1. Prepared by: Keri Norrie, Camosun College
ACCOUNTING PRINCIPLES
Third Canadian Edition
Prepared by: Keri Norrie, Camosun College

2. FINANCIAL STATEMENT ANALYSIS
CHAPTER 18
FINANCIAL STATEMENT ANALYSIS

3. COMPARATIVE ANALYSIS Three types of comparisons: Intracompany basis
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COMPARATIVE ANALYSIS
Three types of comparisons:
Intracompany basis
Intercompany basis
Industry averages 30

4. COMPARATIVE ANALYSIS Three tools: Horizontal analysis
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COMPARATIVE ANALYSIS
Three tools:
Horizontal analysis
Vertical analysis
Ratio analysis 34

5. Percentage change since base period Dollar amount of change
HORIZONTAL ANALYSIS
Percentage change since base period
Dollar amount of change
Base year amount =
127% % % % %
ANY COMPANY INC.
Net Sales
Year Ended December 31 (in millions)
2005
2004
2003
2002
2001
$ 6,562.8
$ 6,295.4
$ 6,190.6
$ 5,786.6
$ 5,181.4

6. VERTICAL ANALYSIS
Expresses each item in a financial statement as a percent of a base amount (total assets or net sales)
ANY COMPANY, INC.
Condensed Balance Sheets (partial)
December 31 (in millions)
_____
Assets Amount Percent Amount Percent
Current assets $1, $1,
Property, plant,
and equipment 2, ,
Intangible assets
Total assets $5, % $4, %

7. RATIO ANALYSIS
Ratio analysis evaluates three characteristics of a company:
1. its liquidity
2. its profitability
3. its solvency

8. RATIO ANALYSIS Liquidity ratios
Measure short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash

9. LIQUIDITY RATIOS Working capital Current Assets – Current Liabilities
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LIQUIDITY RATIOS
Working capital Current Assets – Current Liabilities
Current ratio Current Assets ÷ Current Liabilities
Inventory turnover Cost of Goods Sold
Average Inventory
Days sales in inventory Days
Inventory Turnover
Receivables turnover Net Credit Sales
Average Gross Receivables
Collection period Days
Receivables Turnover 61

10. RATIO ANALYSIS Solvency ratios
Measure the ability of the company to survive over a long period of time
XYZ Co.
Since 1892

11. Debt to total assets Total Liabilities
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SOLVENCY RATIOS
Debt to total assets Total Liabilities
Total Assets
Interest coverage Net Income + Interest Expense
+ Income Tax Expense (EBIT)
Interest Expense
Free cash flow Cash Provided (Used) by Operating Activities – Net Capital Expenditures – Dividends Paid 61

12. RATIO ANALYSIS Profitability ratios
Measure the income or operating success of a company for a given period of time

13. PROFITABILITY RATIOS Gross profit margin Gross Profit
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PROFITABILITY RATIOS
Gross profit margin Gross Profit
Net Sales
Profit margin Net Income
Asset turnover Net Sales
Average Total Assets
Return on assets Net Income
Return on equity Net Income
Average Shareholders’ Equity 61

14. PROFITABILITY RATIOS
Earnings per share Net Income – Preferred Dividends
Weighted Average Number Of
Common Shares
Price-earnings (PE) ratio Market Price Per Share
Earnings Per Share
Payout ratio Cash Dividends
Net Income
EBITDA Net Income + Interest Expense
+ Income Tax Expense
+ Amortization Expense

15. LIMITATIONS OF FINANCIAL ANALYSIS
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LIMITATIONS OF FINANCIAL ANALYSIS
Estimates
Historical cost
Alternative accounting principles
Quality of earnings
Earning power and irregular items
Diversification
107

16. EARNING POWER AND IRREGULAR ITEMS
Earning power is net income adjusted for irregular or non-typical items
Two types of irregular items are reported separately, net of income tax, on the income statement:
Discontinued operations
Extraordinary items

17. DISCONTINUED OPERATIONS
The disposal of an identifiable reporting or operating segment of a business is reported separately on the income statement as follows:
Discontinued operations
Loss from operations of chemical division, net of $60,000 income tax saving $140,000
Loss from disposal of chemical division, net of $30,000 income tax saving , ,000
Net income $350,000
This presentation indicates the separate effects of continuing operations and discontinued operations on net income.

18. EXTRAORDINARY ITEMS
Extraordinary items are events and transactions that meet three conditions. They are:
Infrequent
Non-typical
Not subject to management decision
Extraordinary items are reported net of income tax in a separate section of the income statement immediately following discontinued operations

19. EXAMPLES OF EXTRAORDINARY AND ORDINARY ITEMS
Extraordinary Items
1. Effects of major casualties (acts of God) if rare in the area
2. Expropriation (takeover) of property by a government
3. Effects of a newly enacted law or regulation, such as a condemnation action
4. The destruction of property
Ordinary Items
1. Effects of major casualties (acts of God) if frequent in the area
2. Write down of inventories or write off of receivables
3. Losses attributable to labour disputes
4. Gains or losses from sale of property, plant, and equipment

20. STATEMENT PRESENTATION OF EXTRAORDINARY ITEMS
Extraordinary item Expropriation of property, net of $21,000 income tax saving ,000

21. COPYRIGHT
Copyright © 2004 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.