HOW TO READ, ANALYZE, AND INTERPRET FINANCIAL REPORTS Chapter Thirteen Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

1. Explain the purpose and the key items on the balance sheet. 2. Explain and complete vertical and horizontal analysis. LU13-1: Balance Sheet -- Report as of a Particular Date LEARNING UNIT OBJECTIVES LU 13-1: Income Statement -- Report for a Specific Period of Time 1. Explain the purpose and the key items on the income statement. 2. Explain and complete vertical and horizontal analysis LU 13-3: Trend and Ratio Analysis 1. Explain and complete a trend analysis. 2. List, explain, and calculate key financial ratios.

ACCOUNTING EQUATION Accounting Equation: Assets = Liabilities + Owner’s Equity 13-3

BALANCE SHEET Gives a financial picture of what a company is worth as of a particular date. AssetsLiabilities + Owner’s Equity = (How much the company owns) (How much the owner is worth) (How much the company owes) 13-4

BALANCE SHEET Assets – Liabilities = Owner’s equity (capital) $10,000 - $2,500 = $7,

ELEMENTS OF THE BALANCE SHEET (FIGURE 13.1) MOOL COMPANY Balance Sheet December 31, 2014 Assets Liabilities a. Current assets: a. Current liabilities: b. Cash $ 7,000 b. Accounts payable $ 80,000 c. Accounts receivable 9,000 c. Salaries payable 12,000 d. Merchandise inventory 30,000 d. Total current liabilities $ 92,000 e. Prepaid expenses 15,000 e. Long-term liabilities: f. Total current assets $61,000 f. Mortgage note payable 58,000 g. Plant and equipment: g. Total liabilities $150,000 h. Building (net) $60,000 i. Land 84,000 Stockholders’ Equity j. Total plant and equipment 144,000 a. Common stock $ 20,000 b. Retained earnings 35,000 c. Total stockholders’ equity 55,000 k. Total assets $205,000 d. Total liab. and stkhlds’ equity $205,000 Assets broken down into current assets and plant and equipment Liabilities broken down into current and long-term Total of current assets and plant and equipment. (Total is double-ruled) Total of all liabilities and stockholders’ equity. 13-6

VERTICAL ANALYSIS AND THE BALANCE SHEET Step 2. Divide each liability and stockholders’ equity (the portions) as a percent of total liabilities and stockholders’ equity (the base). Round as indicated. Step 1. Divide each asset (the portion) as a percent of total assets (the base). Round as indicated. 13-7

COMPARATIVE BALANCE SHEET: VERTICAL ANALYSIS (FIGURE 13.2) ROGER COMPANY Comparative Balance Sheet December 31, 2013 and AmountPercentAmountPercent Assets Current Assets: Cash$22, $18, Accounts Receivable 8, , Merchandise inventory 9, , Prepaid rent 4, , Total current assets$43, $39, * Plant and equipment: Building (net)$18, $18, Land 24, , Total plant and equipment$42, *$42, Total assets$85, $81, * Due to rounding 13-8

COMPARATIVE BALANCE SHEET: VERTICAL ANALYSIS (FIGURE 13.2) ROGER COMPANY Comparative Balance Sheet December 31, 2013 and AmountPercentAmountPercent Liabilities Current liabilities: Accounts payable $14, $ 8, Salaries payable 18, , Total current liabilities $32, $25, * Long-term liabilities: Mortgage note payable $12, $20, Total liabilities $44, * $45, * Stockholders’ Equity Common stock $20, $20, Retained earnings 21, , Total stockholders’ equity $41, $36, Total liabilities and stockholders’ equity $85, $81, * Due to rounding 13-9

PREPARING A HORIZONTAL ANALYSIS OF A COMPARATIVE BALANCE SHEET Step 1. Calculate the increase or decrease (portion) in each item from the base year. Step 2. Divide the increase or decrease in Step 1 by the old or base year. Step 3. Round as indicated

COMPARATIVE BALANCE SHEET: HORIZONTAL ANALYSIS (FIGURE 13.3) ABBY ELLEN COMPANY Comparative Balance Sheet December 31, 2013 and 2014 Increase (decrease) AmountPercent Assets Current Assets: Cash$ 6,000$ 4,000$ 2, * Accounts receivable 5,000 6,000 (1,000) Merchandise inventory 9,000 4,000 5, Prepaid rent 5,000 7,000 (2,000) Total current assets$25,000$21,000 $ 4, Plant and equipment: Building (net)$12,000 $12, Land 18,000 18, Total plant and equipment$30,000 $30, Total assets$55,000 $51,000$4,

