1. FINANCIAL STATEMENT ANALYSIS

2. FINANCIAL STATEMENT ANALYSIS Objectives
Prediction of future returns
Assessment of risks associated with those returns
Creditors
Short term liquidity
Long-term solvency
Investors
Profitability
Dividends
Stock price appreciation

3. HORIZONTAL ANALYSIS Percentage changes in comparative statements
(Year to Year comparisons)
Establishment of “Base Period”
Trend percentages
Form of horizontal analysis
Series of years
Current year data / Base year data

4. Relationship of statement items to a specified “Base Item”
VERTICAL ANALYSIS
Relationship of statement items to a specified “Base Item”
Income statement = Net sales
Balance sheet = Total assets

5. COMMON-SIZE STATEMENTS
Reports only percentages for statement items
“Base Items” normally same as vertical analysis
Allows comparison of firms of different size %

6. BENCHMARKING
Comparison of a company to standards found in the environment
Against Industry Average
Against a Major Competitor
Against yourself (over time)

7. FINANCIAL STATEMENT RATIOS Objectives
Ability to pay current liabilities (Liquidity)
Ability to sell inventory and collect receivables
(Liquidity / Turnover)
Ability to pay long-term debt (Solvency)
Profitability of the company
Analysis of company’s stock as an investment

8. FINANCIAL STATEMENT ANALYSIS Limitations
Statements are largely historical and involve many estimates
Comparability between firms may be difficult
Financial ratios are only indicators
Specific reasons for problems must still be identified
External factors will often impact the financial results of a company
Users must look at the entire picture when using financial statement analysis

9. A profitability measure Also known as profit margin ratio
Return on Sales (ROS)
A profitability measure
Also known as profit margin ratio
Considers relative firm size
Net Income
Sales Revenue
ROS =
$39,700
$305,000
= 13.0% =
Cup-A-Jo expects to generate 13 cents of bottom line profit for every dollar of sales revenue.
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10. [Net income + Interest expense × (1 – Tax rate)]
Return on Assets (ROA)
A profitability measure
Considers relative firm size
[Net income + Interest expense × (1 – Tax rate)]
Total assets
ROA = =
$39,700 + [$6,300 × (62.3%)]
$472,450
= 9.2%
*Effective Tax rate = $24,000/$63,700 = 37.7%
Cup-A-Jo has earnings of 9.2% available for its business capital providers.
@Cambridge Business Publishers, 2009 10

11. A profitability measure Also known as return on shareholders’ equity
Return on Equity (ROE)
A profitability measure
Also known as return on shareholders’ equity
Considers relative firm size
Net income
Shareholders’ equity
$39,700
$371,700
ROE = =
= 10.7%
Cup-A-Jo is expected to generate about 10.7 cents of profit for every dollar of shareholders’ investment in the company.
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12. Return on Equity Paradigm
Reveals four ways to improve ROE
Improve return on sales
Improve asset turnover
Improve use of financial leverage
Some combination of 1, 2, and 3
Return on Shareholders’ Equity
Return on Sales
Asset Turnover
Financial Leverage
@Cambridge Business Publishers, 2009 12

13. Key performance indictor
Asset Turnover
How effective a business’s assets are being used by management to generate sales revenue
Key performance indictor
Asset Turnover
Sales revenue
Total assets
$305,000
$472,450 = =
= 0.646
For every dollar invested in the company’s assets. Cup-A-Jo generated 64.6 cents of sales.
@Cambridge Business Publishers, 2009 13

14. Relative mix of debt versus equity financing used by a business
Financial Leverage
Relative mix of debt versus equity financing used by a business
Financial
Leverage
Total assets
Shareholders’ equity
$472,450
$371,700 = =
= 1.27
Cup-A-Jo’s assets are about 1.27 times the amount of shareholders’ equity invested
@Cambridge Business Publishers, 2009 14

15. Return on Equity for Cup-A-Jo
ROE = Return on Sales × Assets Turnover × Financial Leverage
Net income
Sales revenue
Sales revenue
Total assets
Total assets
Shareholders’ equity = × ×
$39,700
$305,000
$305,000
$472,450
$472,450
$371,700 = × × ×
= %
0.646 ×
1.27
= %
@Cambridge Business Publishers, 2009 15

16. Long-term Debt-to-Equity
Reveals the relative investment of long-term lenders versus that of shareholders
Indicates whether the financing strategy of the company is heavier on debt or equity
Debt-to-Equity
Long-term debt
Shareholders’ equity
$67,500
$371,700 = = =
Cup-A-Jo’s long-term debt is about 18% of the amount of shareholders’ equity.
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17. Times-Interest-Earned Ratio
Reveals the extent to which operating earnings is able to ‘cover’ current debt service charges (interest)
Interest
Coverage
Operating income
Interest expense
$70,000
$6,300 = =
= 11.1
Cup-A-Jo’s operating income is able to cover interest about 11 times per year.
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