McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Chapter Fourteen: Financial Statement Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Internal UsersExternal Users Financial statement analysis helps users make better decisions. Managers Officers Internal Auditors Shareholders Lenders Customers Purpose of Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Purpose of Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Financial Statements Are Designed for Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Dollar & Percentage Changes Trend Percentages Component Percentages Ratios Tools of Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Dollar Change: Analysis Period Amount Base Period Amount Dollar Change =– Percentage Change: Dollar Change Base Period Amount Percent Change = ÷ % Dollar and Percentage Changes

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Dollar and Percentage Changes

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Let’s look at the asset section of Clover, Inc. comparative balance sheet and income statement for 2005 and Compute the dollar change and the percentage change for cash. Let’s look at the asset section of Clover, Inc. comparative balance sheet and income statement for 2005 and Compute the dollar change and the percentage change for cash. Dollar and Percentage Changes

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 14-9

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved $12,000 – $23,500 = $(11,500)

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved ($11,500 ÷ $23,500) × 100% = 48.94% Complete the analysis for the other assets.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Trend analysis is used to reveal patterns in data covering successive periods. Trend Percent Analysis Period Amount Base Period Amount 100% = × Trend Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved is the base period so its amounts will equal 100%. Berry Products Income Information For the Years Ended December 31, Trend Analysis

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Examine the relative size of each item in the financial statements by computing component (or common-sized) percentages. Component Percent 100% Analysis Amount Base Amount = × Financial StatementBase Amount Balance SheetTotal Assets Income StatementRevenues Financial StatementBase Amount Balance SheetTotal Assets Income StatementRevenues Component Percentages

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved ($12,000 ÷ $315,000) × 100% = 3.8% ($23,500 ÷ $289,700) × 100% = 8.1%

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Ratios

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Use this information to calculate the liquidity ratios for Matrix, Inc.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Working capital is the excess of current assets over current liabilities. Working Capital

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Current Ratio Current Assets Current Liabilities = = 1.55 : 1 This ratio measures the short-term debt-paying ability of the company. Current Ratio Current Ratio $65,000 $42,000 =

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Quick assets are cash, marketable securities, and receivables. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. Quick Assets Current Liabilities = Quick Ratio Quick Ratio

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Quick Ratio Quick Assets Current Liabilities = Quick Ratio This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. $50,000 $42,000 =1.19 : 1= Quick Ratio

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved A measure of creditor’s long-term risk. The smaller the percentage of assets that are financed by debt, the smaller the risk for creditors. A measure of creditor’s long-term risk. The smaller the percentage of assets that are financed by debt, the smaller the risk for creditors. Debt Ratio

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Uses and Limitations of Financial Ratios

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved An income statement can be prepared in either a multiple-step or single-step format. The single-step format is simpler. The multiple-step format provides more detailed information. The single-step format is simpler. The multiple-step format provides more detailed information. Measures of Profitability

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Proper Heading { Gross Margin { Operating Expenses { { Non- operating Items Income Statement (Multiple-Step) Remember to compute EPS.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Proper Heading { Income Statement (Single-Step) Expenses & Losses { Revenues & Gains { Remember to compute EPS.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Use this information to calculate the profitability ratios for Matrix, Inc.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved This ratio is generally considered the best overall measure of a company’s profitability. This ratio is generally considered the best overall measure of a company’s profitability. Return On Assets (ROA)

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved This measure indicates how well the company employed the owners’ investments to earn income. Return On Equity (ROE)

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved End of Chapter Fourteen