1. AC239 Managerial Accounting Seminar 2 Jim Eads, CPA, MST, MSF 1

2. Financial Statement Analysis Horizontal Analysis: A percentage analysis of increases and decreases in related items in comparative financial statements. Each item is compared to its previous value to determine its change. The change is stated both in dollar amount and percentage of change. 2

3. Financial Statement Analysis 3

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6. Vertical Analysis: A percentage analysis used to show the relationship of each component to the total within a single. 6

7. Financial Statement Analysis In a vertical analysis of the balance sheet, each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity. 7

8. Financial Statement Analysis 8

9. In a vertical analysis of the income statement, each item is stated as a percent of net sales. 9

10. Financial Statement Analysis 10

11. Financial Statement Analysis Common-Sixed Statements All items are expressed as a percentage. Common-sized statements are useful in comparing the current period with prior periods, individual businesses, or one business with with industry percentages. 11

12. Financial Statement Analysis 12

13. Financial Statement Analysis Solvency The ability of a business to meet its financial obligations (debts). Profitability The ability of a business to earn income. 13

14. Financial Statement Analysis Current Position Analysis Using measures to assess a business’s ability to pay its current liabilities. Such analysis is of special interest to short-term creditors. 14

15. Financial Statement Analysis Working Capital The excess of current assets of a business over its current liabilities. The working capital is often used in evaluating a company’s ability to meet currently maturing debts. 15

16. Financial Statement Analysis 16 2010 2009 Current assets$550,000$533,000 Current liabilities –210,000 –243,000 Working capital$340,000$290,000

17. Financial Statement Analysis Current Ratio Total current assets divided by total current liabilities. 17 Current assets$550,000 Current liabilities$210,000 Current ratio2.6

18. Financial Statement Analysis Accounts Receivable Turnover Net sales divided by average accounts receivable. The ratio assesses the efficiency of the firm in collecting receivables and managing of credit. 18 Net sales $1,498,000 Accounts receivable (net): Beginning of year$ 120,000 End of year 115,500 Total$ 235,000 Average (Total ÷ 2)$ 117,500

19. Financial Statement Analysis Number of Days’ Sales in Receivables 365 divided by A/R Turnover 365 / 12.7 = 29 days 19

20. Financial Statement Analysis Inventory Turnover Cost of goods sold divided by average inventory. Assesses the efficiency of the firm in managing its inventory. 20 2010 Cost of goods sold$1,043,000 Inventories: Beginning of year$ 283,000 End of year 264,000 Total$ 547,000 Average (Total ÷ 2)$ 273,500

21. Example Exercise 17-5 (page 753) A company reports the following: Cost of goods sold$560,000 Average inventory112,000 Determine (a) the inventory turnover and (b) the number of days’ sales in inventory. Round to one decimal place. 21

22. Example Exercise 17-5 (page 753) Inventory Turnover = Cost of Goods Sold / Average Inventory Inventory Turnover = 560,000 / $112,000 Inventory Turnover = 5.0 times 22

23. Example Exercise 17-5 (page 753) Number of Days’ Sales in Inventory = Average Inventory / Average Daily COGS Number of Days’ Sales in Inventory = $112,000 / ($560,000/365) Number of Days’ Sales in Inventory = $112,000 / $1,534 = 73.0 days 23

24. Financial Statement Analysis Ratio of fixed assets to long-term liabilities Fixed assets divided by long-term liabilities. A solvency measure of the margin of safety of debt holders and indicates the ability of the business to borrow additional funds on a long-term basis. 24 Fixed assets (net)$444,500 Long-term liabilities$100,000

25. Financial Statement Analysis Ratio of Liabilities to Stockholder’s Equity Liabilities divided by owners’ equity. A solvency measure that indicates the margin of safety for creditors. 25 Total liabilities$310,000 Total stockholders’ equity$829,500

26. Financial Statement Analysis Times Interest Earned Income before interest expense / interest expense. Measures the relative risk of the debt holders. 26 Income before income tax$162,500 Add interest expense 6,000 Amount available to meet interest charges$168,500

27. Financial Statement Analysis Net Sales to Assets Net sales divided by total assets (excluding long- term investments). A profitability measure that shows how effectively a firm utilizes its assets. 27 Net sales $1,498,000 Total assets (minus long-term): Beginning of year$1,053,000 End of year 1,044,500 Total$2,097,500 Average (Total ÷ 2)$1,048,750

28. Financial Statement Analysis Rate Earned on Total Assets Net income divided by average assets. Measures the profitability of total assets, without considering how the assets are financed. 28 Net income$ 91,000 Plus interest expense 6,000 Total$ 97,000 Total assets: Beginning of year$1,230,500 End of year 1,139,500 Total$2,370,000 Average (Total ÷ 2)$1,185,000

29. Financial Statement Analysis Rate Earned on Common Stockholders’ Equity (Net income – preferred dividends) / average common stockholders’ equity. Measures the rate earned on the amount invested by common stockholders. 29 Net income$ 91,000 Less preferred dividends 9,000 Remainder—common stock$ 82,000 Common stockholders’ equity: Beginning of year $ 637,500 End of year 679,500 Total$1,317,000 Average (Total ÷ 2)$ 658,500

30. Financial Statement Analysis Earnings Per Share (EPS) (Net Income – Preferred Dividends) / Number of Outstanding Common Shares. 30 Net income$91,000 Preferred dividends 9,000 Remainder—identified with common stock$82,000 Shares of common stock50,000

31. Financial Statement Analysis Price-Earnings Ratio Current market price per share divided by the earnings per share. The price-earnings ratio is an indicator of a firm’s future earnings prospects. 31 Market price per share of common stock$41.00 Earnings per share on common stock 1.64

32. Example Exercise 17-11 (page 760) A company reports the following: Net income$250,000 Preferred dividends$ 15,000 Shares of common stock outstanding20,000 Market price per share of common stock$35 a. a. Determine the company’s earnings per share on common stock. b. b. Determine the company’s price-earnings ratio. Round to one decimal place. 32

33. Example Exercise 17-11 (page 760) (a) (a) Earnings Per Share of Common Stock = (Net Income – Preferred Dividends) / Shares of Common Stock Outstanding Earnings per Share of Common Stock = ($250,000 – $15,000) / 20,000 Earnings per Share of Common Stock = $11.75 33

34. Example Exercise 17-11 (page 760) (b) Price-Earnings Ratio = Market Price per Share of Common Stock / Earnings per Share on Common Stock Price-Earnings Ratio = $35.00 / $11.75 Price-Earnings Ratio = 3.0 34

35. Financial Statement Analysis Dividends per share can be reported with earnings per share to indicate the relationship between dividends and earnings. Comparing these two per share amounts indicates the extent to which the corporation is retaining its earnings for use in operations and growth. 35

36. Financial Statement Analysis In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections:   Management Discussion and Analysis   Report on adequacy of internal control   Report on fairness of financial statements 36

37. Financial Statement Analysis Management Discussion and Analysis (MD&A) Section of the annual report that analyzes the results of operations and discusses management’s opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition. 37

38. Financial Statement Analysis Report on Adequacy of Internal Control The Sarbanes-Oxley Act of 2002 requires that management provides a report stating their responsibility for establishing and maintaining internal control. In addition, the report must state management’s conclusion concerning the effectiveness of internal controls over financial reporting. 38

39. Financial Statement Analysis Report on fairness of financial statements All publicly held corporations are required to have an independent audit (examination) of their financial statements. The CPAs who conduct the audit render an opinion on the fairness of the statements. 39

40. Questions? 40

41. One last thought…. Make sure you read through Chapter 18 before next week’s seminar. 41