1. 11-117-1 Financial Statement Analysis 17

2. 11-217-2 Basic Analytical Methods Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are as follows: 1.Horizontal analysis 2.Vertical analysis 3.Common-sized statements 1

3. 11-317-3 Horizontal Analysis The percentage analysis of increases and decreases in related items using comparative financial statements is called horizontal analysis. 1

4. 11-417-4 Comparative Balance Sheet— Horizontal Analysis 1 Exhibit 1

5. 11-517-5 1 Horizontal Analysis: Horizontal Analysis: Difference $17,000 Base year (2009) $533,000 = 3.2% Exhibit 1 Comparative Balance Sheet— Horizontal Analysis

6. 11-617-6 Comparative Schedule of Current Assets—Horizontal Analysis 1 Exhibit 2

7. 11-717-7 Horizontal Analysis: Horizontal Analysis: Difference $25,800 Base year (2009) $64,700 = 39.9% 1 Comparative Schedule of Current Assets—Horizontal Analysis Exhibit 2

8. 11-817-8 Comparative Income Statement— Horizontal Analysis 1 Exhibit 3

9. 11-917-917-11 Horizontal Analysis: Horizontal Analysis: Increase amount$296,500 Base year (2009) $1,234,000 = 24.0% 1 Comparative Income Statement— Horizontal Analysis Exhibit 3

10. 11-1017-10 Comparative Retained Earnings Statement—Horizontal Analysis Horizontal Analysis: Horizontal Analysis: Increase amount$37,500 Base year (2009) $100,000 = 37.5% 1 Exhibit 4

11. 11-1117-11 Vertical Analysis A percentage analysis used to show the relationship of each component to the total within a single statement is called vertical analysis. 1

12. 11-1217-12 In a vertical analysis of the balance sheet, each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity. Vertical Analysis of Balance Sheet 1

13. 11-1317-13 Compar- ative Balance Sheet— Vertical Analysis 1 Exhibit 5

14. 11-1417-14 Compar- ative Balance Sheet— Vertical Analysis Vertical Analysis: Vertical Analysis: Current assets $550,000 Total assets $1,139,500 = 48.3% 1 Exhibit 5

15. 11-1517-15 In a vertical analysis of the income statement, each item is stated as a percent of net sales. Vertical Analysis of the Income Statement 1

16. 11-1617-16 Comparative Income Statement—Vertical Analysis 1 Exhibit 6

17. 11-1717-17 Vertical Analysis: Vertical Analysis: Selling expenses $191,000 Net sales $1,498,000 = 12.8% 1 Comparative Income Statement—Vertical Analysis Exhibit 6

18. 11-1817-18 Common-Size Statements In a common-sized statements, all items are expressed as a percentage. Common-sized statements are useful in comparing the current period with prior periods, individual businesses, or one business with with industry percentages. 1

19. 11-1917-19 Common-Sized Income Statement 1 Exhibit 7

20. 11-2017-20 Solvency Analysis All users of financial statements are interested in the ability of a company to do the following: 1.Meet its financial obligations (debts), called solvency. 2.Earn income, called profitability. 2

21. 11-2117-21 Current Position Analysis Using measures to assess a business’s ability to pay its current liabilities is called current position analysis. Such analysis is of special interest to short-term creditors. 2

22. 11-2217-22 Working Capital The excess of current assets of a business over its current liabilities is called working capital. The working capital is often used in evaluating a company’s ability to pay current liabilities. 2

23. 11-2317-23 Working Capital = Current Assets – Current Liabilities 2010 2009 Current assets$550,000$533,000 Current liabilities –210,000 –243,000 Working capital$340,000$290,000 2

24. 11-2417-24 Current Ratio The current ratio, sometimes called the working capital ratio or bankers’ ratio measures a company’s ability to pay its current liabilities. 2

25. 11-2517-25 2010 2009 Current assets$550,000$533,000 Current liabilities$210,000$243,000 Current ratio2.62.2 $550,000 $210,000 $533,000 $243,000 2 Current Ratio = Current Assets Current Liabilities

26. 11-2617-26 Quick Ratio A ratio that measures the “instant” debt-paying ability of a company is called the quick ratio or acid- test ratio. 2

27. 11-2717-27 20102009 Quick ratio (a ÷ b) 1.3 1.0 Quick assets: Cash$ 90,500$ 64,700 Temporary Investments 75,00060,000 Accounts receivable (net)115,000120,000 a. Total quick assets$280,500$244,700 b. Current liabilities$210,000$243,000 Quick assets are cash and other current assets that can be quickly converted to cash. 2

