1. Welcome Back Atef Abuelaish1

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3. Homework assignment  Using Connect 7Questions for 60Chapter 11  Using Connect – 7 Questions for 60 Points; Chapter 11.  Last day of the Homework for ALLChapters1 - 9 is 5/4 at 11:59 PM.  Last day of the Homework for ALL Chapters 1 - 9 is 5/4 at 11:59 PM.  Prepare chapter 13 Last Chapter in the course; Analysis of Financial Statements  Prepare chapter 13 Last Chapter in the course; “Analysis of Financial Statements.” Happiness is having all homework up to date Atef Abuelaish3

4. Chapter 13 Analysis of financial statements

5. Purpose of Analysis 5

6. Application of analytical tools Involves transforming data Reduces uncertainty Basics of Analysis 6 Financial statement analysis helps users make better decisions. Internal Users Managers Officers Internal Auditors External Users Shareholders Lenders Customers C 1

7. Building Blocks of Analysis 7 C 1 1) Liquidity and efficiency 2) Solvency 4) Market prospects 3) Profitability

8. Information for Analysis 8 C 1 1.Income Statement 2.Balance Sheet 3.Statement of Stockholders’ Equity 4.Statement of Cash Flows 5.Notes to the Financial Statements

9. Standards for Comparisons Standards for Comparisons 9

10.  Intracompany  Competitors  Industry  Guidelines Standards for Comparison 10 C 2 When we interpret our analysis, it is essential to compare the results we obtained to other standards or benchmarks.

11. Horizontal Analysis Comparing a company’s financial condition and performance across time. Tools of Analysis 11 Vertical Analysis Comparing a company’s financial condition and performance to a base amount. Ratio Analysis Measurement of key relations between financial statement items. C 2

12. Comparative Statements Comparative Statements 12

13. Horizontal Analysis 13 P 1 Horizontal analysis refers to examination of financial statement data across time.

14. Comparative Statements 14 Dollar Amount Calculate Change in Dollar Amount Dollar change Dollar change Analysis period amount Analysis period amount Base period amount Base period amount = = – – When measuring the amount of the change in dollar amounts, compare the analysis period balance to the base period balance. The analysis period is usually the current year while the base period is usually the prior year. P 1

15. Comparative Statements 15 Percent Calculate Change as a Percent Percent change Percent change Dollar change Base period amount Dollar change Base period amount 100 = × P 1 When calculating the change as a percentage, divide the amount of the dollar change by the base period amount, and then multiply by 100 to convert to a percentage.

16. Horizontal Analysis 16 P 1

17. Horizontal Analysis 17 P 1

18. Trend Analysis 18 Trend analysis is used to reveal patterns in data covering successive periods. Trend percent Analysis period amount Base period amount 100 = × P 1

19. Using 2009 as the base year we will get the following trend information: P 1 Trend Analysis 19

20. Trend Analysis 20 We can use the trend percentages to construct a graph so we can see the trend over time. P 1

21. NEED-TO-KNOW Compute trend percents for the following accounts, using 20X1 as the base year (round percents to whole numbers). State whether the situation as revealed by the trends appears to be favorable or unfavorable for each account. ($ in millions)20X420X320X220X1 Sales$500$350$250$200 Cost of goods sold40017510050 Sales trend percents250%175%125%100% $500/$200$350/$200$250/$200$200/$200 Cost of goods sold trend percents800%350%200%100% $400/$50$175/$50$100/$50$50/$50 P 1 21

22. Common-Size Statements Common-Size Statements 22

23. Vertical Analysis 23 Common-Size Statements Common-size percent Analysis amount Base amount 100 = × Financial StatementBase Amount Balance SheetTotal Assets Income StatementRevenues Financial StatementBase Amount Balance SheetTotal Assets Income StatementRevenues P 2

24. Common-Size Balance Sheet 24 P 2

25. Common-Size Income Statement 25 P 2

26. Common-Size Graphics 26 P 2 Common-Size Graphic of Asset Components Common-Size Graphic of Income Statement

27. NEED-TO-KNOW Express the following comparative income statements in common-size percents and assess whether or not this company’s situation has improved in the most recent year (round percents to whole numbers). ($ in millions)20X220X1 Sales$800$500 Total expenses560400 Net income$240$100 Common-size percents Sales100% ($800/$800)($500/$500) Total expenses70%80% ($560/$800)($400/$500) Net income30%20% ($240/$800)($100/$500) Each item is expressed as a % of current year’s sales P 2 27

28. Ratio Analysis Ratio Analysis 28

29. Ratio Analysis 29 P 3 I) Liquidity and efficiency II) Solvency IV) Market prospects III) Profitability

30. 1) Current Ratio 1) Current Ratio 2) Acid-test Ratio 2) Acid-test Ratio 3) Accounts Receivable Turnover 4) Inventory Turnover 5) Days’ Sales Uncollected 6) Days’ Sales in Inventory 7) Total Asset Turnover I) Liquidity and Efficiency 30 P 3

31. Working Capital 31 Working capital represents current assets financed from long-term capital sources that do not require near-term repayment. Current assets – Current liabilities = Working capital More working capital suggests a strong liquidity position and an ability to meet current obligations. P 3

32. This ratio measures the short-term debt-paying ability of the company. A higher current ratio suggests a strong liquidity position. 1) Current Ratio 32 Current ratio = Current assets Current liabilities P 3

33. This ratio is like the current ratio but excludes current assets such as inventories and prepaid expenses that may be difficult to quickly convert into cash. 2) Acid-Test Ratio 33 Acid-test ratio = Cash + Short-term investments + Current receivables Current liabilities Referred to as Quick Assets P 3

