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©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
©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.
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.
©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.
Learning Objective 1
Describe basic financial statement analytical procedures
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Horizontal Analysis• The __________ analysis of _________ and
_________ in related items in _________ financial statements
Exhibit 1: Comparative Balance Sheet— Horizontal Analysis
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Vertical Analysis• A __________ analysis used to show the
relationship of each __________ to the ________ within __________ statement
Exhibit 5: Comparative Balance Sheet— Vertical Analysis
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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
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Common-Sized StatementsExhibit 7: Common- Sized Income Statement
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Learning Objective 2
Use financial statement analysis to assess the liquidity and solvency of
a business
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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!
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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
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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
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Current Position Analysis – Working Capital
and Current Ratio
Mooney Company
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Current Position Analysis – Quick RatioQuick Ratio =Quick Ratio = Quick Assets
Current Liabilities
Quick Assets$280,500
Quick Assets$160,000
Quick Ratio:
$__________÷ $______= ______Mooney
Wendt $__________÷ $______= ______
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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
==
==
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Accounts Receivable Turnover
The company _______ its accounts receivable turnover by _____ measured in terms of the number of times receivables are collected within the year.
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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.
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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
==
==
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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.
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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.
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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==
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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.
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Ratio of Liabilities to Stockholders’ Equity
• Indicates the margin of ___________.• Indicates the ability to __________________.
Liabilities to Stockholders’ Equity
Total LiabilitiesTotal Stockholders’
Equity
=
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Ratio of Liabilities to Stockholders’ Equity
The ratio shows an increasing margin of safety for creditors.
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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
==
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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.
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Learning Objective 3
Use financial statement analysis to assess the profitability of a
business
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Profitability Analysis• Normally assessed by examining the income
statement and balance sheet resources, using the following major analyses:• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________• _____________________________
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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)
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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.
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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.
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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
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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.
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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.
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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.
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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
=
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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=
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Learning Objective 4
Describe the contents of corporate annual reports
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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:• ___________________________• ___________________________• ___________________________
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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.
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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.
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End of Chapter 9
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