1. 13 Introduction to Financial Accounting Information, 7/e Financial
Statement Analysis
Statements and
the Annual Report 13
PowerPoint Author: Catherine Lumbattis
COPYRIGHT © 2011 South-Western/Cengage Learning

2. Financial Statement Analysis
Creditors
Will I
be paid?
How
good is our
investment?
How are we
performing?
Stockholders
Management

3. Limitations of Financial Statement Analysis
Nonoperating items on income statement
Effects of inflation
Apples
Oranges =

4. Horizontal Analysis $ %
A comparison of financial statement items over a period of time
Read right to left to compare one year’s results with the next as a dollar amount of change and as a percentage of change from year to year $ %
LO2

5. Horizontal Analysis December 31 Increase (Decrease)
Dollars Percent
Cash $ $1, $(1,030) (76)%
Accounts receivable , , ,
Inventory , , ,
Prepaid insurance (50) (25)
Total current assets $10, $8, $ 1,
Dollar change from
year to year
Percentage change
from one year to
the next year

6. Tracking items over a series of years
Trend Analysis
GameStop Corp.
Inventory turnover
Tracking items over a series of years

7. Vertical Analysis
Common-size statements recast items as a percentage of a selected item
Allows comparisons of companies of different size
Compares percentages across years to identify trends % % %
LO3

8. Vertical Analysis December 31, 2010 December 31, 2009
Dollars Percent Dollars Percent
Cash $ % $ 1, %
Accounts receivable , ,
Inventory , ,
Prepaid insurance
Total current assets $10, % $8, %
Compare percentages
across years to spot
year-to-year trends

9. Liquidity Analysis Nearness to cash
Ability to pay debts as they become due
LO4

10. – Working Capital Excess of current assets over current liabilities
Lacks meaningful comparisons for companies of different size –

11. Acid-Test (Quick) Ratio
Stricter test of ability to pay debts
Excludes inventories and prepaid assets
Quick Assets
Current Liabilities

12. Cash Flow from Operations to Current Liabilities
Focuses on cash only
Can be used to indicate the flow of cash during the year to cover the debts due
Net Cash Provided by Operating Activities
Average Current Liabilities

13. Accounts Receivable Turnover Ratio
Net Credit Sales
Average Accounts Receivable
Indicates how quickly a company is collecting (i.e., turning over) its receivables

14. Number of Days’ Sales in Receivables
Number of Days in the Period
Accounts Receivable Turnover
Represents the average number of days
an account is outstanding

15. Inventory Turnover Ratio
Cost of Goods Sold
Average Inventory
Represents the number of times per period inventory is turned over (i.e., sold).

16. Number of Days’ Sales in Inventory
Number of Days in the Period
Inventory Turnover
Represents the average number of days
inventory is on hand before it’s sold

17. Cash Operating Cycle
Time between the purchase of merchandise and the collection of the from the sale
Number of Days’ Sales in Inventory +
Number of Days’ Sales in Receivables
Collection of
Accounts
Receivable
Purchase of
Inventory

18. Solvency Analysis Ability to stay in business over the long-term Times
Interest
Earned
Debt-to-Equity
Ratio
Cash Flow
from Operations
to Capital
Expenditures
Debt
Service
Coverage
LO5

19. How much have creditors contributed compared to owners?
Debt-to-Equity Ratio
How much have creditors contributed compared to owners?
Total Liabilities
Total Stockholders’ Equity

20. Net Income + Interest Expense + Income Tax Expense
Times Interest Earned
Measures ability to meet current interest payments
The greater the coverage the better
Net Income + Interest Expense + Income Tax Expense
Interest Expense

21. Debt Service Coverage
Measures amount of cash from operating activities available to “service” the debt
Cash Flow from Operations Before
Interest and Tax Payments
Interest and Principal Payments

22. Cash Flow from Operations to Capital Expenditures Ratio
Measures company’s ability to use operations (vs. creditors and owners) to finance its acquisitions of productive assets
Cash Flow from Operations – Total Dividends Paid
Cash Paid for Acquisitions

23. Profitability Analysis
Rate of Return on Assets
Return on Common Stockholders’ Equity
Earnings per Share
Price/Earnings Ratio
Dividend Ratios
LO6

24. Net Income + Interest Expense, Net of Tax
Return on Assets Ratio
Measures return to all providers of capital (creditors and owners)
Net Income + Interest Expense, Net of Tax
Average Total Assets

25. Return on Common Stockholders’ Equity
Net Income – Preferred Dividends
Average Common Stockholders’ Equity
The owners
earned 15%
on their investment
in ABC Co...
Not bad!

26. Earnings per Share Presents profits on a per-share basis
Net Income – Preferred Dividends
Weighted Average Number of
Common Shares Outstanding

27. Price/Earnings Ratio Current Market Price Earnings per Share
Relates earnings to the market price of the stock
Current Market Price
Earnings per Share
very high P/E
very low P/E
possibly overpriced
possibly underpriced

28. Common Dividends per Share
Dividend Payout Ratio
Common Dividends per Share
Earnings per Share
We need to
decide what percentage of the firm’s income we can return to owners

29. Common Dividends per Share
Dividend Yield Ratio
Investors willing to forgo dividends in lieu of price appreciation
Common Dividends per Share
Market Price per Share
usually
< 5% =

30. Accounting Tools: Reporting and Analyzing Other Income Statement Items
Appendix
Accounting Tools: Reporting and Analyzing Other Income Statement Items

31. Common Characteristics
All such items are reported after income from continuing operations
Reported separately
Shown net of tax effects
Most analysts ignore these items, since they are not likely to reoccur
LO7

32. Discontinued Operations
Any gain or loss from disposal of a division or segment of the business
Any net income or loss from operating this portion until the date of disposal

33. Extraordinary Items Gain or loss due to an event that is:
Unusual in nature AND
Infrequent in occurrence

34. End of Chapter 13