Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Chapter 5 The Analysis of Financial Statements 5-1

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 5The Analysis of Financial Statements

5-1

5-2Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 5-2

Objectives of Analysis

Objectives will vary depending on the:

• perspective of the financial statement user

• specific questions that are addressed by the analysis



Creditors

• A creditor is concerned with the ability of an existing or prospective borrower to make interest and principal payments on borrowed funds.

• The questions raised by a creditor include: What is the borrowing cause?

What is the firm’s capital structure?

What will be the source of debt repayment?



Investors

• An investor attempts to attach a value to the securities being considered for purchase or liquidation.

• The questions raised by an investor include: What is the company’s performance record and

future expectations?

How much risk is inherent in the firm’s capital structure?

How successfully does the firm compete in its industry?



Management

• Management must consider questions that creditors, investors, employees, the general public, regulators, and the financial press have.

• Additional questions raised by a manager include: How well has the firm performed and why?

What are the strengths and weaknesses of the firm’s financial position?

What changes should be implemented to improve future performance?



Financial statements

• provide insight into the company’s current status

• lead to the development of policies and strategies for the future

• are prepared by management


Sources of Information

• Analysis should begin with the financial statements and the notes to financial statements.

• Other resources include: Proxy statement

Auditor’s report

Management discussion and analysis

Supplementary schedules

Form 10-K and Form 10-Q

Other sources



Proxy Statement

• Contains useful information about: the board of directors

director and executive compensation

option grants

audit-related matters

related party transactions

proposals to be voted on by shareholders



Auditor’s Report

• Contains the expression of opinion as to the fairness of the financial statement presentation

• Can be: unqualified (presented fairly)

qualified (suggests careful evaluation be made)

unqualified opinion with explanatory language (should be reviewed carefully)



Management Discussion and Analysis

• Section of the annual report that is required and monitored by the SEC

• Includes facts and estimates not found elsewhere in the annual report

• Contains detailed coverage of the firm’s liquidity, capital resources, and operations

• Discloses favorable or unfavorable trends and significant events or uncertainties related to the historical or prospective financial condition and operations



Supplementary Schedules

• Certain schedules are required for inclusion in the annual report

• Frequently helpful to the analysis



Form 10-K and Form 10-Q

• Form 10-K is an annual document filed with the SEC by companies that sell securities to the public. Contains much of the same information

as the annual report

Shows additional detail that may be of interest

• Form 10-Q is a less extensive document filed quarterly with the SEC.



Other Sources

• Computerized financial statement analysis packages

• General resources that provide comparative statistical ratios

• Free Internet sites

• Internet sites with subscription fees (often available through public and college libraries)

• Web sites containing company profiles and stock prices

• Articles from current periodicals


Tools and Techniques

• Common-size financial statements

• Key financial ratios

• Trend analysis

• Structural analysis

• Industry comparisons

• Common sense and judgment



Common-size financial statements

• Express each account on the balance sheet as a percentage of total assets

• Express each account on the income statement as a percentage of net sales



Sage Inc. Common-Size Balance Sheet (Exhibit 2.2, p. 50)

• Inventories have become more dominant.

• Holdings of cash and cash equivalents have decreased.

• The firm has opened 43 new stores in the past two years.

• Buildings, leasehold improvements, equipment, and accumulated depreciation and amortization have increased as a percentage of total assets.

• Proportion of debt required to finance investments in assets has risen, primarily from long-term borrowings.



Sage Inc. Common-Size Income Statement (Exhibit 3.3, p. 100)

• Cost of goods sold percentage has increased slightly, resulting in a small decline in gross profit percentage.

• Depreciation and amortization have increased relative to sales.

• Selling and administrative expenses rose in 2011 but were controlled in 2012 and 2013 relative to overall sales.

• Profit percentages deteriorated through 2012 but rebounded in 2013.



