“How Well Am I Doing?” Financial Statement Analysis Chapter 16 “How Well Am I Doing?” Financial Statement Analysis

Objectives Objectives differ for investors and creditors Investors - concerned with profitability, dividends and future stock prices Creditors - concerned with liquidity and solvency Short-term creditors - also concerned with short-term liquidity and solvency Risks are evaluated

Financial Statement Analysis Trend Analysis Horizontal Analysis Trend percentages Vertical Analysis Percentages Common-size statements Ratio Analysis

Horizontal Analysis Compare year to year Actual dollar change Percentage change: Actual dollar change Base year Trend Analysis: Annual amount Compare percentage changes and trend analyses to industry averages

Vertical Analysis Compare figures within the same year Income statement - all items divided by net sales: Cost of goods sold/Net sales, Operating expenses/Net sales, Net income/Net sales, etc. Balance sheet - all items divided by total assets: Cash/Total assets, Accounts payable/total assets, etc.

Vertical Analysis Common-size statements Balance sheet: Only percentages shown. All items divided by total assets to get percentages Income Statement: Only percentages shown All items divided by net sales to get percentages Benchmark - compare figures to key competitors Compare to industry averages

Industry Averages Ratios and trend percentages will vary by industry Check a particular company’s ratios to the industry averages Sources: EDGAR, Almanac of Business and Industrial Financial Ratios, AMA Annual Statement Studies, FreeEdgar, Hoover’s Online, Industry Norms & Key Business Ratios, Mergent Industrial Manual and Mergent Bank and Finance Manual, Standard & Poor’s Industry Survey, YahooFinance.com

Ratio Analysis Categories depend on who is analyzing financial statements Common Stockholders Short-term Creditors Long-term Creditors

Common Stockholders Earnings per share (Basic and diluted) Price/earnings ratio (Market price/EPS) Dividend payout (Divs. Per share/EPS) Dividend yield (Divs. per share/Mkt price) Return on total assets (Net income + interest expense x (1-tax rate)/Avrg.assets) Return on stockholders’ equity (Net income - pref. divs./Average common S/E Book value per share

Financial Leverage Acquiring assets with funds that have been obtained from creditors or from preferred stockholders at a fixed rate of return. Positive financial leverage: ROE > ROA Negative financial leverage: ROE < ROA

Short-term Creditors Working capital (CA-CL) Current ratio(CA/CL) Acid-test (quick) ratio (Quick assets/CL) Accounts receivable turnover (Credit sales/Average receivables) Inventory turnover (COGS/Avg. Inventory)

Long-term Creditors Times-interest earned (Operating income/interest expense) Debt-to-equity ratio (Total liabs/total assets)