- 1. Financial Statement Analysis Chapter 15PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights
reserved.
2. 15-2Limitations of Financial Statement Analysis Differences
in accounting methods between companies sometimes make comparisons
difficult.We use the LIFO method to value inventory.We use the
average cost method to value inventory. 3. 15-3Limitations of
Financial Statement Analysis Analysts should look beyond the
ratios. Industry trends Technological changesChanges within the
companyConsumer tastes Economic factors 4. 15-4Learning Objective 1
Prepare and interpret financial statements in comparative and
common-size form. 5. 15-5Statements in Comparative and Common-Size
Form Dollar and percentage changes on statements An item on a
financial statement has little meaning by itself. The meaning of
the numbers can be enhanced by drawing comparisons. Common-size
statements Ratios 6. 15-6Dollar and Percentage Changes on
Statements Horizontal analysis (or trend analysis) shows the
changes between years in the financial data in both dollar and
percentage form. 7. 15-7Horizontal Analysis The following slides
illustrate a horizontal analysis of Clover Corporations comparative
balance sheets and comparative income statements for this year and
last year. 8. 15-8Horizontal Analysis CLOVER CORPORATION
Comparative Balance Sheets December 31This Year Assets Current
assets: Cash Accounts receivable, net Inventory Prepaid expenses
Total current assets Property and equipment: Land Buildings and
equipment, net Total property and equipment Total assetsIncrease
(Decrease) Last Year Amount %$$12,000 60,000 80,000 3,000
155,00040,000 120,000 160,000 $ 315,00023,500 40,000 100,000 1,200
164,70040,000 85,000 125,000 $ 289,700 9. 15-9Horizontal Analysis
Calculating Change in Dollar Amounts Dollar Change=Current Year
FigureBase Year FigureThe dollar amounts for last year become the
base year figures. 10. 15-10Horizontal Analysis Calculating Change
as a Percentage Percentage Change=Dollar Change Base Year
Figure100% 11. 15-11Horizontal Analysis CLOVER CORPORATION
Comparative Balance Sheets December 31This YearIncrease (Decrease)
Last Year Amount %Assets Current assets: Cash $ 12,000 $ 23,500 $
(11,500) (48.9) Accounts receivable, net 60,000 40,000 Inventory
80,000 100,000 Prepaid expenses 3,000 1,200 Total current assets
155,000 164,700 Property and equipment: $12,000 $23,500 = $(11,500)
Land 40,000 40,000 Buildings and equipment, net 120,000 85,000
($11,500 $23,500) 100% = (48.9%) Total property and equipment
160,000 125,000 Total assets $ 315,000 $ 289,700 12.
15-12Horizontal Analysis CLOVER CORPORATION Comparative Balance
Sheets December 31This Year Assets Current assets: Cash Accounts
receivable, net Inventory Prepaid expenses Total current assets
Property and equipment: Land Buildings and equipment, net Total
property and equipment Total assetsIncrease (Decrease) Last Year
Amount %$$12,000 60,000 80,000 3,000 155,00040,000 120,000 160,000
$ 315,00023,500 40,000 100,000 1,200 164,70040,000 85,000 125,000 $
289,700$ (11,500) 20,000 (20,000) 1,800 (9,700)(48.9) 50.0 (20.0)
150.0 (5.9)35,000 35,000 $ 25,3000.0 41.2 28.0 8.7 13.
15-13Horizontal Analysis We could do this for the liabilities and
stockholders equity, but now lets look at the income statement
accounts. 14. 15-14Horizontal Analysis CLOVER CORPORATION
Comparative Income Statements For the Years Ended December 31This
Year Last Year Sales $ 520,000 $ 480,000 Cost of goods sold 360,000
315,000 Gross margin 160,000 165,000 Operating expenses 128,600
126,000 Net operating income 31,400 39,000 Interest expense 6,400
7,000 Net income before taxes 25,000 32,000 Less income taxes (30%)
7,500 9,600 Net income $ 17,500 $ 22,400Increase (Decrease) Amount
% 15. 15-15Horizontal Analysis CLOVER CORPORATION Comparative
Income Statements For the Years Ended December 31This Year Last
Year Sales $ 520,000 $ 480,000 Cost of goods sold 360,000 315,000
Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net
operating income 31,400 39,000 Interest expense 6,400 7,000 Net
income before taxes 25,000 32,000 Less income taxes (30%) 7,500
9,600 Net income $ 17,500 $ 22,400Increase (Decrease) Amount % $
40,000 8.3 45,000 14.3 (5,000) (3.0) 2,600 2.1 (7,600) (19.5) (600)
(8.6) (7,000) (21.9) (2,100) (21.9) $ (4,900) (21.9) 16.