Key financial ratios

• standardize financial data in terms of mathematical relationships

• are expressed as percentages or times

• are extremely valuable

• have limitations




• serve as screening devices

• indicate areas of potential strength or weakness

• reveal matters that need further investigation

• are not predictive




• should be used with caution and common sense

• should be used in combination with other elements of analysis

• should be evaluated and interpreted within the context of the particular firm, industry, and economic environment




• Liquidity ratios

• Activity ratios

• Leverage ratios

• Profitability ratios

• Market ratios



Key financial ratios – Liquidity Ratios

• Measure ability to meet cash needs as they arise



Key Financial Ratios – Liquidity Ratios

• Current Ratio

• Quick Ratio (Acid-Test Ratio)

• Cash Flow Liquidity Ratio

• Average Collection Period

• Days Inventory Held

• Days Payable Outstanding



Current Ratio• Commonly used measure of the ability of a firm

to meet its debt requirements as they come due

• Limited by its components

• Some analysts eliminate prepaid assets.

• Necessary to evaluate the trend of liquidity over a period of time and compare with industry competitors



Quick Ratio (Acid-Test Ratio)• More rigorous test of short-run solvency than the

current ratio

• Numerator eliminates inventory (the least liquid current asset and the most likely source of losses)

• Some analysts eliminate prepaid expenses.

• Necessary to evaluate the trend of liquidity over a period of time and compare with industry competitors



Cash Flow Liquidity Ratio

• Considers cash flow from operating activities

• Uses cash and marketable securities as an approximation of cash resources in the numerator of the ratio



Average Collection Period• Average number of days required to convert

receivables into cash

• Credit sales can be substituted for net sales.

• Helps gauge the liquidity of account receivable

• May provide information about credit policies

• Should be compared with the firm’s stated credit policies and the strength of the firm within its industry



Days Inventory Held• Average number of days required to sell inventory

to customers

• Measures efficiency of the firm in managing its inventory

• Type of industry is important in evaluating this ratio

• Necessary to check the cost flow assumption used to value inventory and cost of goods sold when making comparisons among firms



Days Payable Outstanding

• Average number of days it takes to pay payables in cash

• Offers insight into a firm’s pattern of payments to suppliers



Key Financial Ratios – Cash Conversion Cycle

• Also called Net Trade Cycle

• Normal operating cycle of a firm that consists of: buying or manufacturing inventory, with

some purchases on credit selling inventory, with some sales on credit collecting the cash

• Helps the analyst understand why cash flow generation has changed



Key Financial Ratios – Cash Conversion Cycle



Key financial ratios – Activity Ratios

• Measure liquidity of specific assets and efficiency of managing assets



Key Financial Ratios – Activity Ratios

• Accounts Receivable Turnover

• Inventory Turnover

• Accounts Payable Turnover

• Fixed Asset Turnover

• Total Asset Turnover



Accounts Receivable Turnover

• Measures how many times on average accounts receivable are collected in cash during the year

• Measures efficiency of a firm’s collection and credit policies



Inventory Turnover

• Measures how many times on average inventory is sold during the year

• Measures efficiency of a firm in managing its inventory



Accounts Payable Turnover

• Measures how many times on average payables are paid during the year

• Helps to gain insight into a firm’s pattern of payment to suppliers



Fixed Asset Turnover

• Assesses management’s effectiveness in generating sales from investments in fixed assets

• Considers only the firm’s investment property, plant, and equipment

• Extremely important for a capital-intensive firm

• High ratio generally means only a small investment is required to generate sales (and thus the firm will be more profitable).



Total Asset Turnover

• Assesses management’s effectiveness in generating sales from investments in assets

• Considers all assets

• High ratio generally means only a small investment is required to generate sales (and thus the firm will be more profitable).



Key financial ratios – Leverage Ratios

• Measure the extent of financing with debt relative to equity and ability to cover interest and other fixed charges

• Use of debt provides a trade-off of risk and return

• Debt ratios do not present the whole picture with regard to risk.

• Operating earnings must be sufficient to cover the associated fixed charges for debt to translate to leverage.



