1. HOW TO READ, ANALYZE, AND INTERPRET FINANCIAL REPORTS Chapter Thirteen Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. 1. Explain the purpose and the key items on the balance sheet. 2. Explain and complete vertical and horizontal analysis. LU13-1: Balance Sheet -- Report as of a Particular Date LEARNING UNIT OBJECTIVES LU 13-1: Income Statement -- Report for a Specific Period of Time 1. Explain the purpose and the key items on the income statement. 2. Explain and complete vertical and horizontal analysis. 13-2 LU 13-3: Trend and Ratio Analysis 1. Explain and complete a trend analysis. 2. List, explain, and calculate key financial ratios.

3. ACCOUNTING EQUATION Accounting Equation: Assets = Liabilities + Owner’s Equity 13-3

4. BALANCE SHEET Gives a financial picture of what a company is worth as of a particular date. AssetsLiabilities + Owner’s Equity = (How much the company owns) (How much the owner is worth) (How much the company owes) 13-4

5. BALANCE SHEET Assets – Liabilities = Owner’s equity (capital) $10,000 - $2,500 = $7,500 13-5

6. ELEMENTS OF THE BALANCE SHEET (FIGURE 13.1) MOOL COMPANY Balance Sheet December 31, 2014 Assets Liabilities a. Current assets: a. Current liabilities: b. Cash $ 7,000 b. Accounts payable $ 80,000 c. Accounts receivable 9,000 c. Salaries payable 12,000 d. Merchandise inventory 30,000 d. Total current liabilities $ 92,000 e. Prepaid expenses 15,000 e. Long-term liabilities: f. Total current assets $61,000 f. Mortgage note payable 58,000 g. Plant and equipment: g. Total liabilities $150,000 h. Building (net) $60,000 i. Land 84,000 Stockholders’ Equity j. Total plant and equipment 144,000 a. Common stock $ 20,000 b. Retained earnings 35,000 c. Total stockholders’ equity 55,000 k. Total assets $205,000 d. Total liab. and stkhlds’ equity $205,000 Assets broken down into current assets and plant and equipment Liabilities broken down into current and long-term Total of current assets and plant and equipment. (Total is double-ruled) Total of all liabilities and stockholders’ equity. 13-6

7. VERTICAL ANALYSIS AND THE BALANCE SHEET Step 2. Divide each liability and stockholders’ equity (the portions) as a percent of total liabilities and stockholders’ equity (the base). Round as indicated. Step 1. Divide each asset (the portion) as a percent of total assets (the base). Round as indicated. 13-7

8. COMPARATIVE BALANCE SHEET: VERTICAL ANALYSIS (FIGURE 13.2) ROGER COMPANY Comparative Balance Sheet December 31, 2013 and 2014 2014 2013 AmountPercentAmountPercent Assets Current Assets: Cash$22,000 25.88$18,000 22.22 Accounts Receivable 8,000 9.41 9,000 11.11 Merchandise inventory 9,000 10.59 7,000 8.64 Prepaid rent 4,000 4.71 5,000 6.17 Total current assets$43,000 50.59$39,000 48.15* Plant and equipment: Building (net)$18,000 21.18$18,000 22.22 Land 24,000 28.24 24,000 29.63 Total plant and equipment$42,000 49.41*$42,000 51.85 Total assets$85,000 100.00$81,000 100.00 * Due to rounding 13-8

9. COMPARATIVE BALANCE SHEET: VERTICAL ANALYSIS (FIGURE 13.2) ROGER COMPANY Comparative Balance Sheet December 31, 2013 and 2014 2014 2013 AmountPercentAmountPercent Liabilities Current liabilities: Accounts payable $14,000 16.47 $ 8,000 9.88 Salaries payable 18,000 21.18 17,000 20.99 Total current liabilities $32,000 37.65 $25,000 30.86* Long-term liabilities: Mortgage note payable $12,000 14.12 $20,000 24.69 Total liabilities $44,000 51.76* $45,000 55.56* Stockholders’ Equity Common stock $20,000 23.53 $20,000 24.69 Retained earnings 21,000 24.7116,000 19.75 Total stockholders’ equity $41,000 48.24 $36,000 44.44 Total liabilities and stockholders’ equity $85,000 100.00 $81,000 100.00 * Due to rounding 13-9

10. PREPARING A HORIZONTAL ANALYSIS OF A COMPARATIVE BALANCE SHEET Step 1. Calculate the increase or decrease (portion) in each item from the base year. Step 2. Divide the increase or decrease in Step 1 by the old or base year. Step 3. Round as indicated. 13-10

11. COMPARATIVE BALANCE SHEET: HORIZONTAL ANALYSIS (FIGURE 13.3) ABBY ELLEN COMPANY Comparative Balance Sheet December 31, 2013 and 2014 Increase (decrease) 2014 2013AmountPercent Assets Current Assets: Cash$ 6,000$ 4,000$ 2,000 50.00* Accounts receivable 5,000 6,000 (1,000) -16.67 Merchandise inventory 9,000 4,000 5,000 125.00 Prepaid rent 5,000 7,000 (2,000) -28.57 Total current assets$25,000$21,000 $ 4,000 19.05 Plant and equipment: Building (net)$12,000 $12,000 0 0 Land 18,000 18,000 0 0 Total plant and equipment$30,000 $30,000 0 0 Total assets$55,000 $51,000$4,000 7.84 13-11

