1. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 1

2. 22 Financial Statement Analysis Chapter 13

3. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 3 Perform a horizontal analysis

4. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 4 Horizontal Analysis Study of percentage changes from year-to-year Two steps: ▫1. Compute dollar amount of change ▫2. Divide dollar amount of change by base- period amount

5. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 5 Exercise 13-16A McMahon Music Company Comparative Income Statements Years Ended December 31, 2012 and 2011 20122011$ Change% Change Total revenue $1,007,000$917,000$90,000 9.8% Expenses: Cost of goods sold$477,000$408,750$68,25016.7% Selling & gen’l expense287,000265,00022,0008.3% Interest expense23,50013,50010,00074.1% Income tax expense105,50084,65020,85024.6% Total expenses893,000771,900121,10015.7% Net income$184,000$145,100$38,90026.8%

6. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 6 Trend Percentages Form of horizontal analysis Base year selected and set equal to 100% ▫Amount of each following year stated as a percent of base Trend % Any year Base year

7. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 7 Perform a vertical analysis

8. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 8 Vertical Analysis Shows relationship of a financial-statement item to its base ▫For Income Statement, total revenue is the base ▫For Balance Sheet, total assets is the base Vertical analysis % Total revenue Each income statement item

9. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 9 Prepare common-size financial statements

10. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 10 Common-Size Statements Report only vertical analysis percents ▫No dollar amounts Help in the comparison of different companies ▫Financial results in terms of a common denominator

11. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 11 Benchmarking Compares company to a standard set by others ▫Often a key competitor Facilitated by common-size statements Has goal of improvement

12. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 12 Analyze the statement of cash flows Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

13. 13 Cash-Flow Signs of Healthy Company Operations are major source of cash Investing includes more purchases than sales Financing not dominated by borrowing

14. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 14 Use ratios to make business decisions Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

15. 15 Ratio Categories Measuring ability to pay current liabilitiesMeasuring turnover and cash conversionMeasuring leverageMeasuring profitabilityAnalyzing stock as an investment

16. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 16 Ability to Pay Current Liabilities Working capital Current ratio Quick (Acid- test) ratio

17. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 17 Working Capital & Current Ratio Working capital Current assets Current liabilities Current ratio Current assets Current liabilities Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

18. 18 Quick (Acid-Test) Ratio Cash + Short-term investments + Net current receivables Current liabilities Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

19. 19 Measuring Turnover and the Cash Conversion Cycle Inventory turnover Accounts receivable turnover Accounts payable turnover

20. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 20 Inventory Turnover Cost of goods sold Average inventory (Beginning inventory + Ending inventory)/2) Days’ inventory outstanding 365 Inventory turnover

21. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 21 Accounts Receivable Turnover Net sales Average net accounts receivable (Beginning net receivables + Ending net receivables)/2)

22. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 22 Days’-Sales-In-Receivables Average daily sales Net sales 365 days Convert average daily sales to DSO Convert average daily sales to DSO Average net accounts receivable Average daily sales

23. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 23 Accounts Payables Turnover Cost of goods sold Average accounts payable 365 Days’ payable outstanding Payables turnover

24. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 24 Cash Conversion Cycle DIODPODSO DIO = Days’ Inventory Outstanding DSO = Days’ Sales Outstanding DPO = Days’ Payable Outstanding

25. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 25 Measuring Leverage: Overall Ability to Pay Debts Debt ratio Times-interest- earned

26. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 26 Debt ratio Total liabilities Total assets

27. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 27 Times-Interest-Earned Income from operations Interest expense

28. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 28 Exercise 13-22A 20122011 Cash$50,000$49,000 Short-term investments28,00027,000 Net receivables115,000128,000 Inventory240,000268,000 Prepaid expenses22,0008,000 Total assets510,000540,000 Total current liabilities207,000262,000 Long-term debt97,000174,000 Income from operations301,000150,000 Interest expense41,00042,000

29. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 29 Exercise 13-22A Working capital Current assets Current liabilities Current assets Cash + Short-term investments + Net receivables + Inventory + Prepaid expenses $50,000 + 28,000 + 115,000 + 240,000 + 22,000 2012 $455,000 $207,000 $248,000

30. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 30 Exercise 13-22A Working capital Current assets Current liabilities Current assets Cash + Short-term investments + Net receivables + Inventory + Prepaid expenses $49,000 + 27,000 + 128,000 + 268,000 + 8,000 2011 $480,000 $262,000$278,000

31. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 31 Exercise 13-22A Current ratio Current assets Current liabilities $455,000 $207,000 2.20 2012 2011 $480,000 $262,000 1.83

32. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 32 Exercise 13-22A Cash + Short-term investments + Net current receivables Current liabilities Quick ratio 2012 = $50,000 +28,000 + 115,000 $207,000.93.93

33. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 33 Exercise 13-22A Cash + Short-term investments + Net current receivables Current liabilities Quick ratio 2011 = $49,000 + 27,000 + 128,000 $262,000.78

34. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 34 Exercise 13-22A Debt ratio Total liabilities Total assets Current liabilities + Long-term debt $207,000 +97,000 $304,000 $510,000 2012.60 2011 $262,000 + 174,000 $436,000 $540,000.81

35. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 35 Exercise 13-22A Income from operations Interest expense Times Interest Earned 2012 $301,000 $41,000 $150,000 $42,000 7.34 3.57 2011

36. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 36 Measuring Profitability Gross margin Operating income percentage DuPont Analysis Net profit margin Asset turnover Return on Assets Leverage ratio Return on equity Earnings per share

37. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 37 Gross margin & Operating profit Percentages Operating profit % Net sales Gross margin Gross margin % Operating income Net sales

38. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 38 DuPont Analysis Return on assets Net profit margin Asset turnover Leverage ratio Return on equity Leverage ratio Return on equity Net income Net sales Average total assets Average common equity Net income Average common equity

39. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 39 Rate of Return (Net Profit Margin) on Sales Net income Net sales

40. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 40 Asset Turnover Net sales Average total assets

41. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 41 Rate of Return on Total Assets Rate of Return on Sales Asset turnover

42. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 42 Leverage (Equity Multiplier) Ratio Average total assets Average common stockholders’ equity

43. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 43 Rate of Return on Common Equity Net income – Preferred dividends Average common stockholders’ equity

44. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 44 Earnings per Share Net income –Preferred dividends Average number of common shares outstanding

45. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 45 Analyzing Stock Investments Price/Earnings ratio Dividend yield Book Value per Share of Common Stock.

46. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 46 Price/Earnings Ratio Market price per share of common stock Earnings per share

47. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 47 Dividend Yield Dividend per share of common stock Market price per share of common stock

48. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 48 Book Value Total stockholders’ equity Preferred equity Weighted-average number of common shares outstanding

49. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 49 Use other measures to make investment decisions

50. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 50 Economic Value Added (EVA ® ) Combines accounting and finance data Measures if operations have increased stockholder wealth ▫Positive EVA ® suggests increase in wealth Net income Interest expense Capital charge

51. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 51 Cost of Capital Notes payable Current maturities of long-term debt Long-term debt Stockholders’ equity Capital charge = Cost of capital

52. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 52 Red Flags in Financial Statement Analysis Earnings problems Decreased cash flow Too much debt Inability to collect receivables Buildup of inventories Trends of sales, inventory and receivables

53. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 53 Efficient Markets Market prices fully reflect all information ▫Managers cannot fool market with accounting manipulations ▫Market sets fair price for stock Appropriate investment strategy: ▫Manage risk ▫Diversify investments ▫Minimize transaction costs

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55. Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 55