Key Financial Ratios – Leverage Ratios

• Debt Ratio

• Long-Term Debt to Total Capitalization

• Debt to Equity

• Times Interest Earned

• Cash Interest Coverage

• Fixed Charge Coverage

• Cash Flow Adequacy



Debt Ratio

• Measures the extent of the firm’s financing with debt

• Considers the proportion of all assets that are financed with debt



Long-Term Debt to Total Capitalization


• Reveals the extent to which long-term debt is used for the firm’s permanent financing



Debt to Equity


• Measures the riskiness of the firm’s capital structure in terms of the relationship between the funds supplied by creditors (debt) and investors (equity)



Times Interest Earned

• Indicates how well operating earnings cover fixed interest expenses

• The higher the ratio, the better

• Can be misleading depending on cash flow



Cash Interest Coverage

• Measures how many times interest payments can be covered by cash flow from operations before interest and taxes



Fixed Charge Coverage

• Broader measure of coverage capability than the times interest earned ratio

• Includes the fixed payments associated with leasing

• Important for firms that operate extensively with operating leases



Cash Flow Adequacy

• Measures firm’s ability to cover capital expenditures, long-term debt payments, and dividends each year

• Defined differently by analysts

• Operating cash flow should cover investing and financing activities.



Key financial ratios – Profitability Ratios

• Measure the overall performance of a firm and its efficiency in managing assets, liabilities, and equity



Key Financial Ratios – Profitability Ratios

• Gross Profit Margin

• Operating Profit Margin

• Net Profit Margin

• Cash Flow Margin

• Return on Total Assets (ROA)

• Return on Equity (ROE)

• Cash Return on Assets



Gross Profit Margin

• Represents firm’s ability to translate sales dollars into profits

• Shows the relationship between sales and the cost of products sold

• Measures the ability to control costs of inventories or manufacturing and to pass along price increases through sales



Operating Profit Margin


• Measures overall operating efficiency

• Incorporates all expenses associated with ordinary business activities



Net Profit Margin


• Measures profitability after consideration of all revenue and expense, including interest, taxes, and nonoperating items



Cash Flow Margin

• Measures ability to translate sales into cash

• Cash is needed to service debt, pay dividends, and invest in new capital assets.



Return on Total Assets (ROA)

• Also called Return on Investment (ROI)

• Measures the overall efficiency of the firm in managing its total investment in assets

• Indicates the amount of profit earned relative to the level of investment in total assets



Return on Equity (ROE)

• Measures the overall efficiency of the firm in generating return to shareholders

• Calculated as return on common equity if a firm has preferred stock outstanding



Cash Return on Assets

• Offers a useful comparison to return on investment

• Measures the firm’s cash-generating ability of assets



Key financial ratios – Market Ratios

• Measure returns to stockholders and the value the marketplace puts on a company’s stock

• Reporting of these numbers has a significant impact on stock price changes in the marketplace.

• Thorough analysis of a company, its environment, and its financial information offers a much better gauge of future prospects of the company than looking exclusively at these ratios.



Key Financial Ratios – Market Ratios

• Earnings Per Common Share

• Price-to-Earnings (P/E) Ratio

• Dividend Payout Ratio

• Dividend Yield



Earnings per Common Share

• Provides the investor with a common denominator to gauge investment returns

• Must be disclosed on the income statement for publicly held companies



Price to Earnings (P/E) Ratio

• Relates earnings per common share to the market price at which the stock trades, expressing the “multiple” that the stock market places on a firm’s earnings

• Function of a myriad of factors including quality of earnings, future earnings potential, and performance history



Dividend Payout Ratio

• Relates cash dividends per share to earnings per share



Dividend Yield

• Shows the relationship between cash dividends and market price





Trend analysis

• Requires the evaluation of financial data over several accounting periods



Structural analysis

• Looks at the internal structure of a business enterprise



Industry comparisons

• Relate one firm with averages compiled for the industry in which it operates


Analyzing the Data

There are five broad areas that would typically constitute a fundamental analysis of financial statements.

