principles of financial accounting - ch 17 notes
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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPAWinston Kwok, Ph.D., CPA
McGraw-H il l/I rwin Copyri ght 2011 by The McGraw-H il l Companies, I nc. Al l ri ghts reserved.
ANALYSIS
OF
FINANCIAL
STATEMENTS
Chapter 17
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Applicationof analytical
tools
Involvestransforming
data
Reducesuncertainty
BASICSOFANALYSIS
Financial statement analysis helps usersmake better decisions.
Internal UsersManagersOfficers
Internal Auditors
External UsersShareholdersLenders
Customers
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BUILDINGBLOCKSOFANALYSIS
C 1
Liquidity and
efficiency Solvency
Marketprospects
Profitability
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INFORMATIONFORANALYSIS
C 1
1. Income Statement (Statement ofComprehensive Income)
2. Balance Sheet (Statement ofFinancial Position)
3. Statement of Changes in Equity4. Statement of Cash Flows
5. Notes to the Financial Statements
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Intracompany
CompetitorsIndustry
Guidelines
STANDARDSFORCOMPARISON
C 1
When we interpret our analysis, it is essential tocompare the results we obtained to other
standards or benchmarks.
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Horizontal Analysis
Comparing a companys financial condition andperformance across time.
TOOLSOFANALYSIS
Vertical Analysis
Comparing a companys financial condition andperformance to a base amount.
Ratio Analysis
Measurement of key relations between financial statementitems.
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HORIZONTALANALYSIS
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COMPARATIVESTATEMENTS
Calculate Change in Dollar Amount
DollarChange
Analysis PeriodAmount
Base PeriodAmount=
When measuring the amount of the
change in dollar amounts, compare theanalysis period balance to the base
period balance. The analysis period isusually the current year while the base
period is usually the prior year.
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COMPARATIVESTATEMENTS
Calculate Change as a Percent
Percent
Change
Dollar Change
Base Period Amount 100=
P 1
When calculating the change as a
percentage, divide the amount of thedollar change by the base period
amount, and then multiply by 100 toconvert to a percentage.
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$1,550,861$835,546 = $715,315
P 1
($715,315 $835,546) 100 = 85.6%
HORIZONTALANALYSIS
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HORIZONTALANALYSIS
($3,888,038 $11,065,186) 100 = 35.1%
$14,953,224$11,065,186 = $3,888,038
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TRENDANALYSIS
Trend analysis is used to reveal patterns in datacovering successive periods.
TrendPercent
Analysis Period AmountBase Period Amount
100=
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TRENDANALYSIS
Research in MotionIncome Statement Information
Using 2006 as the base year we will get the following trend information:
Examples of 2006-2008 Calculations for Revenues:2006 is base year. Set to 100%2007: $3,037,103$2,065,845100 = 147.0%
2008: $6,009,395$2,065,845100 = 290.9%
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TRENDANALYSIS
We can use the trend percentages to construct agraph so we can see the trend over time.
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VERTICALANALYSIS
Common-Size Statements
Common-size
Percent
Analysis Amount
Base Amount100
=
Financial Statement Base Amount
Balance Sheet Total Assets
Income Statement Revenues
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($1,550,861 $10,204,409) 100 = 15.2%
($835,546 $8,101,372) 100 = 10.3%
COMMON-SIZEBALANCESHEET
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COMMON-SIZEINCOMESTATEMENT
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($8,368,958 $14,953,224) 100 = 56.0%
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COMMON-SIZEGRAPHICS
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RATIOANALYSIS
P 3
Liquidity
andefficiency Solvency
Marketprospects
Profitability
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CurrentRatio
Acid-testRatio
Accounts
ReceivableTurnover
InventoryTurnover
DaysSales
Uncollected
DaysSales
in Inventory
Total Asset
Turnover
LIQUIDITYANDEFFICIENCY
P 3
DaysPurchases in
AccountsPayable
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WORKINGCAPITAL
Working capitalrepresents current assetsfinanced from long-term capital sources that
do not require near-term repayment.
Current assetsCurrent liabilities= Working capital
More working capital suggests a strong liquidityposition and an ability to meet current obligations.
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This ratio measures the short-term debt-paying ability of the company. A higher current
ratio suggests a strong liquidity position.
CURRENTRATIO
Current Ratio =Current Assets
Current Liabilities
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This ratio is like the current ratio but excludes current assetssuch as inventories and prepaid expenses that may be
difficult to quickly convert into cash.
