CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning LESSON 17 - 1 Trend Analysis and Component Percentages
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
LESSON 17-1
Trend Analysis and Component Percentages
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Trend Analysis and Component Percentage
Financial statements report the financial condition and progress of a business for a fiscal period. Accounting concepts “Adequate Disclosure” and “Consistent Reporting” are important concepts to consider when preparing the financial statements and supporting schedules. Various groups use the financial information in different ways to assist with decision making; therefore, all information must be disclosed, even if it doesn’t make the company look good.
2
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Trend Analysis and Component Percentage
Comparative Financial Statements— Financial statements providing information for two or more fiscal
periods in order to compare specific items from one fiscal period to past fiscal periods. The Consistent Reporting concept states that the same accounting procedures must be followed in the same way in each accounting period.
Ratio— A comparison between two numbers showing how many times one
number exceeds the other; it may be stated as either a ratio, percentage, or fraction. All three ways of expressing the ratios are essentially the same.
Example: For a business with net sales of $2,000,000.00 and net income of $200,000.00, the relationship may be stated as any of these ratios:
3
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
4
LESSON 17-1
RATIO ANALYSIS
Net IncomeNet Sales Stated Ratio÷ =$2,000,000.00 ÷ = 10 times
(10 to 1 or 10:1)$200,000.00
The stated ratio means net sales is 10 times net income.
Net SalesNet Income Percentage Ratio÷ =$200,000.00 ÷ = .10 or 10%$2,000,000.00
Net income is 10% of sales.
Net SalesNet Income Fractional Ratio÷ =$200,000.00 ÷ = 1/10$2,000,000.00
Net income is one-tenth of net sales.
page 495
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Trend Analysis on the Income Statement
Trend Analysis—also called Horizontal Analysis— Comparison of the relationship between one item on a financial
statement and the same item on a previous fiscal period’s financial statement. Various trend analysis calculations include a trend analysis of the Income Statement, trend analysis of the Statement of Stockholder’s Equity, trend analysis of the Balance Sheet. Trend analysis is one method of financial analysis used to help predict how well a business will perform in the future. It is often performed using financial statement for a 3-5 year period.
5
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
6
LESSON 17-1
page 496
TREND ANALYSIS ON THE INCOME STATEMENT
1 2 34
Current Year Net Sales $4,767,200.00 1– Prior Year Net Sales 3,633,000.00 2
÷ Prior Year Net Sales 3,633,000.00= Increase or Decrease in Net Sales $1,134,200.00 3
= % Increase or Decrease in Net Sales 31.2% 4
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
7
LESSON 17-1
TREND ANALYSIS ON THE STATEMENT OF STOCKHOLDERS’ EQUITY page 497
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
TREND ANALYSIS ON THE BALANCE SHEET
Trend analysis of the Balance Sheet (p. 498)—one method of financial analysis used to help predict how well a business will perform in the future. Often performed using financial statements for a three-to-five year period. Favorable trends over a period of several years often indicate that management is making good decisions.
Calculate Amount of Increase/ Decrease from Prior YearIncrease/Decrease ÷ Prior Year = % Increase/Decrease
8
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
9
LESSON 17-1
page 498
TREND ANALYSIS ON THE BALANCE SHEET
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
10
LESSON 17-1
page 498
TREND ANALYSIS ON THE BALANCE SHEET
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
COMPONENT PERCENTAGE ANALYSIS
also called Vertical Analysis. Component percentages (usually shown as a percent of net
sales) on comparative statements show changes in a specific item from year to year. The cause of significant unfavorable changes should be investigated so that corrective action can be taken. Usually done on the Income Statement, but can also be done on other financial statements such as the Statement of Stockholders’ Equityand Balance Sheet.
11
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
12
LESSON 17-1
page 499
COMPONENT PERCENTAGES ON THE INCOME STATEMENT
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
13
LESSON 17-1
page 499
COMPONENT PERCENTAGES ON THE INCOME STATEMENT
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
COMPONENT PERCENTAGES ON THE STATEMENT OF STOCKHOLDERS’ EQUITY
Component percentages on the Statement of Stockholders’ Equity (p. 500) is calculated as a percentage of total stockholders’ equity.