• Background on the firm, industry, economy, and outlook

• Short-term liquidity

• Operating efficiency

• Capital structure and long-term solvency

• Profitability


Analyzing the Data

Steps of a Financial Statement Analysis

1. Establish objectives of the analysis.

2. Study the industry in which firm operates and relate industry climate to current and projected economic developments.

3. Develop knowledge of the firm and the quality of management.


Analyzing the Data

Steps of a Financial Statement Analysis

4. Evaluate financial statements Tools: Common-size financial statements, key

financial ratios, trend analysis, structural analysis, and comparison with industry competitors

Major Areas: Short-term liquidity, operating efficiency, capital structure and long-term solvency, profitability, market ratios, segmental analysis (when relevant), and quality of financial reporting.

5. Summarize findings based on analysis and reach conclusions about firm relevant to the established objectives.


Analyzing the Data

Background: Economy, Industry, and Firm

• Economic developments

• Actions of competitors

• Environment in which the firm conducts business

• Blending hard facts with guesses and estimates


Analyzing the Data

Background – Sage Inc.

• Third largest retailer of recreational products in the United States

• Offers a broad line of sporting goods and equipment and active sports apparel in medium to higher price ranges to the general public

• Sells sporting goods on a direct basis to institutional customers such as schools and athletic teams

• General and executive offices are located in Dime Box, Texas.


Analyzing the Data


• Most retail stores occupy leased spaces and are located in major regional or suburban shopping districts throughout the southwestern United States.

• Eighteen new retail outlets were added in late 2012.

• Twenty-five new stores were opened in 2013.

• The firm owns distribution center warehouses located in Arizona, California, Colorado, Utah, and Texas.


Analyzing the Data


• Recreational products industry is affected by current trends in: consumer preferences

a cyclical sales demand

weather conditions

• Most retail sales occur in November, December, May, and June.

• Sales to institutions are highest in August and September.

• Recreational product retailers rely heavily on sales of sportswear for profits.


Analyzing the Data


• Running boom has shifted to walking and aerobics.

• Golf is increasing in popularity.

• Competition within the industry is based on: price

quality and variety of goods offered

location of outlets

quality of services offered


Analyzing the Data


• Current outlook for sporting goods industry is promising, following a recessionary year in 2012.

• Americans have become increasingly aware of the importance of physical fitness and have become more involved in recreational activities.

• The 25 to 44 age group is the most athletically active and is projected to be the largest age group in the United States during the next decade.

• The southwestern United States is expected to increase in population.


Analyzing the Data

Short-Term Liquidity

• Predicts future ability of the firm to meet prospective needs for cash

• Analysis of selected financial ratios

• Comparison of ratios to industry averages

• Important to creditors, suppliers, and management


Analyzing the Data

Short-Term Liquidity – Sage Inc.

• Inventories have increased relative to cash and cash equivalents.

• Increase in the proportion of debt, both short and long term

• Policies and financing needs related to new store openings

• Financial ratios are somewhat contradictory.


Analyzing the Data



Analyzing the Data


• Cash conversion cycle worsened from 2009 to 2012 but improved in 2013 due to an improvement in management of current assets and liabilities.

• Growth in inventories has been necessary to satisfy the requirements of opening new retail outlets. Has been accomplished by reducing holdings of

cash and cash equivalents

• Efficient management of inventories in the future will be critical.


Analyzing the Data


• Problems in 2012 resulted from the depressed economy and poor ski conditions, which reduced sales growth and credit availability from suppliers.

• Easing of sales demand coincided with the beginning of major market expansion.

• Inventories and receivables increased too fast for limited sales growth of a recessionary year.

• Consequence was negative cash flow from operations in 2012.


Analyzing the Data


• In 2013, there was considerable improvement in cash from operations and in managing of inventories and receivables.

• No major problem with short-term liquidity at present.

• Timing of future expansion of retail outlets will be of critical importance.


Analyzing the Data

Operating Efficiency

• Turnover ratios measure operating efficiency.


Analyzing the Data

Operating Efficiency – Sage Inc.


Analyzing the Data

Operating Efficiency– Sage Inc.

• Sage Inc. has increased its investment in fixed assets as a result of expansion.

• Asset turnover ratios reveal a downward trend in efficiency in generating sales from investments in fixed and total assets. Efficiency should improve if expansion

is successful.


