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Building Blocks of Analysis C 1 Liquidity and efficiency Solvency Market prospects Profitability
Citation preview
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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., CPA
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Analysis of Financial Statements
Chapter 17
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Application of analytical
tools
Involves transforming
data
Reduces uncertainty
Basics of Analysis
Financial statement analysis helps users make better decisions.
Internal UsersManagersOfficers
Internal Auditors
External UsersShareholders
LendersCustomers
C 1
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Building Blocks of AnalysisC 1
Liquidity and efficiency Solvency
Market prospectsProfitability
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Information for AnalysisC 1
1. Income Statement2. Balance Sheet 3. Statement of
Stockholders’ Equity4. Statement of Cash Flows5. Notes to the Financial
Statements
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IntracompanyIntracompany
CompetitorsCompetitors
IndustryIndustry
GuidelinesGuidelines
Standards for ComparisonC 1
When we interpret our analysis, it is essential to compare the results we obtained to other
standards or benchmarks.
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Horizontal AnalysisComparing a company’s financial condition and
performance across time.
Tools of Analysis
Vertical AnalysisComparing a company’s financial condition and
performance to a base amount.
Ratio AnalysisMeasurement of key relations between financial
statement items.
C 2
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Horizontal AnalysisP 1
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Comparative Statements
Calculate Change in Dollar Amount
DollarChange
Analysis Period Amount
Base PeriodAmount= –
When measuring the amount of the change in dollar amounts, compare the
analysis period balance to the base period balance. The analysis period is usually the current year while the base
period is usually the prior year.
P 1
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Comparative Statements
Calculate Change as a Percent
PercentChange
Dollar Change Base Period Amount 100= ×
P 1
When calculating the change as a percentage, divide the amount of the
dollar change by the base period amount, and then multiply by 100 to
convert to a percentage.
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$325,336 – $393,927 = $(68,591)
($(68,591) ÷ $393,927) × 100 = (17.4)%
Horizontal AnalysisP 1
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Horizontal Analysis
($665,810 ÷ $1,991,139) × 100 = 33.4%
$2,656,949 – $1,991,139 = $665,810
P 1
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Trend Analysis
Trend analysis is used to reveal patterns in data covering successive periods.
TrendPercent
Analysis Period Amount Base Period Amount 100= ×
P 1
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Polaris Industries Inc.Income Statement Information
Using 2007 as the base year we will get the following trend information:
Examples of 2007-2011 Calculations for Revenues:2007 is base year. Set to 100%2008: $1,948,254 ÷ $1,780,009 × 100 = 109.5%2009: $1,565,887 ÷ $1,780,009 × 100 = 88.0%
P 1
Trend Analysis
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Trend Analysis
We can use the trend percentages to construct a graph so we can see the trend over time.
P 1
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Vertical Analysis
Common-Size Statements
Common-size Percent
Analysis AmountBase Amount 100= ×
Financial Statement Base Amount
Balance Sheet Total Assets
Income Statement Revenues
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($325,336 ÷ $1,228,024) × 100 = 26.5%
($393,927 ÷ $1,061,647) × 100 = 37.1%
Common-Size Balance SheetP 2
•Percents are rounded to tenths and thus may not exactly sum to totals and subtotals.
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Common-Size Income StatementP 2
($1,916,366 ÷ $2,656,949) × 100 = 72.1%
($1,460,926 ÷ $1,991,139) × 100 = 73.4%
•Percents are rounded to tenths and thus may not exactly sum to totals and subtotals.
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Common-Size GraphicsP 2
Common-Size Graphic ofAsset Components
Common-Size Graphic ofIncome Statement
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Ratio AnalysisP 3
Liquidity and efficiency Solvency
Market prospectsProfitability
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Current Ratio
Acid-test Ratio
Accounts Receivable
Turnover
Inventory Turnover
Days’ Sales Uncollected
Days’ Sales in Inventory
Total Asset Turnover
Liquidity and EfficiencyP 3
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Working Capital
Working capital represents current assets financed from long-term capital sources that
do not require near-term repayment.
Current assets– Current liabilities= Working capital
More working capital suggests a strong liquidity More working capital suggests a strong liquidity
position and an ability to meet current obligations.position and an ability to meet current obligations.
P 3
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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.
