John J. Wild Sixth Edition Financial Accounting John J. Wild Sixth Edition McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Analyzing and Interpreting Financial Statements Chapter 13 Analyzing and Interpreting Financial Statements

Conceptual Learning Objectives C1: Explain the purpose and identify the building blocks of analysis. C2: Describe standards for comparisons in analysis. 13-3

Analytical Learning Objectives A1: Summarize and report results of analysis. A2: Appendix 13A – Explain the form and assess the content of a complete income statement (see text for details). 13-4

Procedural Learning Objectives P1: Explain and apply methods of horizontal analysis. P2: Describe and apply methods of vertical analysis. P3: Define and apply ratio analysis. 13-5

Building Blocks of Analysis Ability to meet short-term obligations and to efficiently generate revenues Ability to generate future revenues and meet long-term obligations Liquidity and Efficiency Solvency Ability to provide financial rewards sufficient to attract and retain financing Ability to generate positive market expectations Market Prospects Profitability 13-6

Standards for Comparison When interpreting measures, we need to decide whether the measures indicate good, bad, or average performance. We can use the following to make that judgment: Intracompany Competitor Industry Guidelines (rule of thumb) The more experience one gains in performing such analyses, the easier it becomes to interpret the results. Like anything else, practice goes a long way in this area. 13-7

Horizontal Analysis Vertical Analysis Tools of Analysis C 1 Horizontal Analysis Comparing a company’s financial condition and performance across time. Vertical Analysis Comparing a company’s financial condition and performance to a base amount. Measurement of key relations between financial statement items Ratio Analysis 13-8

Comparative Statements Calculate Change in Dollar Amount Dollar change Analysis period amount Base period amount – = Since we are measuring the amount of the change between 2011 and 2010, the dollar amounts for 2010 become the “base” period amounts. Calculate Change as a Percent Percent change Dollar change Base period amount = × 100 13-9

Analysis period amount Trend Analysis P 1 Trend analysis is used to reveal patterns in data covering successive periods. Trend percent Analysis period amount Base period amount 100 = × 13-10

Common-Size Statements P 2 Calculate Common-size Percent Common-size percent Analysis amount Base amount × = 100 Financial Statement Base Amount Balance Sheet Total Assets Income Statement Revenues 13-11

Comparative (Partial) Balance Sheets December 31, 2011 Common-size CLOVER CORPORATION Comparative (Partial) Balance Sheets December 31, 2011 Common-size Percents* 2011 2010 Liabilities and Shareholders' Equity Current liabilities: Accounts payable 67,000 $ 44,000 21.3% 15.2% Notes payable 3,000 6,000 1.0% 2.1% Total current liabilities 70,000 50,000 22.2% 17.3% Long-term liabilities: Bonds payable, 8% 75,000 80,000 23.8% 27.6% Total liabilities 145,000 130,000 46.0% 44.9% Shareholders' equity: Preferred stock 20,000 6.3% 6.9% Common stock 60,000 19.0% 20.7% Additional paid-in capital 10,000 3.2% 3.5% Total paid-in capital 90,000 28.6% 31.1% Retained earnings 69,700 25.4% 24.1% Total shareholders' equity 170,000 159,700 54.0% 55.1% Total liabilities and shareholders' equity 315,000 289,700 100.0% * Percent rounded to first decimal point. P 2 13-12

Liquidity and Efficiency P 3 Current Ratio Inventory Turnover Acid-test Ratio Days’ Sales Uncollected Accounts Receivable Turnover Days’ Sales in Inventory Total Asset Turnover 13-13

Pledged Assets to Secured Liabilities Solvency P 3 Debt Ratio Equity Ratio Pledged Assets to Secured Liabilities Times Interest Earned 13-14

Profitability Profit Margin Basic Earnings per Share Gross Margin Book Value per Common Share Return on Total Assets Return on Common Stockholders’ Equity 13-15

A1 Summarizing Results A financial statement analysis report helps by directly assessing the building blocks of analysis and by identifying weaknesses in inference and by requiring explanation. It usually consists of six sections: Executive summary Analysis overview Evidential matter Assumptions Key Factors Inferences 13-16

End of Chapter 13 13-17