Chapter 5 Robinson, Munter, Grant Common-size Analysis Chapter 5 Robinson, Munter, Grant

Learning Objectives Prepare and evaluate common-size financial statements in cross-sectional and time-series Explain operating leverage Evaluate common-size interim data Use this analysis to forecast earnings Grant, Munter & Robinson Chapter 5

Common-size Analysis Allows comparisons of companies of different sizes Based on assets or revenues Understand the nature of costs Variable: move in proportion to sales Fixed: unchanged within a relevant range of activity Grant, Munter & Robinson Chapter 5

Common-size Analysis Income Statement Vertical analysis – income statement items are expressed as a percentage of sales Sales = 100% Each line item = Item/Sales Horizontal analysis with a base year Each line item of base year = 100% Growth/decline is relative to base year Focus on changes over time Use to forecast earnings Grant, Munter & Robinson Chapter 5

Nokia Income Statements Grant, Munter & Robinson Chapter 5

Nokia’s Vertical Common-size Income Statements Grant, Munter & Robinson Chapter 5

Nokia Common-size Income Statements (1999 is base year) Grant, Munter & Robinson Chapter 5

Nokia Common-size Income Statements (Change from base, 1999 is base year) Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Operating Leverage Positive when percentage increases in net income exceed percentage increases sales A scalar indicating how net income will change as revenues change Grant, Munter & Robinson Chapter 5

Operating Leverage Example Revenues = $1,250 Variable costs = $950 (Contribution margin = $300) Operating income = $200 Operating leverage = 1.5 ($300/$200) A 10% increase in sales will result in a 15% increase in operating income Grant, Munter & Robinson Chapter 5

Operating Leverage Approximated by: Grant, Munter & Robinson Chapter 5

Common-size Analysis Balance Sheet Vertical analysis Set total assets = 100% Divided each balance sheet time by total assets Horizontal analysis Set base year = 100% Determine relative change (growth/decline) from base year amount Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Grant, Munter & Robinson Chapter 5

Cross-sectional Comparisons Compare firm to peers Compare firm to industry averages In a single time period Differences in accounting methods and business models make this analysis difficult Grant, Munter & Robinson Chapter 5

Cross-section: 2001 Nokia Motorola Sales 100% Operating profit 11% -23% Pretax income -18% Net profit 7% -13% Grant, Munter & Robinson Chapter 5

Cross-section Balance Sheet 2001 Nokia Motorola Industry Current Assets 69% 51% 65% Fixed Assets, net 11% 27% 23% Current Liabilities 43% 29% 33% Long-term Debt 1% 25% 12% Stockholders’ Equity 54% 41% Grant, Munter & Robinson Chapter 5

Interim Reports Generally unaudited More timely; prepared quarterly or semi-annually Detect trends and seasonality Compare results of current period to those presented in annual reports Data can be used to forecast earnings Grant, Munter & Robinson Chapter 5

Motorola Interim Analysis First Quarter 2002 2001 Net revenue $6,021 100% $7,683 Gross margin 1,773 29% 1,566 21% Operating income (362) -6% (1,106) -14% Net income (449) -7% (533) Grant, Munter & Robinson Chapter 5

Summary Common-size income statement Operating leverage Common-size balance sheet Interim reports Grant, Munter & Robinson Chapter 5