12. COMPARATIVE BALANCE SHEET: HORIZONTAL ANALYSIS (FIGURE 13.3) ABBY ELLEN COMPANY Comparative Balance Sheet December 31, 2013 and 2014 Increase (decrease) 2014 2013AmountPercent Liabilities Current liabilities: Accounts payable$ 3,200$ 1,800$1,400 77.78 Salaries payable 2,900 3,200 (300) -9.38 Total current liabilities$ 6,100$ 5,000 $1,100 22.00 Long-term liabilities: Mortgage note payable17,000 15,0002,000 13.33 Total liabilities $ 23,100$20,000$3,100 15.50 Owner’s Equity Abby Ellen, capital$31,900$31,000$ 9002.90 Total liabilities and owner’s equity $55,000 $51,000$4,000 7.84 13-12

13. INCOME STATEMENT – REPORT FOR A SPECIFIC PERIOD OF TIME Income Statement -- A financial report that tells how well a company is performing (its profitability or net profit) during a specific period of time (month, year, etc). Service Business: Net income = Revenues -- Operating expenses Retail Business: Revenues (sales) -- Cost of merchandise sold = Gross profit from sales -- Operating expenses = Net income (profit) Income Statement $ 13-13

14. INCOME STATEMENT 13-14

15. MOOL COMPANY Income Statement For Month Ended December 31, 2014 Revenues a. Gross Sales $22,080 b. Less: Sales returns and allowances$ 1,082 c. Sales discounts4321,514 d. Net Sales Cost of merchandise (goods) sold: $20,566 a. Merchandise Inventory 12/1/2014$1,248 b. Purchases$10,512 c. Less: Purchases returns and allowances $336 d. Less: Purchase discounts 204 540 e. Cost of net purchases9,972 f. Cost of merchandise (goods available for sale) $11,220 g. Less: Merchandise inventory 12/31/2014 1,600 h. Cost of merchandise (goods sold)9,620 Gross profit from sales$10,946 Operating expenses: a. Salary $2,200 b. Insurance 1,300 c. Utilities 400 d. Plumbing 120 e. Rent 410 f. Depreciation 200 g.Total operating expenses4,630 Net income$ 6,316 INCOME STATEMENT (FIGURE 13.4) 13-15

16. KEY CALCULATIONS ON INCOME STATEMENT Net sales = Gross sales -- Sales returns allowances -- Sales discounts Net income = Gross profit -- Operating expenses Gross profit from sales = Net sales -- Cost of merchandise (goods) sold Cost of Net purchases merchandise = Beginning + (purchase less -- Ending (goods) sold inventory returns & discounts) inventory 13-16

17. INCOME STATEMENT VERTICAL ANALYSIS (FIGURE 13.5) ROYAL COMPANY Comparative Income Statement For Years Ended December 31, 2013 and 2014 2014 Percent 2013 Percent of net of net Net Sales$45,000 100.00$29,000 100.00* Cost of merchandise sold 19,000 42.22 12,000 41.38 Gross profit from sales$26,000 57.78$17,000 58.62 Operating expenses: Depreciation $1,000 2.22$ 500 1.72 Selling and Advertising 4,200 9.33 1,600 5.52 Research 2,900 6.44 2,000 6.90 Miscellaneous 500 1.11 200.69 Total operating expenses $8,600 19.11* $ 4,300 14.83 Income before interest and taxes$17,400 38.67$12,700 43.79 Interest expense 6,000 13.33 3,000 10.34 Income before taxes$11,400 25.33* $ 9,700 33.45 Provision for taxes 5,500 12.22 3,000 10.34 Net income $ 5,900 13.11 $ 6,700 23.10* * Off due to rounding 13-17

18. HORIZONTAL ANALYSIS INCOME STATEMENT (FIGURE 13.6) FLINT COMPANY Comparative Income Statement For Years Ended December 31, 2013 and 2014 2014 2013 Increase (decrease) Amount Percent Sale$ 90,000 $80,000$10,000 Sales returns and allowances 2,000 2,000 0 Net Sales$88,000 $78,000$10,000 + 12.82 Cost of merchandise sold45,000 40,000 5,000+ 12.50 Gross profit from sales$43,000 $38,000$ 5,000 + 13.16 Operating expenses: Depreciation$ 6,000 $ 5,000$ 1,000 + 20.00 Selling and Administrative16,000 12,000 4,000 + 33.33 Research 600 1,000 (400) - 40.00 Miscellaneous1,200 500 700 + 140.00 Total operating expenses$23,800 $18,500 $ 5,300 + 28.65 Income before interest and taxes$19,200 $19,500$ (300) - 1.54 Interest expense 4,000 4,000 0 Income before taxes$15,200$15,500$ (300) - 1.94 Provision for taxes3,800 4,000(200) - 5.00 Net income$11,400 $11,500$ (100) -.87 13-18

19. COMPLETING A TREND ANALYSIS Trend Analysis – Analyzes the changes that occur by expressing each number as a percent of the base year. Step 1. Select the base year (100%). Step 2. Express each amount as a percent of the base year amount (rounded to the nearest whole percent). Each Item Base Amount 13-19

20. TREND ANALYSIS Given (base year 2012) 2015201420132012 Sales$621,000$460,000$340,000$420,000 Gross Profit 182,000 141,000 112,000 124,000 Net Income 48,000 41,000 22,000 38,000 Trend Analysis 2015201420132012 Sales*148%110%81%100% Gross Profit14711490100 Net Income12610858100 $340,000 $420,000D * Round to nearest whole percent 13-20 Sales of 2013 were 81% of the sales of 2012

21. RATIO ANALYSIS 13-21