Basics of Analysis Chapter 5 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #2 Liquidity –Measures a firm’s ability to meet its current obligations Leverage (borrowing capacity) –Measures the degree of protector for long-term creditors Profitability –Measures the earning ability of a firm Investor-focused Cash flow –Indicate liquidity, borrowing capacity, and profitability Ratio Analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #3 Ratio Analysis Interpreted in comparison with –Prior ratios –Competitor ratios –Industry ratios –Predetermined standards Trend and variability of a ratio are important considerations. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #4 Complexities and Context Use of average data from balance sheet accounts –Necessary when comparing against income statement data –Does not Eliminate cyclical or seasonal variations Capture changes that occur unevenly throughout the year Analysis must be performed and understood within the context of –Native accounting principles –Native business practices and culture © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #5 The use of percentages is usually preferable to the use of absolute amounts Vertical analysis –All amounts of a year expressed as a percentage of a base amount (e.g., net sales revenue, total assets) Horizontal analysis –Amounts for comparative years are expressed as a percentage of the base year amount Common-Size Analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #6 Vertical Analysis Each financial statement element is presented as a percentage of a designated base which is sales revenue on the Income Statement. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #7 Horizontal Analysis Each financial statement element is presented as a percentage of a base amount from a selected year. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #8 Use both absolute and percentages Guidelines: –When an item has value in the base year and none in the next period, the decrease is 100% –A meaningful percent change cannot be computed when one number is positive and the other number is negative –A percent change is incomputable when there is no figure for the base year. Year-to-Year Change Analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #9 Financial components vary by type of industry Merchandising –Inventory is a principal asset –Sales may be primarily for cash or on credit Service –Inventory is low or nonexistent Manufacturing –Large inventory holdings –Substantial investment in plant assets Industry Variations © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #10 Narrative data –Annual report –Trade periodicals –Industry reviews Further explains the financial position of a firm Descriptive Information © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #11 Provides context for analysis of ratios and financial data Common types –Trend analysis –SIC: Standard Industrial Classification. The U.S. Department of Labor provides website for searching for key words ( –NAICS: North American Industry Classification System –Industry averages; competitor comparisons Comparisons © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #12 A study of the financial history of a firm Longitudinal ratio comparison –Falling –Rising –Relatively constant Highlight –Effective management –Evidence of problems Comparisons: Trend Analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #13 Classifies business by industry Defines industries in accordance with the composition and structure of the economy Coding structure –Division –Major group –Industry group –Industry Reported in SEC registrant filings Comparisons: SIC © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #14 Joint creation of NAFTA partners: Canada, U.S., and Mexico Industry is defined by similar production processes Coding structure –Sector, sub-sector, industry group, NAICS industry and national industry –U.S. Census Bureau provides website: and under “business and industry click on NAICS. Comparisons: NAICS © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #15 Industry comparison complicated by highly diversified companies Financial services –Base their analysis on industry placement –Provide composite industry data Comparisons: Industry © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #16 Financial Services’ Publications PublicationServiceCoverageDataClassification The Department of Commerce Financial Report Economic Surveys Division, Bureau of the Census Manufacturing, mining, and trade corporations Income statement and balance sheet data and ratios NAICS Annual Statement Studies Risk Management Association Manufacturing, wholesaling, retailing, service, agriculture, and construction Common-size financial statements and ratios NAICS and SIC Standard & Poor’s Industry Surveys Standard & Poor’s 50 North American and global industries Industry write- ups and statistics NAICS Almanac of Business and Industrial Financial Ratios CCH, Inc.192 industriesCorporate tax return data NAICS © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #17 Financial Services’ Publications (cont’d) PublicationServiceCoverageDataClassification Industry Norms and Key Business Ratios Dun & Bradstreet800 business lines; 5 segments Condensed financial statements; ratios SIC [various]Value Line Investment Service 98 industriesLongitudinal financial information © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #18 Comparisons: Caution Ratios are subject to variance from: Differing data Inconsistent formula construction Optional (elective) accounting treatment Different fiscal year-ends Varying financial policies Inconsistent basis (before or after tax) © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #19 Relative Size of Firm Comparison of disparate size firms –Capital market access –Economy of scale (purchasing) –Wider customer base Information –Absolute: amplifies comparison difficulty –Common-size: eliminates some of the difficulty Percent of market helps to define relative size © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #20 Domestic private and public companies Up to 20 items of information are provided for each company listed Ward’s Business Directory went digital in 2007 under Gale Directory Library. Other Resources: Ward’s Business Directory © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #21 Companies listed on various stock exchanges Alphabetical by exchange –NYSE –American Stock Exchange –NASDAQ stock market –Regional exchanges Other Resources: Standard & Poor’s Stock Reports © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #22 2-volumes –V1Alphabetical by firm name –V2§2Industries in 7 subsections Other Resources: Standard & Poor’s Register Of Corporations, Directors, And Executives © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #23 Selected income statement and balance sheet items Related ratios Applicable to Standard & Poor’s industry group stock price indexes Other Resources: Standard & Poor’s Analyst’s Handbook © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #24 U.S. corporations –Background information –Detailed financial statistics Standard & Poor’s Standard Corporation Descriptions © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #25 Covers 5,300 common and preferred stocks. It contains: –Trading activity –Price range –Dividends Other Resources: AQ1 Standard & Poor’s Security Owner’s Guide © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #26 Industry statistics –Agriculture –Metals –Building –Transportation –etc. Other Resources: Standard & Poor’s Statistical Service © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #27 Available in may academic libraries Other publication available with Net Advantage –Standard & Poor’s stock reports –Standard & Poor’s Register of Corporations, Directors and Executives –Stand and Poor’s Standard Corporation Descriptions AQ2 Standard & Poor’s Net Advantage © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #28 Mergent Dividend Record Standard & Poor’s Annual Dividend Record Provide a dividend record of payments on virtually all publicly owned American and some foreign companies. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #29 Companies must meet at least one of two inclusion requirements: - $9 million or more in sales volume or more employees if company is in single location, 900 or more if employees if company is a branch. Company listings –Alphabetical –Geographically –SIC Other Resources: D&B ® Million Dollar Directory ® © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #30 Corporate information –Divisions –Subsidiaries –Affiliates Indexes –Alphabetical –Geographical –SIC Other Resources: Directory Of Corporate Affiliates © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #31 Comprehensive reference –Products –Services –Company profiles –Catalog file Other Resources: Thomas Register Of American Manufacturers © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #32 Covers 2000 industrial corporations New York and American Stock Exchanges –History –Business –Properties –Subsidiaries –Financial statements –SIC codes Other Resources: Mergent Industrial Manual and News Reports © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #33 Principle corporate officers –Year of birth –Education –Military service –Present business position –Previous positions Other Resources: D&B Reference Book of Corporate Managements © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #34 Other Resources: Compact Disclosure Database of textual and financial information Annual and periodic reports filed with the SEC Contents –Major financial statements –Financial ratios –Institutional holdings –Insider ownership –President’s letter –Financial notes © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #35 Accounting, legal, newspaper, and periodical information Financial statements from annual reports Other Resources: Lexis-Nexis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5, Slide #36 The Users of Financial Statements Management –Analyze information from the perspective of both investors and creditors Investors –Analysis of past and present information to project the future prospects of the entity Creditors –Short-term: focus is on current resources –Long-term: consider the future prospects of the firm © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.