14
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
15
LESSON 17-1
COMPONENT PERCENTAGES ON THE STATEMENT OF STOCKHOLDERS’ EQUITY page 500
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
COMPONENT PERCENTAGES ON THE BALANCE SHEET
Component percentages on the Balance Sheet (p. 501). Component percentages for assets are normally calculated as a percentage of total assets. Liabilities and stockholders’ equity amounts are calculated as a percentage of total liabilities and stockholders’ equity.
16
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
17
LESSON 17-1
page 501
COMPONENT PERCENTAGES ON THE BALANCE SHEET
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
18
LESSON 17-1
page 501
COMPONENT PERCENTAGES ON THE BALANCE SHEET
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Two major guides to determine acceptable levels of financial performance:
1. Prior company performance 2. Comparison with published trade performance standards.
Example (p. 500): Wiseman Grocery considers a component percentage of 3.0% for income from operations to be very good. However, Mitchell Manufacturing Co. considers 12% component percentage for income from operations the minimum acceptable result. The difference is due to the different financial characteristics of the two businesses.
-Grocery store has a low investment in plant assets and sells inventory quickly.-The manufacturing co. has a high investment in plant assets and holds its inventory much longer. Their higher investment per sales dollar means that the company must earn a higher rate on sales.
19
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Other sources of performance guides include:
1. Financial and credit-reporting companies such as Dun and Bradstreet
2. The company’s planned financial objectives(budget schedules)
3. Current interest rates that could be earned by investing capital elsewhere
4. Financial information available on the Internet.
20
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
21
LESSON 17-1
page 502TERMS REVIEW
ratio trend analysis
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
LESSON 17-2 - Calculating Earnings Performance and Efficiency Analysis
Earnings Performance Analysis—the amount and consistency of earnings are importance measures of a business’s success.
Common earnings performance ratios:1. Rate earned on average total assets2. Rate earned on average stockholders’ equity3. Rate on earned on net sales4. Earnings per share5. Price-earnings ratio
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
RATE EARNED ON AVERAGE TOTAL ASSETS
The earned shows how well a business is using its assets to earn net income.
23
LESSON 17-2
Average Total Assets
Net Income after Federal Income Tax
Rate Earned on Average Total Assets
÷ =
$222,300.00 ÷ = 11.6%$1,913,700.00
page 503
December 31Total Assets
January 1Total Assets
Average Total Assets+ =÷ 2
($1,759,700.00 + = $1,913,700.00$2,067,700.00) ÷ 2
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
CALCULATING THE RATE EARNED ON AVERAGE TOTAL ASSETS
Goal – 10% (comparable to rates of return on other investments such as bonds, etc.)
24
LESSON 17-2
page 504
Current Year Prior YearNet Income after Federal Income Tax $ 222,300.00 $ 128,400.00January 1 Total Assets 1,759,700.00 1,437,600.00December 31 Total Assets 2,067,700.00 1,759,700.00Average Total Assets 1,913,700.00 1,598,650.00Rate Earned on Average Total Assets 11.6% 8.0%
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
RATE OF RETURN EARNED ON AVERAGE STOCKHOLDERS’ EQUITY
Rate earned on average stockholders’ equity—Investorscompare the rate earned on stockholders’ equity to determine the best investment.
25
LESSON 17-2
December 31Stockholders’
Equity
January 1Stockholders’
Equity
Average Total Stockholders’
Equity+ =÷ 2
Average Total Stockholders’
Equity
Net Income after Federal Income Tax
Rate Earned on Average
Stockholders’ Equity
÷ =
$222,300.00 ÷ = 23.4%$950,450.00
($849,300.00 + = $950,450.00$1,051,600.00) ÷ 2
page 505
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
RATE EARNED ON NET SALES
Rate earned on net sales—A business that carefully controls costs should earn a consistent rate on net sales from year to year. If costs suddenly change, the rate earned on net sales also changes. Compare the rate with businesses similar and to the company’s own past experience. If the rate declines, the company must increase sales or reduce costs to maintain an acceptable rate.
26
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
27
LESSON 17-2
page 506
Net Income after Federal Income Tax ÷ Net Sales = Rate Earned
on Net Sales
RATE EARNED ON NET SALES
÷ $4,767,200.00 = 4.7%$222,300.00
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
EARNINGS PER SHARE
Earnings per share—The amount of net income earned on one share of common stock during a fiscal period. Management and stockholders use earnings per share as a measure of success. As earning per share increase, more people are interested in buying the company’s stock which in turn makes the price go up. Information from the Income Statement and Statement of Stockholders’ Equity is needed to calculate earnings per share.
