount of change Base year amount = 127% 121% 119% 112% 100% ANY COMPANY INC. Net Sales Year Ended December 31 (in millions) 2005 2004 2003 2002 2001 $ 6,562.8 $ 6,295.4 $ 6,190.6 $ 5,786.6 $ 5,181.4

VERTICAL ANALYSIS Expresses each item in a financial statement as a percent of a base amount (total assets or net sales) ANY COMPANY, INC. Condensed Balance Sheets (partial) December 31 (in millions) 2005 2004_____ Assets Amount Percent Amount Percent Current assets $1,496.5 29.6 $1,467.7 30.1 Property, plant, and equipment 2,888.8 57.2 2,733.3 56.9 Intangible assets 666.2 13.2 636.6 13.0 Total assets $5,051.5 100.0% $4,837.6 100.0%

RATIO ANALYSIS Ratio analysis evaluates three characteristics of a company: 1. its liquidity 2. its profitability 3. its solvency

RATIO ANALYSIS Liquidity ratios Measure short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash

LIQUIDITY RATIOS Working capital Current Assets – Current Liabilities PowerPoint Slides LIQUIDITY RATIOS Working capital Current Assets – Current Liabilities Current ratio Current Assets ÷ Current Liabilities Inventory turnover Cost of Goods Sold Average Inventory Days sales in inventory 365 Days Inventory Turnover Receivables turnover Net Credit Sales Average Gross Receivables Collection period 365 Days Receivables Turnover 61

RATIO ANALYSIS Solvency ratios Measure the ability of the company to survive over a long period of time XYZ Co. Since 1892

Debt to total assets Total Liabilities PowerPoint Slides SOLVENCY RATIOS Debt to total assets Total Liabilities Total Assets Interest coverage Net Income + Interest Expense + Income Tax Expense (EBIT) Interest Expense Free cash flow Cash Provided (Used) by Operating Activities – Net Capital Expenditures – Dividends Paid 61

RATIO ANALYSIS Profitability ratios Measure the income or operating success of a company for a given period of time

PROFITABILITY RATIOS Gross profit margin Gross Profit PowerPoint Slides PROFITABILITY RATIOS Gross profit margin Gross Profit Net Sales Profit margin Net Income Asset turnover Net Sales Average Total Assets Return on assets Net Income Return on equity Net Income Average Shareholders’ Equity 61

PROFITABILITY RATIOS Earnings per share Net Income – Preferred Dividends Weighted Average Number Of Common Shares Price-earnings (PE) ratio Market Price Per Share Earnings Per Share Payout ratio Cash Dividends Net Income EBITDA Net Income + Interest Expense + Income Tax Expense + Amortization Expense

LIMITATIONS OF FINANCIAL ANALYSIS PowerPoint Slides LIMITATIONS OF FINANCIAL ANALYSIS Estimates Historical cost Alternative accounting principles Quality of earnings Earning power and irregular items Diversification 107

EARNING POWER AND IRREGULAR ITEMS Earning power is net income adjusted for irregular or non-typical items Two types of irregular items are reported separately, net of income tax, on the income statement: Discontinued operations Extraordinary items

DISCONTINUED OPERATIONS The disposal of an identifiable reporting or operating segment of a business is reported separately on the income statement as follows: Discontinued operations Loss from operations of chemical division, net of $60,000 income tax saving $140,000 Loss from disposal of chemical division, net of $30,000 income tax saving 70,000 210,000 Net income $350,000 This presentation indicates the separate effects of continuing operations and discontinued operations on net income.

EXTRAORDINARY ITEMS Extraordinary items are events and transactions that meet three conditions. They are: Infrequent Non-typical Not subject to management decision Extraordinary items are reported net of income tax in a separate section of the income statement immediately following discontinued operations

EXAMPLES OF EXTRAORDINARY AND ORDINARY ITEMS Extraordinary Items 1. Effects of major casualties (acts of God) if rare in the area 2. Expropriation (takeover) of property by a government 3. Effects of a newly enacted law or regulation, such as a condemnation action 4. The destruction of property Ordinary Items 1. Effects of major casualties (acts of God) if frequent in the area 2. Write down of inventories or write off of receivables 3. Losses attributable to labour disputes 4. Gains or losses from sale of property, plant, and equipment

STATEMENT PRESENTATION OF EXTRAORDINARY ITEMS Extraordinary item Expropriation of property, net of $21,000 income tax saving 49,000

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