©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Financial Statement Analysis Chapter 9

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objectives After studying this chapter, you should be able to: Describe basic financial statement analytical methods. Use financial statement analysis to assess the liquidity and solvency of a business. Use financial statement analysis to assess the profitability of a business. Describe the contents of corporate annual reports.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objective 1 Describe basic financial statement analytical procedures

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Horizontal Analysis The __________ analysis of _________ and _________ in related items in _________ financial statements Exhibit 1: Comparative Balance Sheet— Horizontal Analysis

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Vertical Analysis A __________ analysis used to show the relationship of each __________ to the ________ within __________ statement Exhibit 5: Comparative Balance Sheet— Vertical Analysis

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Benefits of Analysis ________ and ________analysis are useful in assessing relationships and trends in financial conditions and operations of a business ________analysis is useful for comparing one company with another or with industry averages ________ is made easier with common- sized financial statements

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Common-Sized Statements Exhibit 7: Common- Sized Income Statement

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objective 2 Use financial statement analysis to assess the liquidity and solvency of a business

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Liquidity and Solvency _________ – the ability of a business to pay its debts _________ – the ability of a business to convert assets into cash. _________, _______, and __________ are interrelated! _________, _______, and __________ are interrelated!

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Solvency Analysis Normally assessed by examining _________ relationships, using the following major analyses: Current position analysis Accounts receivable analysis Inventory analysis Ratio of fixed assets to long-term liabilities Ratio of liabilities to stockholders’ equity Number of times interest charges are earned

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Current Position Analysis Using measures to assess a business’s ability to ______________ __________– current assets less current liabilities ________ – current assets divided by current liabilities _________ – total “quick” assets divided by current liabilities

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Current Position Analysis – Working Capital and Current Ratio Mooney Company

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Current Position Analysis – Quick Ratio Quick Ratio = Quick Assets Current Liabilities Quick Assets $280,500 Quick Assets $280,500 Quick Assets $160,000 Quick Assets $160,000 Quick Ratio: $__________÷ $______= ______ Mooney Wendt $__________÷ $______= ______

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accounts Receivable Analysis Measures efficiency of collection Reflects liquidity Accounts Receivable Turnover Number of Days’ Sales in Receivables = =

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Accounts Receivable Turnover The company _______ its accounts receivable turnover by _____ measured in terms of the number of times receivables are collected within the year.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Days’ Sales in Receivables The company improved its collections of accounts receivable by 10.9 days in 2012 measured in days receivables have been outstanding.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Inventory Analysis Measures inventory ________ Avoid tying up funds in _________ Avoid _________ Reflects liquidity Inventory Turnover Number of Days’ Sales in Inventory = =

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Inventory Turnover The company turned its inventory 1 time more in 2012, measured in terms of the number of times inventory turns over within the year.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Days’ Sales in Inventory The company reduced the time it held inventory by nearly 28% in 2012 measured in days the inventory was held in warehouses.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Fixed Assets to Long- Term Liabilities Indicates the ___________ for note-holders or bondholders Indicates the ability to ___________ on a long-term basis Fixed Assets to Long-Term Liabilities Fixed Assets (net) Long-Term Liabilities=

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Fixed Assets to Long- Term Liabilities The company increased its margin of safety in financing fixed assets mainly by lowering long- term debt.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Liabilities to Stockholders’ Equity Indicates the margin of ___________. Indicates the ability to __________________. Liabilities to Stockholders’ Equity Total Liabilities Total Stockholders’ Equity =

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Liabilities to Stockholders’ Equity The ratio shows an increasing margin of safety for creditors.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Number of Times Interest Charges Earned Indicates the general ___________________ of the business Indicates the ability to __________ adverse business conditions Times Interest Charges Earned Income before Taxes + Interest Expense Interest Expense=

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Number of Times Interest Charges Earned The number of times interest charges are earned improved from 12.2 to 28.1, a significant measure of safety for creditors.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objective 3 Use financial statement analysis to assess the profitability of a business

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Profitability Analysis Normally assessed by examining the income statement and balance sheet resources, using the following major analyses: _____________________________

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Ratio of Net Sales to Assets Shows how effectively a firm utilizes its assets Net Sales Net Sales Avg. Total Assets (excluding LT Investments)

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Rate Earned on Total Assets Interest Expense + Net Income Avg. Total Assets Measures the profitability of total assets without considering how the assets are financed.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Rate Earned on Stockholders’ Equity Net Income Net Income Avg. Stockholders’ Equity Emphasizes the rate of income earned on the amount invested by the stockholders.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Leverage The effect of leverage for 2012 is 3.1% which compares favorably with the 2.7% leverage for Exhibit 8: Effect of leverage

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Rate Earned on Common Stockholders’ Equity Net Income – Preferred Dividends Avg. Common Stockholders’ Equity Focuses on the rate of profits earned on the amounts invested by the common stockholders.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Earnings Per Share on Common Stock Net Income – Preferred Dividends Common Shares Outstanding The income earned for each share of common stock.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Price-Earnings Ratio Market Price Per Share of Common Stock Annual Earnings Per Share Indicator of the firm’s future earnings prospects.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Dividends per Share and Earnings per Share Exhibit 9: Dividends and Earnings per Share of Common Stock Dividends per Share Common Dividends Total Common Shares Outstanding =

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Dividends Per Share and Dividend Yield Dividend yield shows the rate of return to common stockholders in terms of cash dividends. Dividend Yield Dividends per Share of Common Stock Market Price per Share of Common Stock =

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objective 4 Describe the contents of corporate annual reports

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Corporate Annual Reports Summarize operating activities for the past year and plans for the future. Many variations in the order and form, but all include: ___________________________

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Management Discussion and Analysis (MD&A) Provides critical information in interpreting the financial statements and assessing the future of the company. Includes an analysis about past performance and financial condition. Discusses management’s opinion about future performance. Discusses significant risk exposure.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Independent Auditors’ Report Publicly traded companies must get an independent opinion on the fairness of the financial statements. This opinion must be included in the annual report along with an opinion on the accuracy of management’s internal control assertion.

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. End of Chapter 9