COMPARATIVE BALANCE SHEET: HORIZONTAL ANALYSIS (FIGURE 13.3) ABBY ELLEN COMPANY Comparative Balance Sheet December 31, 2013 and 2014 Increase (decrease) AmountPercent Liabilities Current liabilities: Accounts payable$ 3,200$ 1,800$1, Salaries payable 2,900 3,200 (300) Total current liabilities$ 6,100$ 5,000 $1, Long-term liabilities: Mortgage note payable17,000 15,0002, Total liabilities $ 23,100$20,000$3, Owner’s Equity Abby Ellen, capital$31,900$31,000$ Total liabilities and owner’s equity $55,000 $51,000$4,

INCOME STATEMENT – REPORT FOR A SPECIFIC PERIOD OF TIME Income Statement -- A financial report that tells how well a company is performing (its profitability or net profit) during a specific period of time (month, year, etc). Service Business: Net income = Revenues -- Operating expenses Retail Business: Revenues (sales) -- Cost of merchandise sold = Gross profit from sales -- Operating expenses = Net income (profit) Income Statement $ 13-13

INCOME STATEMENT 13-14

MOOL COMPANY Income Statement For Month Ended December 31, 2014 Revenues a. Gross Sales $22,080 b. Less: Sales returns and allowances$ 1,082 c. Sales discounts4321,514 d. Net Sales Cost of merchandise (goods) sold: $20,566 a. Merchandise Inventory 12/1/2014$1,248 b. Purchases$10,512 c. Less: Purchases returns and allowances $336 d. Less: Purchase discounts e. Cost of net purchases9,972 f. Cost of merchandise (goods available for sale) $11,220 g. Less: Merchandise inventory 12/31/2014 1,600 h. Cost of merchandise (goods sold)9,620 Gross profit from sales$10,946 Operating expenses: a. Salary $2,200 b. Insurance 1,300 c. Utilities 400 d. Plumbing 120 e. Rent 410 f. Depreciation 200 g.Total operating expenses4,630 Net income$ 6,316 INCOME STATEMENT (FIGURE 13.4) 13-15

KEY CALCULATIONS ON INCOME STATEMENT Net sales = Gross sales -- Sales returns allowances -- Sales discounts Net income = Gross profit -- Operating expenses Gross profit from sales = Net sales -- Cost of merchandise (goods) sold Cost of Net purchases merchandise = Beginning + (purchase less -- Ending (goods) sold inventory returns & discounts) inventory 13-16

INCOME STATEMENT VERTICAL ANALYSIS (FIGURE 13.5) ROYAL COMPANY Comparative Income Statement For Years Ended December 31, 2013 and Percent 2013 Percent of net of net Net Sales$45, $29, * Cost of merchandise sold 19, , Gross profit from sales$26, $17, Operating expenses: Depreciation $1, $ Selling and Advertising 4, , Research 2, , Miscellaneous Total operating expenses $8, * $ 4, Income before interest and taxes$17, $12, Interest expense 6, , Income before taxes$11, * $ 9, Provision for taxes 5, , Net income $ 5, $ 6, * * Off due to rounding 13-17

HORIZONTAL ANALYSIS INCOME STATEMENT (FIGURE 13.6) FLINT COMPANY Comparative Income Statement For Years Ended December 31, 2013 and Increase (decrease) Amount Percent Sale$ 90,000 $80,000$10,000 Sales returns and allowances 2,000 2,000 0 Net Sales$88,000 $78,000$10, Cost of merchandise sold45,000 40,000 5, Gross profit from sales$43,000 $38,000$ 5, Operating expenses: Depreciation$ 6,000 $ 5,000$ 1, Selling and Administrative16,000 12,000 4, Research 600 1,000 (400) Miscellaneous1, Total operating expenses$23,800 $18,500 $ 5, Income before interest and taxes$19,200 $19,500$ (300) Interest expense 4,000 4,000 0 Income before taxes$15,200$15,500$ (300) Provision for taxes3,800 4,000(200) Net income$11,400 $11,500$ (100)

COMPLETING A TREND ANALYSIS Trend Analysis – Analyzes the changes that occur by expressing each number as a percent of the base year. Step 1. Select the base year (100%). Step 2. Express each amount as a percent of the base year amount (rounded to the nearest whole percent). Each Item Base Amount 13-19

TREND ANALYSIS Given (base year 2012) Sales$621,000$460,000$340,000$420,000 Gross Profit 182, , , ,000 Net Income 48,000 41,000 22,000 38,000 Trend Analysis Sales*148%110%81%100% Gross Profit Net Income $340,000 $420,000D * Round to nearest whole percent Sales of 2013 were 81% of the sales of 2012

RATIO ANALYSIS 13-21