Financial Statement Analysis: The Big Picture CHAPTER 14 Financial Statement Analysis: The Big Picture Managerial Accounting, Fifth Edition

Basics of Financial Statement Analysis Analyzing financial statements involves: Characteristics Comparison Bases Tools of Analysis Liquidity Profitability Solvency Intracompany Industry averages Intercompany Horizontal Vertical Ratio SO 1 Discuss the need for comparative analysis. SO 2 Identify the tools of financial statement analysis.

Horizontal Analysis Horizontal analysis, also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time. Its purpose is to determine the increase or decrease that has taken place. Horizontal analysis is commonly applied to the balance sheet, income statement, and statement of retained earnings. SO 3 Explain and apply horizontal analysis.

Horizontal Analysis Exercise: The comparative condensed balance sheets of Ramsey Corporation are presented below. Instructions: Prepare a horizontal analysis of the balance sheet data for Ramsey Corporation using 2008 as a base. SO 3 Explain and apply horizontal analysis.

Horizontal Analysis Exercise: The comparative condensed balance sheets of Ramsey Corporation are presented below. Instructions: Prepare a horizontal analysis of the balance sheet data for Ramsey Corporation using 2008 as a base. SO 3 Explain and apply horizontal analysis.

Vertical Analysis Vertical analysis, also called common-size analysis, is a technique that expresses each financial statement item as a percent of a base amount. On an income statement, we might say that selling expenses are 16% of net sales. Vertical analysis is commonly applied to the balance sheet and the income statement. SO 4 Describe and apply vertical analysis.

Vertical Analysis Exercise: The comparative condensed income statements of Hendi Corporation are shown below. Instructions: Prepare a vertical analysis of the income statement data for Hendi Corporation in columnar form for both years. SO 4 Describe and apply vertical analysis.

Vertical Analysis Exercise: The comparative condensed income statements of Hendi Corporation are shown below. Instructions: Prepare a vertical analysis of the income statement data for Hendi Corporation in columnar form for both years. SO 4 Describe and apply vertical analysis.

Financial Ratio Classifications Ratio Analysis Ratio analysis expresses the relationship among selected items of financial statement data. Financial Ratio Classifications Illustration 14-11 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis A single ratio by itself is not very meaningful. The discussion of ratios will include the following types of comparisons. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Liquidity Ratios Measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. Short-term creditors such as bankers and suppliers are particularly interested in assessing liquidity. Ratios include the current ratio, the acid-test ratio, receivables turnover, and inventory turnover. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Illustration SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis All sales were on account. The allowance for doubtful accounts was $3,200 on December 31, 2009, and $3,000 on December 31, 2008. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Liquidity Ratios Compute the Current Ratio for 2009. Current Assets = Current Ratio Current Liabilities $369,900 = 1.82 : 1 $203,500 The ratio of 1.82:1 means that for every dollar of current liabilities, the company has $1.82 of current assets. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Liquidity Ratios Compute the Acid-Test Ratio for 2009. Cash + Short-Term Investments + Receivables (Net) Acid-Test Ratio = Current Liabilities $60,100 + $69,000 + $107,800 = 1.16 : 1 $203,500 The acid-test ratio measures immediate liquidity. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Average Net Receivables Liquidity Ratios Ratio Analysis Compute the Receivables Turnover ratio for 2009. Net Credit Sales Receivables Turnover = Average Net Receivables $1,818,500 = 17.3 times ($107,800 + $102,800) / 2 It measures the number of times, on average, the company collects receivables during the period. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

365 days / 17.3 times = every 21.1 days Liquidity Ratios Ratio Analysis Receivables Turnover $1,818,500 = 17.3 times ($107,800 + $102,800) / 2 A variant of the receivables turnover ratio is to convert it to an average collection period in terms of days. 365 days / 17.3 times = every 21.1 days This means that receivables are collected on average every 21 days. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Liquidity Ratios Compute the Inventory Turnover ratio for 2009. Cost of Good Sold Inventory Turnover = Average Inventory $1,011,500 = 8.1 times ($133,000 + $115,500) / 2 Inventory turnover measures the number of times, on average, the inventory is sold during the period. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