Analyzing the Data

Capital Structure and Long-Term Solvency

• Amount and proportion of debt in a firm’s capital structure

• Ability of the firm to service debt

• Risk and leverage


Analyzing the Data

Capital Structure and Long-Term Solvency – Sage Inc.


Analyzing the Data


• Debt ratios reveal a steady increase in borrowed funds.

• Given the degree of risk implied by borrowing, it is important to determine: why debt has increased

whether the firm is employing debt successfully

how well the firm is covering its fixed charges


Analyzing the Data


• Summary Statement of Cash Flows provides an explanation of borrowing cause: Substantial increase in investment in

capital assets, particularly in 2013

Investments financed largely by borrowing, especially in 2012


Analyzing the Data


• Calculation of the financial leverage index (FLI) provides insight into how effectively financial leverage is being used: When the FLI is greater than 1, the firm

is employing debt successfully.

When the FLI is less than 1, the firm is not employing debt successfully.


Analyzing the Data


The calculation of the financial leverage index (FLI) is as follows:

index leverage Financialassetson return Adjusted

equityon Return *

assets Total

rate) tax - (1 expenseinterest earningsNet assetson return Adjusted*


Analyzing the Data



Analyzing the Data


• The FLI for Sage Inc. is above 1 in 2013, 2012, and 2011.

• This indicates a successful use of financial leverage for the three-year period when borrowing has increased.


Analyzing the Data


• A review of coverage ratios will reveal how well Sage Inc. is covering fixed charges:


Analyzing the Data


• Sage Inc. is generating enough cash to make cash payments.

• Since Sage Inc. leases the majority of its retail outlets, the fixed charge coverage ratio is more relevant than the times interest earned. This ratio has decreased as a result of expansion

and higher lease and interest payments.

Although below industry average, Sage Inc. is covering all fixed charges by more than two times.

This ratio should be monitored closely in the future, particularly if Sage Inc. continues to expand.


Analyzing the Data


• Cash flow adequacy ratio indicates the company does not generate enough cash from operations to cover capital expenditures, debt repayments, and cash dividends. To improve this ratio, Sage Inc. needs to

begin reducing accounts receivables and inventories.

If expansion continues, cash flow adequacy will likely remain below 1.0.


Analyzing the Data

Profitability

• Analysis of how well the firm has performed in terms of profitability

• Requires evaluation of several key ratios


Analyzing the Data

Profitability – Sage Inc.


Analyzing the Data


• Management adopted a new growth strategy. Aggressive marketing

Opening of 18 new stores in 2012 and 25 in 2013

• Strong cash generation from operations in 2013

• Stable gross profit margin during expansion is a positive sign.


Analyzing the Data


• Stable gross profit margin during expansion is a positive sign.

• Increase in operating profit margin is especially noteworthy. Occurred during expansion (a period of

sizable increases in operating expenses)

• Net profit margin improved in spite of increased interest and tax expenses and a reduction in interest revenue from cash equivalents.


Analyzing the Data



Analyzing the Data


• ROA, ROE, and cash return on assets declined through 2012 but rebounded in 2013. ROA and ROE indicate Sage Inc. is able to

generate profits.

Cash return on assets indicates that Sage Inc. is able to generate cash from its investment and management strategies.

• Sage Inc. is well positioned for future growth.


Analyzing the Data


• It will be important to monitor management of inventories. Inventories account for half of total assets.

Inventories have been problematic in the past.

• Sage Inc. has financed much of its expansion with debt. Thus far its shareholders have benefited

from the use of debt through financial leverage.


Analyzing the Data



Analyzing the Data


• Sage Inc. experienced negative cash flow from operation in 2012. Necessary to monitor cash flow in the future.

Occurred in a year of only modest sales and earnings growth.

• Sales expanded rapidly in 2013 as the economy recovered and expansion began to pay off.

• The outlook is for continued economic recovery.


