1. Financial Statement Analysis
Chapter 14

2. Purpose To make informed decisions about a company
Generally based on comparative financial data
From one year to the next
With a competing company
With the industry
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3. Perform a horizontal analysis of financial statements
Learning Objective 1
Perform a horizontal analysis of financial statements

4. Horizontal Analysis
Compares two financial statements to determine dollar and percentage changes
Compute dollar changes
Compute percentage changes
Current year balance
Prior year balance
Dollar change
Base period
Prior year balance
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5. Exercise 14-13
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6. Trend Percentages Any year $ Trend % Base year $
Form of horizontal analysis
Base year selected and set equal to 100%
Any year $
Trend %
Base year $
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7. Perform a vertical analysis of financial statements
Learning Objective 2
Perform a vertical analysis of financial statements

8. Vertical Analysis
Shows relationship of each item to a base amount on financial statements
Income statement – each item expressed as percentage of net sales
Balance sheet – each item expressed as percentage of total assets
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9. Prepare and use common-size financial statements
Learning Objective 3
Prepare and use common-size financial statements

10. Common-Size Statements
Reports only percentages
Removes dollar value bias
Bias from comparing numbers in absolutes rather than relative terms
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11. Benchmarking Comparing a company with another leading company
Two main types:
Against a key competitor
Against the industry average
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12. Compute the standard financial ratios
Learning Objective 4
Compute the standard financial ratios

13. Types of Ratios Copyright (c) 2009 Prentice Hall. All rights reserved.
Ability to pay current liabilities
Ability to sell inventory and collect receivables
Ability to pay long-term debt
Measure profitability
Analyzing stock as an investment
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14. Ability to Pay Current Liabilities
Working capital
Current ratio
Acid-test ratio
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15. Ability to Pay Current Liabilities
Current assets
Current liabilities
Working capital
Results in a dollar amount
Current ratio
Current assets
Current liabilities
Both result in a ratio
Cash + short-term investments + net current receivables
Acid-test ratio
Current liabilities
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16. Ability to Sell Inventory and Collect Receivables
Inventory turnover
Measures number of times a company sells inventory during a year
Accounts receivable turnover
Measures ability to collect cash from credit customers
Days’-sales-in-receivables
Also measures ability to collect receivables
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17. Ability to Sell Inventory and Collect Receivables
The higher the turnover, the quicker it’s selling
Inventory turnover
Average inventory
Cost of goods sold
The higher the turnover, the quicker the collections
Accounts receivable turnover
Net credit sales
Average accounts receivable
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18. Ability to Sell Inventory and Collect Receivables
Days’ sales in receivables
Net sales
365
Average day’s sales
Average net accounts receivable
Average day’s sales
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19. Exercise 14-17 1.34 Current ratio Current assets Current liabilities
$173,000
$129,000
1.34
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20. Exercise 14-17 (continued)
Cash + short-term investments + net current receivables
Acid-test ratio
Current liabilities
$18, , ,000
$129,000
$81,000
$129,000
0.63
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21. Exercise 14-17 (continued)
Inventory turnover
Cost of goods sold
Average inventory
$75, ,000 2
$319,000
$319,000
$74,000
4.31
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22. Exercise 14-17 (continued)
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Exercise (continued)
Days’ sales in receivables
365
Average day’s sales
Net sales
$1,268
$463,000
365
Average net accounts receivable
Average day’s sales
$64,000
$1,268
$53, ,000 2
50 days

23. Ability to Pay Long-Term Debt
Debt ratio
Shows portion of asset financed with debt
The higher the ratio, the higher the risk
Times-interest-earned ratio
Measures number of times income can cover interest expense
High ratio indicates ease in paying interest
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24. Ability to Pay Long-Term Debt
Debt ratio
Total liabilities
Total assets
Times interest earned
Interest expense
Operating income
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25. Measuring Profitability
Return on net sales
Return on total assets
Return on common stockholders’ equity
Earnings per share
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26. Measuring Profitability
Return on sales
Net income
Net sales
Net income + interest expense
Return on assets
Average total assets
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27. Measuring Profitability
Net income – preferred dividends
Return on equity
Average common equity
Net income – preferred dividends
Earnings per share
Number of common shares outstanding
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28. Leverage Trading on the equity Increases profits during goods times
Company borrows at a lower rate then invests the money to earn a higher rate
Increases profits during goods times
Compounds losses during bad times
is greater than
Return onequity
Return on assets
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29. Analyzing Stock Investments
Price/earnings ratio (P/E)
Market price compared to EPS
Dividend yield
Percent of market value that is returned as dividends
Book value
Common equity per share
Some argue its relevance to investors
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30. Analyzing Stock Investments
Market price per share
Earnings per share
P/E ratio
Market price per share
Dividend yield
Dividends per share
Common shares outstanding
Common equity
Book value
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31. Red Flags Suspect movement of sales, inventory, and receivables
Earnings problems
Decreased cash flow
Too much debt
Inability to collect receivables
Inventory buildup
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32. End of Chapter 14