Fundamental Managerial Accounting Concepts Fifth Edition Fundamental Managerial Accounting Concepts Fundamental Managerial Accounting Concepts Fifth Edition Thomas P. Edmonds, Bor-Yi Tsay, and Phillip R. Olds Thomas P. Edmonds Bor-Yi Tsay Philip R. Olds Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Financial Statement Analysis CHAPTER 13 Financial Statement Analysis Chapter 13: Financial Statement Analysis This chapter focuses upon financial statement analysis which is used to assess the financial health of a company. It includes examining trends in key financial data, comparing financial data across companies, and analyzing financial ratios.

Horizontal Analysis Horizontal analysis (or trend analysis) refers to studying the behavior of individual financial statement items over several accounting periods. Absolute Amounts Percentage Analysis 3

Vertical Analysis Vertical analysis uses percentages to compare individual components of financial statements to a key statement figure. A common-size financial statement is a vertical analysis in which each financial statement item is expressed as a percentage. 4

Ratio Analysis Ratio analysis involves studying various relationships between different items reported in a set of financial statements. 5

Liquidity Ratios: Working Capital The excess of current assets over current liabilities is known as working capital. Insert Exhibit showing calculation of working capital. 6

Liquidity Ratios: Current Ratio Current Assets Current Liabilities = The current ratio measures a company’s short-term debt paying ability. A declining ratio may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories. 7

Liquidity Ratios: Quick (Acid-Test) Ratio Quick Assets Current Liabilities = Acid-Test Ratio Quick assets include Cash, Current Marketable Securities, and Accounts Receivable. This ratio measures a company’s ability to meet obligations without having to liquidate inventory. 8

Liquidity Ratios: Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable Accounts Receivable Turnover = This ratio measures how many times a company converts its receivables into cash each year. 9

Liquidity Ratios: Average Days to Collect Receivables Average Collection Period = 365 Days Accounts Receivable Turnover = 21 days Average Collection Period = 365 Days 16.98 Times This ratio measures, on average, how many days it takes to collect an accounts receivable. 10

Liquidity Ratios: Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover = This ratio measures how many times a company’s inventory has been sold and replaced during the year. 11

Liquidity Ratios: Average Days to Sell Inventory Average Sale Period = 365 Days Inventory Turnover = 34 days Average Sale Period = 365 Days 10.80 Times This ratio measures how many days, on average, it takes to sell the inventory. 12

Solvency Ratios: Debt to Assets Ratio Total Liabilities Total Assets Debt to Assets Ratio = This ratio measures the percentage of a company’s assets that are financed by debt. 13

Solvency Ratios: Debt to Equity Ratio Total Liabilities Stockholders’ Equity Debt to Equity Ratio = This ratio indicates the relative proportions of debt to equity on a company’s balance sheet. Stockholders like a lot of debt if the company can take advantage of positive financial leverage. Creditors prefer less debt and more equity because equity represents a buffer of protection. 14

Solvency Ratios: Number of Times Interest is Earned Ratio Times Interest Earned Earnings before Interest Expense and Income Taxes Interest Expense = This is the most common measure of a company’s ability to provide protection for its long-term creditors. 15

Profitability Ratios: Net Margin Net Income Net Sales = This measure describes the percent remaining of each sales dollar after subtracting other expenses as well as cost of goods sold. 16

Profitability Ratios: Asset Turnover Ratio Net Sales Average Total Assets Asset Turnover = This ratio measures how many sales dollars were generated for each dollar of assets invested. 17

Profitability Ratios: Return on Investment (ROI) Net Income Average Total Assets = This is the ratio of wealth generated (net income) to the amount invested (average total assets). 18

Profitability Ratios: Return on Equity Net Income Average Total Stockholders’ Equity = This measure is often used to measure the profitability of the stockholders’ investment. 19

Stock Market Ratios: Earnings Per Share Net Earnings Available for Common Stock Average Number of Outstanding Common Shares = This measure indicates how much income was earned for each share of common stock outstanding. 20

Stock Market Ratios: Price-Earnings Ratio Market Price Per Share Earnings Per Share = This ratio compares the earnings of a company to the market price for a share of the company’s stock. 21