15-16Horizontal Analysis CLOVER CORPORATION Comparative Income
Statements For the Years Ended December 31 Increase (Decrease) This
Year Last Year Amount % Sales $ 520,000 $ 480,000 $ 40,000 8.3 Cost
of goods sold 360,000 315,000 45,000 14.3 Gross margin 160,000
165,000 (5,000) (3.0) OperatingSales increased by 8.3%, yet
expenses 128,600 126,000 2,600 2.1 Net operating income decreased
by 39,000 31,400 net income 21.9%. (7,600) (19.5) Interest expense
6,400 7,000 (600) (8.6) Net income before taxes 25,000 32,000
(7,000) (21.9) Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income $ 17,500 $ 22,400 $ (4,900) (21.9) 17. 15-17Horizontal
Analysis CLOVER CORPORATIONThere were increases in both cost of
goods Comparative Income Statements sold (14.3%) and the Years
Ended December 31 operating expenses (2.1%). For These increased
costs more than offset the Increase increase in sales, yielding an
overall (Decrease) % decrease inThis Year Last Year Amount net
income. Sales $ 520,000 $ 480,000 $ 40,000 Cost of goods sold
360,000 315,000 45,000 Gross margin 160,000 165,000 (5,000)
Operating expenses 128,600 126,000 2,600 Net operating income
31,400 39,000 (7,600) Interest expense 6,400 7,000 (600) Net income
before taxes 25,000 32,000 (7,000) Less income taxes (30%) 7,500
9,600 (2,100) Net income $ 17,500 $ 22,400 $ (4,900)8.3 14.3 (3.0)
2.1 (19.5) (8.6) (21.9) (21.9) (21.9) 18. 15-18Trend Percentages
Trend percentages state several years financial data in terms of a
base year, which equals 100 percent. 19. 15-19Trend Analysis Trend
= PercentageCurrent Year Amount Base Year Amount100% 20. 15-20Trend
Analysis Look at the income information for Berry Products for the
years 2007 through 2011. We will do a trend analysis on these
amounts to see what we can learn about the company. 21. 15-21Trend
Analysis Berry Products Income Information For the Years Ended
December 31 Item Sales Cost of goods sold Gross margin2011 $
400,000 285,000 115,0002010 $ 355,000 250,000 105,000Year 2009 $
320,000 225,000 95,000The base year is 2007, and its amounts will
equal 100%.2008 $ 290,000 198,000 92,0002007 $ 275,000 190,000
85,000 22. 15-22Trend Analysis Berry Products Income Information
For the Years Ended December 31 Item20112010Year 2009Sales Cost of
goods sold Gross margin2008 Amount 2007 Amount 100% ( $290,000
$275,000 ) 100% = 105% ( $198,000 $190,000 ) 100% = 104% ( $ 92,000
$ 85,000 ) 100% = 108%2008 105% 104% 108%2007 100% 100% 100% 23.
15-23Trend Analysis Berry Products Income Information For the Years
Ended December 31 Item Sales Cost of goods sold Gross margin2011
145% 150% 135%2010 129% 132% 124%Year 2009 116% 118% 112%2008 105%
104% 108%By analyzing the trends for Berry Products, we can see
that cost of goods sold is increasing faster than sales, which is
slowing the increase in gross margin.2007 100% 100% 100% 24.
15-24Trend Analysis 160PercentageWe can use the trend 150
percentages to construct a graph so we can see the 140 trend over
time. 130Sales COGS120GM110100 200720082009 Year20102011 25.
15-25Common-Size Statements Vertical analysis focuses on the
relationships among financial statement items at a given point in
time. A common-size financial statement is a vertical analysis in
which each financial statement item is expressed as a percentage.
26. 15-26Common-Size Statements In income statements, all items
usually are expressed as a percentage of sales. 27. 15-27Gross
Margin Percentage Gross Margin = PercentageGross Margin SalesThis
measure indicates how much of each sales dollar is left after
deducting the cost of goods sold to cover expenses and provide a
profit. 28. 15-28Common-Size Statements In balance sheets, all
items usually are expressed as a percentage of total assets. 29.