Current Ratio
Current Ratio = Current AssetsCurrent Liabilities
P 3
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This ratio is like the current ratio but excludes current assets such as inventories and prepaid expenses that may be
difficult to quickly convert into cash.
Acid-Test Ratio
Acid-test ratio = Cash + Short-term investments + Current
receivablesCurrent Liabilities
Referred to as Quick Assets
P 3
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This ratio measures how many times a company converts its receivables
into cash each year.
Accounts Receivable Turnover
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 the number of times
merchandise is sold and replaced during the year.
Inventory Turnover
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 a company collects its accounts receivable.
Days’ Sales Uncollected
Day's sales = uncollected
Accounts receivable, net× 365
Net sales
P 3
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Days’ Sales in Inventory
Day's sales in = Inventory
Ending inventory× 365
Cost of goods sold
This ratio is a useful measure in evaluating inventory liquidity. If a product is demanded by customers, this formula estimates how
long it takes to sell the inventory.
P3
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Total Asset Turnover
Total asset turnover = Net salesAverage total assets
Average assets = (Beginning assets + Ending assets)2
This ratio reflects a company’s ability to use its assets to generate
sales. It is an important indication of operating
efficiency.
P 3
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DebtRatio
EquityRatio
Pledged Assets to Secured Liabilities
Times Interest Earned
SolvencyP 3
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Debt and Equity Ratios
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 ratio expresses total liabilities as a percent of total assets. The equity ratio provides complementary
information by expressing total equity as a percent of total assets.
P 3
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Debt-to-Equity Ratio
Debt-to-equity ratio = Total liabilities Total equity
This ratio measures what portion of a company’s assets are contributed by creditors. A larger debt-to-
equity ratio implies less opportunity to expand through use of debt financing.
P 3
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Times Interest Earned
Times interest earned =
Income before interest and taxes
Interest expense
This is the most common measure of the ability of a company’s operations to provide
protection to long-term creditors.
Net income+ Interest expense+ Income taxes= Income before interest and taxes
P 3
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Profit Margin
Return on Total Assets
Return on Common Stockholders’ Equity
ProfitabilityP 3
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Profit Margin
Profit margin = Net income Net sales
This ratio describes a company’s ability to earn net income from each sales dollar.
P 3
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Return on total asset =
Net income Average total
assets
Return on Total Assets
Return on total assets measures how well assets have been employed by the
company’s management.
P 3
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Return on Common Stockholders’ Equity
Return on common stockholders' equity =
Net income - Preferred dividends Average common stockholders'
equity
This measure indicates how well the company employed the stockholders’ equity to earn net
income.
P 3
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Price-Earnings Ratio
Dividend Yield
Market ProspectsP 3
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Price-Earnings Ratio
Price-earnings ratio = Market price per common share Earnings per share
This measure is often used by investors as a general guideline in gauging stock values.
Generally, the higher the price-earnings ratio, the more opportunity a company has for growth.
P 3
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Dividend Yield
Dividend yield = Annual cash dividends per share Market price per share
This ratio identifies the return, in terms of cash dividends, on the current market price per share
of the company’s common stock.
P 3
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Summary of Ratios
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Global View
Horizontal and Vertical AnalysisHorizontal and vertical analyses help eliminate many differences between U.S. GAAP
and IFRS when analyzing and interpreting financial statements. However, when fundamental differences in reporting regimes impact financial statements, the user
must exercise caution when drawing conclusions.
Ratio AnalysisRatio analysis of financial statements also helps eliminate differences between U.S.
GAAP and IFRS. Importantly, the use of ratio analysis is fine, with some possible changes in interpretation depending on what is and what is not included in certain
accounting measures across U.S. GAAP and IFRS. Care must be taken in drawing inferences from a comparison of ratios across reporting regimes.
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Analysis ReportingA1
1. Executive Summary2. Analysis Overview3. Evidential Matter4. Assumptions5. Key Factors6. Inferences
The purpose of financial statement analyses is to reduce uncertainty in business decisions through a
rigorous and sound evaluation. A financial statement analysis report directly addresses the building blocks of
analysis and documents the reasoning.
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Net IncomeNet Income
Appendix 17A: Sustainable Income
DiscontinuedSegments
ExtraordinaryItems
ContinuingOperations
A 2
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End of Chapter 17
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