28. 11-2817-28 Accounts Receivable Turnover The relationship between sales and accounts receivable may be stated as the accounts receivable turnover. Collecting accounts receivable as quickly as possible improves a company’s solvency. 2

29. 11-2917-29 Accounts receivable turnover (a ÷ b) 12.7 9.2 a. Net sales $1,498,000$1,200,000 Accounts receivable (net): Beginning of year$ 120,000$ 140,000 End of year 115,500 120,000 Total$ 235,000$ 260,000 b.Average (Total ÷ 2)$ 117,500$ 130,000 20102009 Accounts Receivable Turnover = Net Sales Average Accounts Receivable 2

30. 11-3017-30 Number of Days’ Sales in Receivables The number of days’ sales in receivables is an estimate of the length of time (in days) the accounts receivable have been outstanding. Number of Days’ Sales in Receivables Average Accounts Receivable Average Daily Sales = Net Sales 365 2

31. 11-3117-31 Number of days’ sales in receivables (a ÷ b) 28.6 39.5 a.Average accounts receivable (Total accounts receivable ÷ 2)$ 117,500$ 130,000 Net sales$1,498,000$1,200,000 b.Average daily sales (Sales ÷ 365)$ 4,104$ 3,288 20102009 2

32. 11-3217-32 Inventory Turnover The relationship between the volume of goods (merchandise) sold and inventory may be stated as the inventory turnover. The purpose of this ratio is to assess the efficiency of the firm in managing its inventory. 2

33. 11-3317-33 Inventory Turnover = Cost of Goods Sold Average Inventory Inventory turnover (a ÷ b) 3.8 2.8 20102009 a.Cost of goods sold$1,043,000$ 820,000 Inventories: Beginning of year$ 283,000$ 311,000 End of year 264,000 283,000 Total$ 547,000$ 594,000 b.Average (Total ÷ 2)$ 273,500$ 297,000 2

34. 11-3417-34 Number of Days’ Sales in Inventory The number of days’ sales in inventory is a rough measure of the length of time it takes to purchase, sell, and replace the inventory. 2

35. 11-3517-35 Number of Days’ Sales in Inventory Average Inventory Average Daily Cost of Goods Sold = Cost of Goods Sold 365 Number of days’ sales in inventory (a ÷ b) 95.7 132.2 a.Average inventory (Total ÷ 2)$ 273,500$ 297,000 Cost of goods sold$1,043,000$ 820,000 b.Average daily cost of goods sold (COGS ÷ 365 days)$2,858$2,247 20102009 2

36. 11-3617-36 Profitability Analysis Profitability analysis focuses primarily on the relationship between operating results and the resources available to a business. 3

37. 11-3717-37 Earnings per Share on Common Stock Earning per share (EPS) on common stock measures the share of profits that are earned by share of common stock. GAAP require the reporting of earnings per share in the income statement. 3

38. 11-3817-38 Earnings per Share (EPS) on Common Stock Net Income – Preferred Dividends Shares of Common Stock Outstanding = Earnings per share on common stock (a ÷ b) $1.64 $1.35 2010 2009 Net income$91,000$76,500 Preferred dividends 9,000 9,000 a.Remainder—identified with common stock$82,000$67,500 b.Shares of common stock50,00050,000 3

39. 11-3917-39 Price-Earnings Ratio Another profitability measure quoted by the financial press is the price-earnings (P/E) ratio on common stock. The price- earnings ratio on common stock measures a company’s future earnings prospects. 3

40. 11-4017-40 Price-earnings (P/E) ratio Market Price per Share of Common Stock Earnings per Share on Common Stock = Price-earnings ratio on common stock 25 20 2010 2009 Market price per share of common stock$41.00$27.00 Earnings per share on common stock ÷ 1.64÷ 1.35 3

41. 11-4117-41 Corporate Annual Reports In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections: Management discussion and analysis Report on adequacy of internal control Report on fairness of financial statements 4

42. 11-4217-42 The Management Discussion and Analysis (MD&A) includes an analysis of the results of operations and discusses management’s opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition. Management Discussion and Analysis 4

43. 11-4317-43 The Sarbanes-Oxley Act of 2002 requires a report stating management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report. Report on Internal Control 4

44. 11-4417-44 Questions Open Q&A Time What questions do you have?