15-29Common-Size StatementsBurger King McDonald's (dollars in
millions) Dollars Percentage Dollars Percentage 2008 Net income $
190 7.70% $ 4,313 18.30%Common-size financial statements are
particularly useful when comparing data from different companies.
30. 15-30Common-Size Statements Lets take another look at the
information from the comparative income statements of Clover
Corporation for this year and last year. This time, lets prepare
common-size statements. 31. 15-31Common-Size Statements CLOVER
CORPORATION Comparative Income Statements For the Years Ended
December 31 Common-Size Percentages This Year Last Year This Year
Last Year Sales $ 520,000 $ 480,000 100.0 100.0 Cost of goods sold
360,000 315,000 Gross margin 160,000 165,000 Sales is Operating
expenses 128,600 126,000 usually the Net operating income 31,400
39,000 base and is Interest expense 6,400 7,000 expressed Net
income before taxes 25,000 32,000 as 100%. Less income taxes (30%)
7,500 9,600 Net income $ 17,500 $ 22,400 32. 15-32Common-Size
Statements CLOVER CORPORATION Comparative Income Statements For the
Years Ended December 31 Common-Size Percentages This Year Last Year
This Year Last Year Sales $ 520,000 $ 480,000 100.0 100.0 Cost of
goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000
Operating expenses 128,600 126,000 This Years Net operating income
Cost This Years Sales 100% 31,400 39,000 ( $360,000 $520,000 )
7,000 = 69.2% 100% Interest expense 6,400 Net income before taxes
25,000 32,000 Last Years Cost Last Years Sales 100% Less income
taxes (30%) 7,500 9,600 ( $315,000 $ $480,000 ) 100% = 65.6% Net
income 17,500 $ 22,400 33. 15-33Common-Size Statements CLOVER
CORPORATION Comparative Income Statements For the Years Ended
December 31 Common-Size What conclusions can we draw? Percentages
This Year Last Year This Year Last Year Sales $ 520,000 $ 480,000
100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross
margin 160,000 165,000 30.8 34.4 Operating expenses 128,600 126,000
24.8 26.2 Net operating income 31,400 39,000 6.0 8.2 Interest
expense 6,400 7,000 1.2 1.5 Net income before taxes 25,000 32,000
4.8 6.7 Less income taxes (30%) 7,500 9,600 1.4 2.0 Net income $
17,500 $ 22,400 3.4 4.7 34. 15-34Quick Check Which of the following
statements describes horizontal analysis? a. A statement that shows
items appearing on it in percentage and dollar form. b. A
side-by-side comparison of two or more years financial statements.
c. A comparison of the account balances on the current years
financial statements. d. None of the above. 35. 15-35Quick Check
Which of the following statements describes horizontal analysis? a.
A statement that shows items appearing on it in percentage and
dollar form. b. A side-by-side comparison of two or more years
financial statements. c. A comparison of the account balances on
Horizontal years financial statements. the current analysis shows
the changes between years in the financial data in both d. None of
the above. dollar and percentage form. 36. 15-36Now, lets look at
Norton Corporations financial statements for this year and last
year. 37. 15-37NORTON CORPORATION Balance Sheets December 31 This
Year Last Year Assets Current assets: Cash Accounts receivable, net
Inventory Prepaid expenses Total current assets Property and
equipment: Land Buildings and equipment, net Total property and
equipment Total assets$30,000 20,000 12,000 3,000 65,000165,000
116,390 281,390 $ 346,390$20,000 17,000 10,000 2,000 49,000123,000
128,000 251,000 $ 300,000 38. 15-38NORTON CORPORATION Balance
Sheets December 31 This Year Liabilities and Stockholders' Equity
Current liabilities: Accounts payable Notes payable, short-term
Total current liabilities Long-term liabilities: Notes payable,
long-term Total liabilities Stockholders' equity: Common stock, $1
par value Additional paid-in capital Total paid-in capital Retained
earnings Total stockholders' equityLast Year$$39,000 3,000
42,00040,000 2,000 42,00070,000 112,00078,000 120,00027,400 158,100
185,500 48,890 234,39017,000 113,000 130,000 50,000 180,000Total
liabilities and stockholders' equity $ 346,390$ 300,000 39.
15-39NORTON CORPORATION Income Statements For the Years Ended
December 31Sales Cost of goods sold Gross margin Operating expenses
Net operating income Interest expense Net income before taxes Less
income taxes (30%) Net incomeThis Year $ 494,000 140,000 354,000
270,000 84,000 7,300 76,700 23,010 $ 53,690Last Year $ 450,000
127,000 323,000 249,000 74,000 8,000 66,000 19,800 $ 46,200 40.