34. This ratio measures how many times a company converts its receivables into cash each year. 3) Accounts Receivable Turnover 34 Accounts receivable = turnover Net sales Average accounts receivable, net Average accounts receivable = (Beginning acct. rec. + Ending acct. rec.) 2 P 3

35. This ratio measures the number of times merchandise is sold and replaced during the year. 4) Inventory Turnover 35 Inventory turnover = Cost of goods sold Average inventory Average inventory = (Beginning inventory + Ending inventory) 2 P 3

36. Provides insight into how frequently a company collects its accounts receivable. 5) Days’ Sales Uncollected 36 Day's sales = uncollected Accounts receivable, net × 365 Net sales P 3

37. 6) Days’ Sales in Inventory 37 Day's sales in = Inventory Ending inventory × 365 Cost of goods sold This ratio is a useful measure in evaluating inventory liquidity. If a product is demanded by customers, this formula estimates how long it takes to sell the inventory. P 3

38. 7) Total Asset Turnover 38 Total asset turnover = Net sales Average total assets Average assets = (Beginning assets + Ending assets) 2 This ratio reflects a company’s ability to use its assets to generate sales. It is an important indication of operating efficiency. P 3

39. 1) Debt Ratio 1) Debt Ratio 2) Equity Ratio 2) Equity Ratio 3) Pledged Assets to Secured Liabilities 4) Times Interest Earned II) Solvency 39 P 3

40. 1) Debt and Equity Ratios 40 In Millions Amount Ratio Total liabilities $ 83,45140.3% [Debt ratio] Total equity 123,549 59.7% [Equity ratio] Total liabilities and equity $ 207,000 100.0% $83,451 ÷ $207,000 = 40.3% The debt ratio expresses total liabilities as a percent of total assets. The equity ratio provides complementary information by expressing total equity as a percent of total assets. P 3

41. 2) Debt-to-Equity Ratio 41 Debt-to-equity ratio = Total liabilities Total equity This ratio measures what portion of a company’s assets are contributed by creditors. A larger debt-to- equity ratio implies less opportunity to expand through use of debt financing. P 3

42. 4) Times Interest Earned 42 Times interest earned = Income before interest and taxes Interest expense This is the most common measure of the ability of a company’s operations to provide protection to long-term creditors. Net income +Interest expense +Income taxes =Income before interest and taxes P 3

43. 1) Profit Margin 1) Profit Margin 2) Return on Total Assets 3) Return on Common Stockholders’ Equity III) Profitability 43 P 3

44. 1) Profit Margin 44 Profit margin = Net income Net sales This ratio describes a company’s ability to earn net income from each sales dollar. P 3

45. Return on total asset = Net income Average total assets 2) Return on Total Assets 45 Return on total assets measures how well assets have been employed by the company’s management. P 3

46. 3) Return on Common Stockholders’ Equity 46 Return on common stockholders' equity = Net income - Preferred dividends Average common stockholders' equity This measure indicates how well the company employed the stockholders’ equity to earn net income. P 3

47. 1) Price-Earnings Ratio 2) Dividend Yield IV) Market Prospects 47 P 3

48. 1) Price-Earnings Ratio 48 Price-earnings ratio = Market price per common share Earnings per share This measure is often used by investors as a general guideline in gauging stock values. Generally, the higher the price-earnings ratio, the more opportunity a company has for growth. P 3

49. 2) Dividend Yield 49 Dividend yield = Annual cash dividends per share Market price per share This ratio identifies the return, in terms of cash dividends, on the current market price per share of the company’s common stock. P 3

50. Summary of Ratios 50 P 3

51. NEED-TO-KNOW For each ratio listed, identify whether the change in ratio value from 20X1 to 20X2 is regarded as favorable or unfavorable. 20X220X1Change 1. Profit margin ratio6%8%UnfavorableLower % of net income in each sales dollar 2. Debt ratio50%70%FavorableFewer assets are claimed by creditors 3. Gross margin ratio40%36%FavorableHigher % of gross margin in each sales dollar 4. Accounts receivable turnover8.89.4UnfavorableLess efficiency in collection 5. Basic earnings per share$2.10$2.00FavorableHigher net income per common share 6. Inventory turnover3.64.0UnfavorableLess efficient inventory management P 3 51

52. Global View 52 Horizontal and Vertical Analysis Horizontal and vertical analyses help eliminate many differences between U.S. GAAP and IFRS when analyzing and interpreting financial statements. However, when fundamental differences in reporting regimes impact financial statements, the user must exercise caution when drawing conclusions. Ratio Analysis Ratio analysis of financial statements also helps eliminate differences between U.S. GAAP and IFRS. Importantly, the use of ratio analysis is fine, with some possible changes in interpretation depending on what is and what is not included in certain accounting measures across U.S. GAAP and IFRS. Care must be taken in drawing inferences from a comparison of ratios across reporting regimes.

53. Analysis Reporting Analysis Reporting 53

54. Analysis Reporting 54 A1 1.Executive Summary 2.Analysis Overview 3.Evidential Matter 4.Assumptions 5.Key Factors 6.Inferences The purpose of financial statement analyses is to reduce uncertainty in business decisions through a rigorous and sound evaluation. A financial statement analysis report directly addresses the building blocks of analysis and documents the reasoning.

55. Sustainable Income Sustainable Income 55

56. Net Income Sustainable Income Sustainable Income 56 Discontinued Segments Discontinued Segments Extraordinary Items Extraordinary Items Continuing Operations Continuing Operations A 2

57. END OF THE COURSE THANK YOU Atef Abuelaish57

58. Thank you, and see you, Next Week at the Same Time for Course revision on May 9 th. and Final Exam on May 11th,