McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-1 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 11 Financial Statement Analysis

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-2 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Financial Statement Ratios Ratios are used to interpret the financial position and results of operations of an entity and may be grouped in the following four categories: 1.Liquidity. 2.Activity. 3.Profitability. 4.Debt, or financial leverage.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Consideration When Using Ratios Differences in accounting methods between companies sometimes make comparisons difficult. We use the LIFO method to value inventory. We use the FIFO method to value inventory. L O 1

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Liquidity Measures Is the firm paying its bills promptly? Are all cash discounts taken? What are the firm’s working capital and liquidity ratios? Creditors Suppliers L O 2

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Turnover Ratios Differences in inventory cost-flow assumptions and depreciation methods will affect comparability of turnover ratios. We use the LIFO method to value inventory and an accelerated depreciation method. We use the FIFO method to value inventory and the straight-line depreciation method. We report lower inventory and net book value of depreciable assets. We have lower asset turnover ratios L O 3

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Activity Measures Focus primarily on relationships between asset levels and sales. The general model for calculating turnover is: Turnover = Sales ÷ Average assets Turnover is often calculated for (1) Accounts receivable; (2) Inventories; (3) Plant and equipment; (4) Total operating assets; and (5) Total assets. L O 3

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Accounts Receivable Turnover Sales Sales Average accounts receivable Accounts receivable turnover= We will use these amounts to calculate our ratios! L O 3

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Inventory Turnover Cost of goods sold Cost of goods sold Average inventory Inventoryturnover= A measure of the number of times merchandise inventory is sold and replaced during the year. A measure of the number of times merchandise inventory is sold and replaced during the year. L O 3 Sales Averageplant and equipment Average plant and equipment Plant and equipment turnover= Plant and Equipment Turnover

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-9 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Other Activity Measures Days’ in accounts receivable = Accounts receivable Annual Sales ÷ 365 days Number of Days’ Sales in Accounts Receivable A measure, on average, of how many days it takes to collect an account receivable. L O 4 Number of Days’ Sales in Inventory Days’ in inventory =Inventory Cost of goods sold ÷ 365 days A measure, on average, of the number of times inventory is sold and replaced.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Price/Earnings Ratio Price/earningsratio Market price per share Diluted earnings per share Market price per share Diluted earnings per share= A measure often used by investors as a general guideline in gauging stock values. Price-earningsratio $21.50 $1.97 = = times L O 5

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Dividend Yield Dividendyield Dividends per share Dividends per share Market price per share = L O 6 Dividend Payout Ratio Dividend payout ratio Annual dividend per share Annual dividend per share Earnings per share = A gauge of the portion of current earnings being paid out in dividends. Investors seeking current income would like this ratio to be high.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Preferred Dividend Coverage Preferred dividend coverage ratio Net income Annual preferred dividend = Preferred dividend coverage ratio = $55,650 $24,000 = 2.32 times A measure of the margin of safety for preferred shareholders. L O 6

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Debt Ratio Total liabilities Total liabilities Total liabilities + owners’ equity Debt ratio = Measures the percent of assets being provided by creditors. Debt ratio = = 32.33% $112,000 $112,000$346,390 L O 7

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Debt/Equity Ratio Debt/equity ratio = Total liabilities Total liabilities Total owners’ equity Debt/equity ratio = = 47.78% $112,000 $112,000$234,390 Measures the relative proportion of contribution from owners and creditors. L O 7

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Times Interest Earned Times interest earned Earnings before interest and taxes Interest expense = A common measure of the ability of a firm to provide protection to the long-term creditor. Times interest earned = = times $86,100$7,300 L O 7

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Other Analytical Techniques Book Value Per Share of Common Stock A measure of the amount that would be distributed to owners of each share of common stock if all assets were sold at their balance sheet carrying amounts and if all creditors were paid off. = $6.70 Book value per share $234,390 35,000 35,000= Book value per share Common stockholders’ equity Common stockholders’ equity Number of common shares outstanding = L O 8