©2013 cengage learning. all rights reserved. may not be scanned, copied or duplicated, or posted to...

©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part.

Financial Statement Analysis Chapter 9


Learning Objectives

After studying this chapter, you should be able to:

•Describe basic financial statement analytical methods.

•Use financial statement analysis to assess the liquidity and solvency of a business.

•Use financial statement analysis to assess the profitability of a business.

•Describe the contents of corporate annual reports.


Learning Objective 1

Describe basic financial statement analytical procedures


Horizontal Analysis• The __________ analysis of _________ and

_________ in related items in _________ financial statements

Exhibit 1: Comparative Balance Sheet— Horizontal Analysis


Vertical Analysis• A __________ analysis used to show the

relationship of each __________ to the ________ within __________ statement

Exhibit 5: Comparative Balance Sheet— Vertical Analysis


Benefits of Analysis• ________ and ________analysis are useful

in assessing relationships and trends in financial conditions and operations of a business

• ________analysis is useful for comparing one company with another or with industry averages

• ________ is made easier with common-sized financial statements


Common-Sized StatementsExhibit 7: Common- Sized Income Statement



Use financial statement analysis to assess the liquidity and solvency of

a business


Liquidity and Solvency

• _________ – the ability of a business to pay its debts

• _________ – the ability of a business to convert assets into cash.

_________, _______, and __________are interrelated!


Solvency Analysis• Normally assessed by examining _________

relationships, using the following major analyses:• Current position analysis• Accounts receivable analysis• Inventory analysis• Ratio of fixed assets to long-term liabilities• Ratio of liabilities to stockholders’ equity• Number of times interest charges are earned


Current Position Analysis

• Using measures to assess a business’s ability to ______________• __________– current assets less current

liabilities• ________ – current assets divided by current

liabilities• _________ – total “quick” assets divided by

current liabilities


Current Position Analysis – Working Capital

and Current Ratio

Mooney Company


Current Position Analysis – Quick RatioQuick Ratio =Quick Ratio = Quick Assets

Current Liabilities

Quick Assets$280,500

Quick Assets$160,000

Quick Ratio:

$__________÷ $______= ______Mooney

Wendt $__________÷ $______= ______


Accounts Receivable Analysis• Measures efficiency of collection• Reflects liquidity

Accounts Receivable Turnover Accounts Receivable Turnover

Number of Days’ Sales in Number of Days’ Sales in Receivables Receivables

==

==


Accounts Receivable Turnover

The company _______ its accounts receivable turnover by _____ measured in terms of the number of times receivables are collected within the year.


Days’ Sales in Receivables

The company improved its collections of accounts receivable by 10.9 days in 2012 measured in days receivables have been outstanding.


Inventory Analysis• Measures inventory ________

• Avoid tying up funds in _________• Avoid _________

• Reflects liquidity

Inventory Turnover Inventory Turnover

Number of Days’ Sales Number of Days’ Sales in Inventoryin Inventory

==

==


Inventory Turnover

The company turned its inventory 1 time more in 2012, measured in terms of the number of times inventory turns over within the year.


Days’ Sales in Inventory

The company reduced the time it held inventory by nearly 28% in 2012 measured in days the inventory was held in warehouses.


Ratio of Fixed Assets to Long-Term Liabilities

• Indicates the ___________ for note-holders or bondholders

• Indicates the ability to ___________ on a long-term basis

Fixed Assets to Long-Fixed Assets to Long-Term LiabilitiesTerm Liabilities

Fixed Assets (net) Long-Term Liabilities==


Ratio of Fixed Assets to Long-Term Liabilities

The company increased its margin of safety in financing fixed assets mainly by lowering long-term debt.


Ratio of Liabilities to Stockholders’ Equity

• Indicates the margin of ___________.• Indicates the ability to __________________.

Liabilities to Stockholders’ Equity

Total LiabilitiesTotal Stockholders’

Equity

=


Ratio of Liabilities to Stockholders’ Equity

The ratio shows an increasing margin of safety for creditors.


Number of Times Interest Charges Earned

• Indicates the general ___________________ of the business

• Indicates the ability to __________ adverse business conditions

Times Interest Charges Earned

Income before Taxes + Interest Expense Interest Expense

==


Number of Times Interest Charges Earned

The number of times interest charges are earned improved from 12.2 to 28.1, a significant measure of safety for creditors.



Use financial statement analysis to assess the profitability of a

business


Profitability Analysis• Normally assessed by examining the income

statement and balance sheet resources, using the following major analyses:• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________


Ratio of Net Sales to Assets• Shows how effectively a firm utilizes its

assets

Net SalesNet Sales Avg. Total Assets (excluding LT Investments)Avg. Total Assets (excluding LT Investments)


Rate Earned on Total Assets

Interest Expense + Net Income Interest Expense + Net Income Avg. Total AssetsAvg. Total Assets

• Measures the profitability of total assets without considering how the assets are financed.


Rate Earned on Stockholders’ Equity

Net IncomeNet Income Avg. Stockholders’ EquityAvg. Stockholders’ Equity

• Emphasizes the rate of income earned on the amount invested by the stockholders.


Leverage

The effect of leverage for 2012 is 3.1% which compares favorably with the 2.7% leverage for 2011.

Exhibit 8: Effect of leverage


Rate Earned on Common Stockholders’ Equity

Net Income – Preferred DividendsNet Income – Preferred DividendsAvg. Common Stockholders’ EquityAvg. Common Stockholders’ Equity

• Focuses on the rate of profits earned on the amounts invested by the common stockholders.


Earnings Per Share on Common Stock

Net Income – Preferred DividendsNet Income – Preferred DividendsCommon Shares OutstandingCommon Shares Outstanding

• The income earned for each share of common stock.


Price-Earnings Ratio

Market Price Per Share of Common StockMarket Price Per Share of Common StockAnnual Earnings Per ShareAnnual Earnings Per Share

• Indicator of the firm’s future earnings prospects.


Dividends per Share and Earnings per Share

Exhibit 9: Dividends and Earnings per Share of Common Stock

Dividends per Share Common Dividends Total Common Shares Outstanding

=


Dividends Per Share and Dividend Yield

• Dividend yield shows the rate of return to common stockholders in terms of cash dividends.

Dividend Yield Dividends per Share of Common Stock Market Price per Share of Common Stock=



Describe the contents of corporate annual reports


Corporate Annual Reports• Summarize operating activities for the past

year and plans for the future. • Many variations in the order and form, but all

include:• ___________________________• ___________________________• ___________________________


Management Discussion and Analysis (MD&A)

• Provides critical information in interpreting the financial statements and assessing the future of the company.

• Includes an analysis about past performance and financial condition.

• Discusses management’s opinion about future performance.

• Discusses significant risk exposure.


Independent Auditors’ Report• Publicly traded companies must get an

independent opinion on the fairness of the financial statements.

• This opinion must be included in the annual report along with an opinion on the accuracy of management’s internal control assertion.


End of Chapter 9

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