15-40Learning Objective 2 Compute and interpret financial ratios
that would be useful to a common stockholder. 41. 15-41Ratio
Analysis The Common Stockholder NORTON CORPORATION The ratios that
are of the most interest to stockholders include those ratios that
focus on net income, dividends, and stockholders equities.This Year
Number of common shares outstanding Beginning of year End of year
Net income17,000 27,400 $53,690Stockholders' equity Beginning of
year180,000End of year234,390Dividends per share Dec. 31 market
price per share Interest expense2 20 7,300Total assets Beginning of
year300,000End of year346,390 42. 15-42Earnings Per Share Net
Income Preferred Dividends Earnings per Share = Average Number of
Common Shares Outstanding Whenever a ratio divides an income
statement balance by a balance sheet balance, the average for the
year is used in the denominator. Earnings form the basis for
dividend payments and future increases in the value of shares of
stock. 43. 15-43Earnings Per Share Net Income Preferred Dividends
Earnings per Share = Average Number of Common Shares Outstanding
Earnings per Share =$53,690 $0 ($17,000 + $27,400)/2= $2.42This
measure indicates how much income was earned for each share of
common stock outstanding. 44. 15-44Price-Earnings Ratio
Price-Earnings Ratio Price-Earnings Ratio==Market Price Per Share
Earnings Per Share $20.00 $2.42= 8.26 timesA higher price-earnings
ratio means that investors are willing to pay a premium for a
companys stock because of optimistic future growth prospects. 45.
15-45Dividend Payout Ratio Dividend Payout RatioDividend Payout
Ratio=Dividends Per Share Earnings Per Share=$2.00 $2.42= 82.6%This
ratio gauges the portion of current earnings being paid out in
dividends. Investors seeking dividends (market price growth) would
like this ratio to be large (small). 46. 15-46Dividend Yield Ratio
Dividend Yield Ratio Dividend Yield Ratio==Dividends Per Share
Market Price Per Share $2.00 $20.00= 10.00%This ratio identifies
the return, in terms of cash dividends, on the current market price
of the stock. 47. 15-47Return on Total Assets Return on = Total
AssetsNet Income + [Interest Expense (1 Tax Rate)] Average Total
AssetsReturn on = Total Assets$53,690 + [$7,300 (1 .30)] = 18.19%
($300,000 + $346,390) 2 Adding interest expense back to net income
enables the return on assets to be compared for companies with
different amounts of debt or over time for a single company that
has changed its mix of debt and equity. 48. 15-48Return on Common
Stockholders Equity Return on Common = Net Income Preferred
Dividends Stockholders Equity Average Stockholders Equity Return on
Common = $53,690 $0 = 25.91% Stockholders Equity ($180,000 +
$234,390) 2 This measure indicates how well the company used the
owners investments to earn income. 49. 15-49Financial Leverage
Financial leverage results from the difference between the rate of
return the company earns on investments in its own assets and the
rate of return that the company must pay its creditors. Return on
investment in > assetsFixed rate of return on borrowed
fundsPositive = financial leverageReturn on investment in <
assetsFixed rate of return on borrowed fundsNegative = financial
leverage 50. 15-50Quick Check Which of the following statements is
true? a. Negative financial leverage is when the fixed return to a
companys creditors and preferred stockholders is greater than the
return on total assets. b. Positive financial leverage is when the
fixed return to a companys creditors and preferred stockholders is
greater than the return on total assets. c. Financial leverage is
the expression of several years financial data in percentage form
in terms of a base year. 51. 15-51Quick Check Which of the
following statements is true? a. Negative financial leverage is
when the fixed return to a companys creditors and preferred
stockholders is greater than the return on total assets. b.
Positive financial leverage is when the fixed return to a companys
creditors and preferred stockholders is greater than the return on
total assets. c. Financial leverage is the expression of several
years financial data in percentage form in terms of a base year.
52. 15-52Book Value Per Share Book Value per Share Book Value per
Share=Common Stockholders Equity Number of Common Shares
Outstanding=$234,390 27,400= $8.55This ratio measures the amount
that would be distributed to holders of each share of common stock
if all assets were sold at their balance sheet carrying amounts
after all creditors were paid off. 53. 15-53Book Value Per Share
Book Value per Share Book Value per Share=Common Stockholders
Equity Number of Common Shares Outstanding=$234,390 27,400=
$8.55Notice that the book value per share of $8.55 does not equal
the market value per share of $20. This is because the market price
reflects expectations about future earnings and dividends, whereas
the book value per share is based on historical cost. 54.