365 days / 8.1 times = every 45.1 days Liquidity Ratios Ratio Analysis Inventory Turnover $1,011,500 = 8.1 times ($133,000 + $115,500) / 2 A variant of inventory turnover is the days in inventory. 365 days / 8.1 times = every 45.1 days Inventory turnover ratios vary considerably among industries. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Profitability Ratios Measure the income or operating success of a company for a given period of time. Income, or the lack of it, affects the company’s ability to obtain debt and equity financing, liquidity position, and the ability to grow. Ratios include the profit margin, asset turnover, return on assets, return on common stockholders’ equity, earnings per share, price-earnings, and payout ratio. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Profitability Ratios Compute the Profit Margin ratio for 2009. Net Income Profit Margin = Net Sales $199,000 = 10.9% $1,818,500 Measures the percentage of each dollar of sales that results in net income. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Profitability Ratios Compute the Asset Turnover ratio for 2009. Net Sales Asset Turnover = Average Assets $1,818,500 = 2.0 times ($970,200 + $852,800) / 2 Measures how efficiently a company uses its assets to generate sales. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Profitability Ratios Compute the Return on Assets ratio for 2009. Net Income Return on Assets = Average Assets $199,000 = 21.8% ($970,200 + $852,800) / 2 An overall measure of profitability. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Return on Common Stockholders’ Equity Profitability Ratios Ratio Analysis Compute the Return on Common Stockholders’ Equity ratio for 2009. Return on Common Stockholders’ Equity Net Income – Preferred Dividends = Average Common Stockholders’ Equity $199,000 - $0 = 38.6% ($566,700 + $465,400) / 2 Shows how many dollars of net income the company earned for each dollar invested by the owners. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Weighted Average Common Shares Outstanding Profitability Ratios Ratio Analysis Compute the Earnings Per Share for 2009. Net Income Earnings Per Share = Weighted Average Common Shares Outstanding $199,000 = $3.49 per share 57,000 (given) A measure of the net income earned on each share of common stock. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Market Price per Share of Stock Profitability Ratios Ratio Analysis Compute the Price Earnings Ratio for 2009. Price Earnings Ratio Market Price per Share of Stock = Earnings Per Share $25 (given) = 7.16 times $3.49 The price-earnings (P-E) ratio reflects investors’ assessments of a company’s future earnings. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Profitability Ratios Compute the Payout Ratio for 2009. Cash Dividends Payout Ratio = Net Income * $77,700 = 39% $199,000 Measures the percentage of earnings distributed in the form of cash dividends. * From analysis of retained earnings. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Ratio Analysis Solvency Ratios Solvency ratios measure the ability of a company to survive over a long period of time. Debt to total assets and times interest earned are two ratios that provide information about debt-paying ability. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Debt to Total Assets Ratio Solvency Ratios Ratio Analysis Compute the Debt to Total Assets Ratio for 2009. Debt to Total Assets Ratio Total Debt = Total Assets $403,500 = 41.6% $970,200 Measures the percentage of the total assets that creditors provide. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Income before Income Taxes and Interest Expense Solvency Ratios Ratio Analysis Compute the Times Interest Earned ratio for 2009. Income before Income Taxes and Interest Expense Times Interest Earned = Interest Expense $199,000 + $84,000 + $18,000 = 16.7 times $18,000 Provides an indication of the company’s ability to meet interest payments as they come due. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Unit 9 Assignment Example Selected comparative statement data for Weinstock Products Company are presented below. All balance sheet data are as of Compute the following ratios for 2012. (a) Profit margin. (b) Asset turnover. (c) Return on assets. (d) Return on common stockholders' equity.

Unit 9 Assignment Example = Net Income / Net Sales = Net Sales / Average Assets = Net Income / Average Assets = Net Income / Average Common Stk Equity

= Change in COS / Base Year Unit 9 Quiz Example #1 Assume the following cost of goods sold data for a company: 2009 $1,500,000 2008 1,200,000 2007 900,000 If 2007 is the base year, what is the percentage increase in cost of goods sold from 2007 to 2009? 167% 67% 60% 40% = Change in COS / Base Year =(2009 COS – 2007 COS)/ 2007 COS = ($1,500,000 – 900,000) / 900,000 = $600,000 / 900,000 = 67%

Unit 9 Quiz Example #2 = 8,000,000 / [(780,000+820,000)/2] Walker Clothing Store had a balance in the Accounts Receivable account of $780,000 at the beginning of the year and a balance of $820,000 at the end of the year. Net credit sales during the year amounted to $8,000,000. The average collection period of the receivables in terms of days was : 30 days. 365 days. 10 days. 37 days. AR Turnover=Net Sales / Average Receivables = 8,000,000 / [(780,000+820,000)/2] = 8,000,000 / [1,600,000/2] =8,000,000 / 800,000 =10 times a year Collection Period = 365/Turnover Days =365/10days =37 days