Hhtfa8e ch13 stud devry Accounting 212 FINANCIAL ACCOUNTING

Financial Statement Analysis
Chapter 13


Perform a horizontal analysis of financial
statements


Horizontal Analysis
• Study of percentage changes from year-to-
year
• Two steps:
1. Compute dollar amount of change
2. Divide dollar amount of change by base-period
amount


Exercise 13-16A
Sensible Music Company
Comparative Income Statements
Years Ended December 31, 2010 and 2009
2010 2009 $ Change % Change
Total revenue $852,000 $912,000
Expenses:
Cost of goods sold $402,000 $408,000
Selling & gen’l expense 232,000 261,000
Interest expense 9,200 10,500
Income tax expense 83,000 84,000
Total expenses 726,200 763,500
Net income $125,800 $148,500


Trend Percentages
• Form of horizontal analysis
• Base year selected and set equal to 100%

Any year
Trend %
Base year


Perform a vertical analysis of financial
statements


Vertical Analysis
• Shows relationship of a financial-statement item
to its base

Vertical Each income statement item
analysis %
Total revenue


Prepare common-size financial statements


Common-Size Statements
• Report only vertical analysis percents
• Help in the comparison of different
companies


Benchmarking
• Compares company to a standard set by
others
• Facilitated by common-size statements
• Has goal of improvement


Use the statement of cash flows for decisions


Cash-Flow Signs of Healthy
Company


Compute the standard financial ratios


Ratio Categories


Ability to Pay Current Liabilities


Working Capital & Current Ratio
Working Current Current
capital assets liabilities

Current Current Current
ratio assets liabilities


Acid-Test Ratio

?

?


Ability to Sell Inventory and
Collect Receivables


Inventory Turnover

Cost of goods sold

Average inventory

(Beginning inventory + Ending inventory)/2)


Accounts Receivable Turnover

Net sales

Average net accounts receivable

(Beginning net receivables + Ending net receivables)/2)


Days’-Sales-In-Receivables
Net sales
One day’s
sales
365 days

Average net accounts
Days’ sales in receivable
average accounts
receivable
One day’s sales


Exercise 13-21A
Current Preceding
year year
Balance Sheet:
Cash
Short-term investments
Net receivables
Inventory
Prepaid expenses
Total current assets
Total current liabilities
Income Statement:
Net credit sales
Cost of goods sold

Exercise 13-21A
Current Current Current
ratio assets liabilities

?
? ?
?

?

Exercise 13-21A
Acid- test ratio = ?

Cash + Short-term investments + Net current receivables

Current liabilities


Exercise13-21A
Inventory turnover =

Cost of goods sold ?

Average inventory ?

(Beginning inventory + Ending Inventory)/2)
?
(76,000 +94,000)/2)


Exercise 13-21A
Accounts receivable
?
turnover =

Net sales ?

Average net
?
accounts receivable

(Beginning net receivables +
Ending net receivables)/2) ($73,000 + 50,000)/2


Exercise 13-21A
Days’ Sales in Average Receivables

One day’s Net sales
1. sales
?

?
?
?


Exercise 13-21A
Days’ Sales in Average Receivables

Average net accounts
Days’ sales in
receivable
2. average accounts
receivable
One day’s sales

?

46 days


Measuring Ability to Pay Debts


Debt ratio

Total liabilities

Total assets


Times-Interest-Earned

Income from operations

Interest expense


Measuring Profitability


Rate of Return on Sales

Net income

Net sales


Rate of Return on Total Assets

Net income + Interest expense

Average total assets


Rate of Return on Common Equity

Net income – Preferred dividends

Average common stockholders’
equity


Leverage
• Borrowing at a lower rate than invested
funds earn


Earnings per Share

Net income –Preferred dividends

Average number of common shares
outstanding


Use ratios in decision making


Analyzing Stock Investments


Price/Earnings Ratio

Market price per share of
common stock

Earnings per share


Dividend Yield

Dividend per share of common
stock

Market price per share of
common stock


Book Value

Total stockholders’
Preferred equity
equity

Number of common shares
outstanding


Measure the economic value added by
operations


Economic Value Added (EVA ®)
• Combines accounting and finance data
• Measures if operations have increased
stockholder wealth
▫ Positive EVA® suggests increase in wealth

Net Interest Capital
income expense charge


Cost of Capital
Capital charge =

Current
Notes maturities of
payable long-term
debt Cost
of
capital
Long-term Stockholders’
debt equity


Red Flags in Financial Statement
Analysis
• Earnings problems
• Decreased cash flow
• Too much debt
• Inability to collect receivables
• Buildup of inventories
• Trends of sales, inventory and receivables


Efficient Markets
• Market prices fully reflect all information
▫ Managers cannot fool market with accounting
manipulations
▫ Market sets fair price for stock
• Appropriate investment strategy:
▫ Manage risk
▫ Diversify investments
▫ Minimize transaction costs


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