15-54Learning Objective 3 Compute and interpret financial ratios
that would be useful to a short-term creditor. 55. 15-55Ratio
Analysis The ShortTerm Creditor NORTON CORPORATIONShort-term
creditors, such as suppliers, want to be paid on time. Therefore,
they focus on the companys cash flows and working capital.This Year
Cash$30,000Accounts receivable, net Beginning of year17,000End of
year20,000Inventory Beginning of year10,000End of year12,000Total
current assets65,000Total current liabilities42,000Sales on
account494,000Cost of goods sold140,000 56. 15-56Working Capital
The excess of current assets over current liabilities is known as
working capital. Working capital is not free. It must be financed
with longterm debt and equity. 57. 15-57Working Capital December 31
This Year Current assets$Current liabilities Working capital65,000
(42,000)$23,000 58. 15-58Current Ratio Current Ratio=Current Assets
Current LiabilitiesThe current ratio measures a companys short-term
debt paying ability. A declining ratio may be a sign of
deteriorating financial condition, or it might result from
eliminating obsolete inventories. 59. 15-59Current Ratio Current
Ratio=Current Assets Current LiabilitiesCurrent Ratio=$65,000
$42,000=1.55 60. 15-60Acid-Test (Quick) Ratio Acid-Test = Ratio
Acid-Test = RatioQuick Assets Current Liabilities $50,000 $42,000=
1.19Quick assets include Cash, Marketable Securities, Accounts
Receivable, and current Notes Receivable. This ratio measures a
companys ability to meet obligations without having to liquidate
inventory. 61. 15-61Accounts Receivable Turnover Accounts
Receivable Turnover=Sales on Account Average Accounts
ReceivableAccounts $494,000 Receivable = = 26.7 times ($17,000 +
$20,000) 2 Turnover This ratio measures how many times a company
converts its receivables into cash each year. 62. 15-62Average
Collection Period Average Collection = Period Average Collection =
Period365 Days Accounts Receivable Turnover 365 Days 26.7 TimesThis
ratio measures, on average, how many days it takes to collect an
account receivable.= 13.67 days 63. 15-63Inventory Turnover
Inventory Turnover=Cost of Goods Sold Average InventoryThis ratio
measures how many times a companys inventory has been sold and
replaced during the year. If a companys inventory turnover Is less
than its industry average, it either has excessive inventory or the
wrong types of inventory. 64. 15-64Inventory Turnover Inventory
Turnover=Inventory Turnover=Cost of Goods Sold Average Inventory
$140,000 = 12.73 times ($10,000 + $12,000) 2 65. 15-65Average Sale
Period Average Sale Period=Average = Sale Period365 Days Inventory
Turnover365 Days 12.73 TimesThis ratio measures how many days, on
average, it takes to sell the entire inventory.= 28.67 days 66.
15-66Learning Objective 4 Compute and interpret financial ratios
that would be useful to a long-term creditor. 67. 15-67Ratio
Analysis The LongTerm Creditor Long-term creditors are concerned
with a companys ability to repay its loans over the long-run.
NORTON CORPORATION This Year Earnings before interest expense and
income taxes Interest expenseThis is also referred to as net
operating income.$84,000 7,300Total stockholders'
equity234,390Total liabilities112,000 68. 15-68Times Interest
Earned Ratio Times Interest = Earned Times Interest =
EarnedEarnings Interest Expense and Income Taxes Interest
Expense$84,000 = 11.51 times $7,300This is the most common measure
of a companys ability to provide protection for its longterm
creditors. A ratio of less than 1.0 is inadequate. 69.
15-69Debt-to-Equity Ratio Debtto Total Liabilities Equity =
Stockholders Equity RatioThis ratio indicates the relative
proportions of debt to equity on a companys balance sheet.
Stockholders like a lot of debt if the company can take advantage
of positive financial leverage.Creditors prefer less debt and more
equity because equity represents a buffer of protection. 70.
15-70Debt-to-Equity Ratio Debtto Total Liabilities Equity =
Stockholders Equity Ratio Debtto Equity = Ratio$112,000 = 0.48
$234,390 71. 15-71Published Sources That Provide Comparative Ratio
Data 72. 15-72End of Chapter 15