ACID-TESTRATIO
Acid-test ratio =
Cash + Short-term investments + Currentreceivables
Current LiabilitiesReferred to as Quick Assets
P 3
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This ratio measures howmany times a companyconverts its receivables
into cash each year.
ACCOUNTSRECEIVABLETURNOVER
Accounts receivable =turnover
Net salesAverage accounts receivable,
net
Average accounts receivable =(Beginning acct. rec. + Ending acct. rec.)
2
P 3
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This ratio measures thenumber of times
merchandise is sold andreplaced during the year.
INVENTORYTURNOVER
Inventory turnover =Cost of goods soldAverage inventory
Average inventory = (Beginning inventory + Ending inventory)2
P 3
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Provides insight into how frequently acompany collects its accounts receivable.
DAYSSALES UNCOLLECTED
Day's sales =uncollected
Accounts receivable, net 365
Net sales
P 3
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DAYSSALES IN INVENTORY
Day's sales in =Inventory
Ending inventory 365
Cost of goods sold
This ratio is a useful measure in evaluatinginventory liquidity. If a product is demandedby customers, this formula estimates how
long it takes to sell the inventory.
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DAYSPURCHASES IN ACCOUNTSPAYABLE
Accounts =Payable
Accounts payable 365
Cost of goods sold
This ratio is a useful measure in evaluatinghow long the business takes to pay its credit
suppliers.
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CASH CONVERSION CYCLE
The sum of the dayssales uncollected and thedayssales in inventory subtracting the dayspurchases in accounts payable. It represents
the number of days a firms cash remains tiedup within the operations of the business.
The lower the cash conversion cycle, the morehealthy a company generally is.
P 3
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TOTALASSETTURNOVER
Total asset turnover =Net sales
Average total assets
Average assets =(Beginning assets + Ending assets)
2
This ratio reflects a
companys ability to useits assets to generate
sales. It is an importantindication of operating
efficiency.
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DebtRatio
Equity
Ratio
Pledged Assetsto Secured
Liabilities
TimesInterestEarned
SOLVENCY
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DEBTANDEQUITYRATIOS
Amount RatioTotal liabilities $ 8,000,000 66.7% [Debt ratio]Total equity 4,000,000 33.3% [Equity ratio]
Total liabilities and equity $ 12,000,000 100.0%
$8,000,000$12,000,000 = 66.7%
The debt ratioexpresses total liabilities as a percent oftotal assets. The equity ratioprovides complementary
information by expressing total equity as a percent of totalassets.
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DEBT-TO-EQUITYRATIO
Debt-to-equity ratio =Total liabilitiesTotal equity
This ratio measures what portion of a companysassets are contributed by creditors. A larger debt-to-
equity ratio implies less opportunity to expand
through use of debt financing.
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TIMESINTERESTEARNED
Times interest earned =
Income before interest andtaxes
Interest expense
This is the most common measure of theability of a companys operations to provide
protection to long-term creditors.
Net income+ Interest expense
+ Income taxes
= Income before interest and taxes
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ProfitMargin
Return onTotal Assets
Return on OrdinaryShareholders
Equity
PROFITABILITY
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PROFITMARGIN
Profit margin =Net incomeNet sales
This ratio describes a companys abilityto earn net income from each sales dollar.
P 3
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Return on total asset =Net income
Average total
assets
RETURNONTOTALASSETS
Return on total assets measures how well
assets have been employed by thecompanys management.
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RETURN ON ORDINARY SHAREHOLDERS'EQUITY
Return on ordinary shareholders'equity =
Net income - Preferencedividends
Average ordinary shareholders'equity
This measure indicates how well thecompany employed the shareholdersequity
to earn net income.
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Price-EarningsRatio
DividendYield
MARKETPROSPECTS
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PRICE-EARNINGSRATIO
Price-earnings ratio =Market price per ordinary share
Earnings per share
This measure is often used by investors as ageneral guideline in gauging share values.
Generally, the higher the price-earnings ratio,the more opportunity a company has for growth.
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DIVIDENDYIELD
Dividend yield =Annual cash dividends per share
Market price per share
This ratio identifies the return, in terms of cashdividends, on the current market price per share
of the companys ordinary shares.
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ANALYSISREPORTING
A1
1. Executive Summary2. Analysis Overview3. Evidential Matter4. Assumptions5. Key Factors
6. Inferences
The purpose of financial statement analyses is toreduce uncertainty in business decisions through a
rigorous and sound evaluation. A financial statement
analysis report directly addresses the building blocks ofanalysis and documents the reasoning.
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ENDOFCHAPTER17
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