Download - Analyzing Financial Statements Chapter 14 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc
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Analyzing Financial StatementsAnalyzing Financial Statements
Chapter 14
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.
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Slide 2McGraw-Hill/IrwinMcGraw-Hill/Irwin
THREE TYPES OF FINANCIAL STATEMENT INFORMATION
PastPerformance
PresentCondition
FuturePerformance
Income, sales volume, cash flows, return-
on-investments,EPS.
Assets, debt, inventory,
various ratios.
Sales and earnings trends are good
indicators of future performance.
Financial Statement Analysis
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Slide 3McGraw-Hill/IrwinMcGraw-Hill/Irwin
Financial Statement Analysis
Examines a single company to identify
trends over time.
Financial statement analysisis based on comparisons.
Time seriesanalysis
Comparison with similar companies
Provides insightsconcerning a
company’s relativeperformance.
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Slide 4McGraw-Hill/IrwinMcGraw-Hill/Irwin
Component Percentages
Express each item on a particular statement as a percentage of a single base amount.
Total assetson the balance
sheet
Net saleson the income
statement
The comparative income statements of Home Depot for 2007 and 2006 appear on the next slide.
Prepare component percentage income statements where net sales equal 100%.
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Slide 5McGraw-Hill/IrwinMcGraw-Hill/Irwin
HOME DEPOTComparative Income Statements (Condensed)
Amounts in Millions Except Per Share Data2007 Percent 2006 Percent
Net Sales 90,837$ 100.0% 81,511$ 100.0% Cost of Merchandise Sold 61,054 67.2% 54,191 66.5%
Gross Profit 29,783 32.8% 27,320 33.5% Operating Expenses 20,110 22.1% 17,957 22.0%
Operating Income 9,673 10.6% 9,363 11.5% Interest and Investment Income 27 0.0% 62 0.1% Interest Expense (392) -0.4% (143) -0.2%
Earnings Before Income Taxes 9,308 10.2% 9,282 11.4% Income Taxes 3,547 3.9% 3,444 4.2% Net Earnings 5,761$ 6.3% 5,838$ 7.2%
Basic Earnings Per Share 2.80$ 2.73$ Weighted-Average Number of Common Shares Outstanding 2,062 2,147 Diluted Earnings Per Share 2.79$ 2.72$
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Slide 6McGraw-Hill/IrwinMcGraw-Hill/Irwin
Commonly Used Ratios
The 2007 and 2006 balance sheets for Home Depot are presented next.
We will be referring to these financial statements throughout the ratio analyses.
The 2007 and 2006 balance sheets for Home Depot are presented next.
We will be referring to these financial statements throughout the ratio analyses.
Home Depot
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Slide 7McGraw-Hill/IrwinMcGraw-Hill/Irwin
Continued
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Slide 8McGraw-Hill/IrwinMcGraw-Hill/Irwin
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Slide 9McGraw-Hill/IrwinMcGraw-Hill/Irwin
Test of Profitability ─ Return on Equity
Return on Equity $5,761
($25,030 + $26,909) ÷ 2= = 22.2%
This measure indicates how much income was earned for every dollar invested by the owners.This measure indicates how much income was earned for every dollar invested by the owners.
Profitability is a primary measure ofthe overall success of a company.
Profitability is a primary measure ofthe overall success of a company.
Net Income
Average Stockholders’ EquityReturn on Equity =
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Slide 10McGraw-Hill/IrwinMcGraw-Hill/Irwin
Test of Profitability ─ Earnings per Share (EPS)
EPS $5,761
(1,970 + 2124) ÷ 2= = $2.81
Earnings per share is probably the single most widely watched financial ratio.
Earnings per share is probably the single most widely watched financial ratio.
Average number of shares based on the numberof shares at the beginning and end of the year.
Net Income* Average Number of Shares Outstanding for the Period
EPS =
*If there are preferred dividends, the amount is subtracted from net income.
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Slide 11McGraw-Hill/IrwinMcGraw-Hill/Irwin
Tests of Liquidity ─ Current Ratio
Current
Ratio
Current Assets
Current Liabilities=
Current
Ratio
$18,000
$12,931
= = 1.39 to 1
This ratio measures the abilityof the company to pay current
debts as they become due.
This ratio measures the abilityof the company to pay current
debts as they become due.
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Slide 12McGraw-Hill/IrwinMcGraw-Hill/Irwin
Tests of Liquidity ─ Receivable Turnover
Net Credit Sales
Average Net ReceivablesReceivable
Turnover=
Receivable
Turnover
$90,837
($3,223 + $2,396) ÷ 2= 32.3 Times=
This ratio measures how quickly a company collects its
accounts receivable.
This ratio measures how quickly a company collects its
accounts receivable.
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Slide 13McGraw-Hill/IrwinMcGraw-Hill/Irwin
This ratio indicates a margin of protection for creditors.
Tests of Solvency ─ Times Interest Earned
Net Interest Income Tax
Income Expense Expense
Interest Expense
Times
Interest
Earned=
+ +
$5,761 + $392 + $3,547
$392
Times
Interest
Earned= = 24.7 Times
Tests of solvency measure a company’sability to meet its long-term obligations.
Tests of solvency measure a company’sability to meet its long-term obligations.
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Slide 14McGraw-Hill/IrwinMcGraw-Hill/Irwin
Tests of Solvency ─ Debt-to-Equity Ratio
This ratio measures the amount of liabilities that exists for each $1
invested by the owners.
This ratio measures the amount of liabilities that exists for each $1
invested by the owners.
$27,233
$25,030= 1.09=
Debt-to-Equity
Ratio
Total Liabilities
Stockholders’ Equity
Debt-to-Equity
Ratio=
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Slide 15McGraw-Hill/IrwinMcGraw-Hill/Irwin
Market Tests ─ Price/Earnings (P/E) Ratio
P/E Ratio =Current Market Price Per Share
Earnings Per Share
P/E Ratio =$34
$2.80= 12.1
This ratio measures the relationship between the current market price of the stock and its earnings per share.
A recent price for Home Depot stock was $34 per share.
Market tests relate the current market price of a share of stock to an indicator of the return that might accrue to the investor.
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Slide 16McGraw-Hill/IrwinMcGraw-Hill/Irwin
Other Financial Information In addition to financial ratios, special factors might affect company
analysis: Rapid growth. Uneconomical expansion. Subjective factors.
A securities market in which prices fully reflect available information is called an efficient
market.
In an efficient market, a company’s stock reacts quickly when new, relevant information is
released about the company.