12-1 Discontinued Operations  Parts of a company’s operations that are eliminated  A one-time occurrence  Income/loss from discontinued operations separately reported  Net of taxes  Gain/loss from disposal of discontinued operations separately reported  Net of taxes

12-2 Extraordinary Items  Events that are  Unusual in nature  Abnormal  Infrequent in occurrence  Not reasonably expected to occur again in the foreseeable future  Much judgment required to determine if an event is an extraordinary item

12-3 Reporting Taxes  Income taxes shown as separate line item  Last item before income from continuing operations  Does not include tax expense/savings from extraordinary items or discontinued operations

12-4 Horizontal Analysis  Evaluating financial statements across time  Express change in a financial statement item in percentages instead of dollars Current year amount – Base year amount Base year amount  Reported as a percentage  Two ways to compute  Choose a single year as base period for all years analyzed  Use the prior year as base period

12-5 Horizontal Analysis  Compute the change in accounts receivable using  2010 as the base year  The prior year as the base year

12-6 Vertical Analysis  Compares items w/in single fin stmt  All items expressed as a percent of a common amount  Also called common-sizing financial statements  Income statement items  Percent of sales  Balance sheet  Percent of total assets

12-7 Vertical Analysis

12-8 A Review of All Ratios  Liquidity Liquidity ratios  Measure ability to pay current bills and operating costs  Solvency Solvency ratios  Measure ability to meet long-term obligations and survive over long term  Profitability Profitability ratios  Measure operating or income performance  Market Market indicators  Ratios relating current market price of stock to earnings or dividends

12-9 Current Ratio Current Assets _ Current Liabilities  Measure ability to pay current liabilities with current assets  Helps creditors determine if a company can meet its short-term obligations

12-10 Quick Ratio Cash + s-t investments + A/R net Current liabilities  Measure ability to meet short-term obligations  Similar to the current ratio  Stricter test because it limits numerator to only very liquid assets

12-11 Working Capital Current assets – Current liabilities  Measure ability to meet short-term obligations  Not a ratio  Often measured as part of financial statement analysis

12-12 Inventory Turnover Ratio Cost of goods sold _ Average current liabilities  Measure how quickly a company is selling its inventory

12-13 Accounts Receivable Turnover Ratio Net credit sales _ Average net accounts receivable  Measure ability to collect the cash from its credit customers

12-14 Current Cash Debt Coverage Ratio Net cash from operating activities Average current liabilities  Measure ability to generate cash needed to pay current liabilities from company’s operations

12-15 Debt to Equity Ratio Total liabilities _ Total shareholders’ equity  Compare amount of company’s debt with amount owners have invested in the company

12-16 Times Interest Earned Ratio Income from operations_ Interest expense  Compare amount of income earned in an accounting period (before interest) to interest obligation for same period  If net income used in numerator, add back interest expense and taxes

12-17 Cash Flow Adequacy Ratio Net cash from operating activities _ Net cash required for investing activities  Cash required for investing activities  Cash paid for capital expenditures and acquisitions minus cash proceeds from disposal of capital assets  Measures the firm’s ability to generate enough cash from operating activities to pay for its capital expenditures

12-18 Return on Assets Net income + Interest expense_ Average total assets  Measure success in using assets to earn income for owners and creditors  Those who are financing the business  Interest added back to numerator  Interest part of what has been earned to pay creditors  Net income is return to the owners  Interest expense is return to creditors

12-19 Asset Turnover Ratio Net sales _ Average total assets  Measure how efficiently a company uses its assets

12-20 Return on Equity Net income – preferred dividends _ Average common shareholders’ equity  Measure how much income is earned with the common shareholders’ investment in the company

12-21 Gross Profit Ratio Gross profit_ Net sales  Describes percentage of sales price that is gross profit  Carefully watched by management  A small shift usually indicates a big change in the profitability of the company’s sales

12-22 Profit Margin Ratio Net income_ Net sales  Measure percentage of each sales dollar that results in net income

12-23 Earnings Per Share Net income – preferred dividends_ Weighted average # of shares of common stock outstanding  Calculate net income per share of common stock

12-24 Price-earnings Ratio Market price per common share_ Earnings per share  Calculate market price for $1 of earnings  Investors and analysts believe it indicates future earnings potential

12-25 Dividend Yield Ratio Dividends per share _ Market price per share  Calculate percentage return on investment in a share of stock via dividends

12-26 Understanding Ratio Analysis  Ratios must be compared with something to be useful  Same company for prior periods  Other companies for same period  Industry average for same period

12-27 Using Ratio Analysis

12-28 It’s More than Just the Numbers  Information found in notes to financial statements  Inventory cost flow methods  Depreciation methods  How various items are valued  Description of accounting policies

12-29 Business Risk, Control, and Ethics  Investor perspective  How do you minimize the risks of stock ownership?  Consult with a financial professional  Diversify your investments  What kinds of investments would make up a diversified portfolio?  Can you eliminate all investment risk?

12-30 Assign #9: pg #E12-1A, #E12-2A Assign #10: pg #P12-4A, #P12-5A