One of the most widely recognized financial ratios
28
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
29
LESSON 17-2
page 507EARNINGS PER SHARE
Net Income after Federal Income Tax ÷ = Earnings per
ShareShares of Capital Stock Outstanding
= $3.71$222,300.00 ÷ 60,000.00
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
PRICE-EARNINGS RATIO
Price-earnings ratio—Investors want to buy stock in companies that will earn a reasonable return on their investment. The relationship between the market value per share of stock and the earnings per share is the price-earnings ratio. Market Price is determined by the amount that investors are willing to pay for a share of stock. Compare ratio with prior years to see if there is a favorable trend.
30
LESSON 17-2
page 508
Earnings per Share
Market Price per Share
Price-Earnings Ratio÷ =
$43.50 ÷ = 11.7 times$3.71
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Efficiency Analysis
Efficiency Analysis—Profitability and continued growth of the business are influenced by how efficiently the business utilizes its assets (mainly accounts receivable and merchandise inventory). Three phases of the operating cycle are: 1) purchase merchandise, 2) Sell merchandise, 3) Collect accounts receivable.
Accounts Receivable Turnover Ratio—The number of times the average amount of accounts receivable is collected annually. Use information from the Balance Sheet and Income Statement
31
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
32
LESSON 17-2
page 509
ACCOUNTS RECEIVABLE TURNOVER RATIO
Ending Book Value of Accounts
Receivable
Beginning Book Value of Accounts
Receivable
Average Book Value of Accounts
Receivable+ =÷ 2
Average Book Value of Accounts
Receivable
Net Sales on Account
Accounts Receivable
Turnover Ratio÷ =
$4,767,200.00 ÷ = 9.1 times$521,600.00
($569,200.00 + = $521,600.00$474,000.00) ÷ 2
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
33
LESSON 17-2
page 510
AVERAGE NUMBER OF DAYS FOR PAYMENT
Accounts Receivable
Turnover RatioDays in Year
Average Number of Days for Payment
÷ =
365 ÷ = 40 days9.1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Merchandise Inventory Turnover Ratio
Merchandise Inventory Turnover Ratio—The number of times the average amount of merchandise inventory is sold annually. The faster a company sells its merchandise inventory, the more efficient and more profitable the business. The ratio can be used to monitor merchandise inventory efficiency.
34
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
35
LESSON 17-2
Average Merchandise
Inventory
Cost of Merchandise
Sold
Merchandise Inventory
Turnover Ratio÷ =
page 510
MERCHANDISE INVENTORY TURNOVER RATIO
December 31Merchandise
Inventory
January 1Merchandise
Inventory
Average Merchandise
Inventory+ =÷ 2
$2,602,800.00 ÷ = 5.4 times$485,850.00
($423,800.00 + = $485,850.00$547,900.00) ÷ 2
Merchandise Inventory
Turnover RatioDays in year
Average # of days sales in
inventory÷ =
365 ÷ = 685.4
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
36
LESSON 17-2
page 511Merchandise Inventory Turnover Ratio
The optimum merchandise inventory turnover ratio is determined by two factors:
1) Amount of sales. 2) Number of days needed to replenish inventory.
The lower-than-desired level of inventory results in lost sales because some items are out of stock before the new inventory arrives.
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
LESSON 17-3 - Calculating Financial Strength Analysis
Short-Term Financial Strength Analysis—for a business to be successful, they need adequate capital. Capital comes from two sources—1) Owners’ investments and retained earnings and 2) Loans.
Capital invested in assets of over long periods of time is called long-term assets or plant assets. Capital invested in assets over short periods of time is called current assets.
3 Measures to analyze short-term financial strength: Working Capital Current Ratio Acid-test Ratio
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
WORKING CAPITAL
Working Capital—the amount of current assets available after current liabilities are paid. Used mainly to compare one period to the next, not with other companies.
Increased – favorable trend
38
LESSON 17-3
Total Current Assets
Total Current Liabilities
Working Capital– =
page 512
=Current Year $1,254,100.00 $596,100.00– $658,000.00=Prior Year $1,118,600.00 $685,400.00– $433,200.00
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
CURRENT RATIO
Current Ratio—a ratio that shows the numeric relationship of current assets to current liabilities.
The current ratio of 2.1 means that the company owns $2.10 in current assets for each $1.00 needed to pay current liabilities.
The industry standard for companies similar to this has a current ratio of at least 2.0.
39
LESSON 17-3
Total Current Assets
Total Current Liabilities
CurrentRatio÷ =
page 513
=Current Year $1,254,100.00 $596,100.00÷ 2.1 times=Prior Year $1,118,600.00 $685,400.00÷ 1.6 times
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
ACID-TEST RATIO
Acid-Test Ratio—this ratio shows the ability of a business to pay all current liabilities almost immediately if necessary. The acid-test ratio that shows the numeric relationship of quick assets to current liabilities
Quick Assets—Current assets such as cash or assets that can be quickly turned into cash, such as Accounts Receivable.
The current year’s ratio of 1.1 indicates that for each $1.00 needed to pay current liabilities, there is $1.10 available in quick assets
In comparison of other companies similar to this one, the desired industry standard is between 0.9 and 1.3. Also, in comparison with the previous year, there is a favorable trend
40
LESSON 17-3
Total Quick Assets (Cash + Accounts Receivable)
Total Current Liabilities
Acid-TestRatio=÷
page 513
($206,100 + $474,000) =Current Year $596,100.00÷ 1.1 times
($104,300 + $569,200) =Prior Year $685,400.00÷ 1.0 times
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
Long-term Financial Strength Analysis
Long-Term Financial Strength Analysis—requires a balancebetween stockholders’ capital and borrowed capital. Borrowed capital (money) must be used wisely. One thing to remember is that borrowed capital must be repaid with interest; therefore, you would not want to continue operating with a large percentage of borrowed capital which may use much of your net income for repaying the loan and if the net income declines you would not be able to make the loan payments. Also, it’s hard to get a loan with a high level of liabilities.
3 Measures to analyze long-term financial strength: Debt Ratio Equity Ratio Equity Per Share
41
LESSON 17-1
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
DEBT RATIO
Debt Ratio—this ratio shows the percentage of assets that are financed with borrowed capital (liabilities).
The current year ratio show that for each $1.00 of assets owned, the company has borrowed 49.1 cents. Compare this with other companies similar (average debt ratio is 43.0%) to this company and you can see that it is unfavorable. The company should consider issuing more capital stock to reduce the total liabilities to the industry average of 43.0%.
42
LESSON 17-3
page 514
Total Liabilities Total Assets Debt Ratio÷ =
=Current Year $1,016,100.00 $2,067,700.00÷ 49.1%=Prior Year $ 910,400.00 $1,759,700.00÷ 51.7%
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
EQUITY RATIO
Equity Ratio—this ratio shows the percentage of assets that are provided by stockholders’ equity.
43
LESSON 17-3
page 515
Total Stockholders’ Equity Total Assets Equity
Ratio÷ =
=Current Year $2,067,700.00÷ 50.9%=Prior Year $1,759,700.00÷ 48.3%
$1,051,600.00$ 849,300.00
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
EQUITY RATIO
The current year ratio show that for each $1.00 of assets owned by the company, 50.9 cents’ worth was acquired with stockholders’ capital. Compare this with other companies similar (average equity ratio is 57.0%) to this company and you can see that it is unfavorable and below the industry average. The company should continue its efforts to increase the equity ratio by reducing its liabilities and issuing additional stock.
The debt and equity ratios show the mix of capital provided by capital borrowed and capital provided by stockholders. The sum of the two ratios should equal 100% as shown below. The totals always equal 100% because the total liabilities and stockholders’ equity represent the source of all asset ownership.
Current Year Prior YearDebt Ratio 49.1% 51.7%Equity Ratio 50.9% 48.3%Totals 100.0% 100.0%
44
LESSON 17-3
page 515
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
EQUITY PER SHARE
Equity Per Share—the amount of total stockholders equity belonging to a single share of stock. It tells stockholders how much ownership of the company each share represents.
The current year equity per share indicates that each share of capital stock represents ownership in $17.53 of the total company’s assets on that date. There is a favorable trend because it increased from the prior year.
45
LESSON 17-3
Total Stockholders’ Equity
Shares of Capital Stock Outstanding
Equityper Share÷ =
=Current Year $60,000.00÷ $17.53=Prior Year $50,000.00÷ $16.99
page 515
$1,051,600.00
$ 849,300.00
CENTURY 21 ACCOUNTING © 2009 South-Western, Cengage Learning
46
LESSON 17-3
page 517TERMS REVIEW
working capital current ratio quick assets acid-test ratio debt ratio equity ratio
Related Documents