Analyzing the Data

Relating the Ratios – The DuPont System

• Evaluation of the interrelationship among individual ratios

• Indicates how a firm’s decisions and activities over the course of an accounting period interact to produce an overall return to shareholders


Analyzing the Data


• Allows the analyst to: identify strengths and weaknesses

trace potential causes of problems in financial condition and performance

evaluate whether changes in condition and performance are indicative of improvement, deterioration, or some combination

focus on specific areas contributing to changes in condition and performance


Analyzing the Data



Analyzing the Data

DuPont System Applied to Sage Inc.


Analyzing the Data


• Return on equity has improved since 2012.

• Both profit margin and asset turnover are lower in 2013 than in 2009 and 2010.

• Combination of increased debt and improvement in profitability and asset utilization has produced an improved overall return in 2013.

• The firm has added debt to finance capital asset expansion and has used its debt effectively.


Analyzing the Data


• Improvement in inventory management in 2013 improved total asset turnover.

• Ability to control operating costs while increasing sales during expansion has improved net profit margin.

• Overall return on investment is now improving as a result.


Analyzing the Data

Projections and Pro Forma Statements

• Additional analytical tools for investment decisions and long-range planning include: Earnings forecasts

Pro forma financial statements


Analyzing the Data

Pro Forma Statements

• Projections of financial statements based on a set of assumptions about: future revenues

expenses

level of investment in assets

financing methods and costs

working capital management


Analyzing the Data

Summary of Analysis

• Analysis of any firm’s financial statements consists of a mixture of interrelated steps and pieces.

• No one part of analysis should be interpreted in isolation.

• Last step of analysis is to integrate the separate pieces into a whole, leading to conclusions about the business enterprise.

• Conclusions will be affected by original objectives of analysis.


Analyzing the Data

Summary of Analysis – Sage Inc.

• Strengths Favorable economic and industry outlook;

firm well-positioned geographically to benefit from expected economic and industry growth

Aggressive marketing and expansion strategies

Recent improvement in management of accounts receivable and inventory

Successful use of financial leverage and solid coverage of debt service requirements


Analyzing the Data


• Strengths Effective control of operating costs

Substantial sales growth, partially resulting from market expansion and reflective of future performance potential

Increased profitability in 2013 and strong, positive generation of cash flow from operations


Analyzing the Data


• Weaknesses Highly sensitive to economic fluctuations

and weather conditions

Negative cash flow from operating activities in 2012

Historical problems with inventory management and some weaknesses in overall asset management efficiency

Increased risk associated with debt financing


Analyzing the Data


• Answers to specific questions regarding Sage Inc. are determined by the values placed on each of the strengths and weaknesses.

• In general, the outlook for the firm is promising.

• Sage Inc. appears to be a sound credit risk with attractive investment potential.

• The management of inventories, a continuation of effective cost controls, and careful timing of future expansion will be critically important to the firm’s future success.


Appendix 5A: The Analysis of Segmental Data

• FASB requires companies to disclose supplementary financial data for each reportable segment including: foreign operations,

sales to major customers, and

information for enterprises that have only one reportable segment.



• Segmental disclosures help the analyst identify: areas of strengths and weakness within a

company,

proportionate contribution to revenue and profit by each division,

the relationship between capital expenditures and rates of return for operating areas, and

segments that should be de-emphasized or eliminated.



• Information on segments is presented as: a supplementary section in the

notes to the financial statements,

part of the basic financial statements, or

in a separate schedule that is referenced to and incorporated into the financial statements.



Analytical tools used to assess segmental data include:

• Percentage contribution to revenue

• Percentage contribution to operating profit

• Operating profit margin

• Capital expenditures

• Return on investment

• An assessment of the relationship between the size of a division and its relative contribution







• Sporting gear and equipment continues to be the largest revenue producer.

• Sporting gear and equipment is contributing more each year to total revenues.

• Sporting apparel has increased its relative contribution to total revenue.

• Footwear has contributed less to revenue each of the past three years.





• Sporting gear and equipment was the leading contributor to operating profit in 2013 and 2011.

• Sporting apparel contributed the most to operating profit in 2012.

• Footwear contributed the least to operating profit all three years. It appears the firm has made strategic

changes to remedy this challenge in 2013 (according to the MD&A).





• Sporting apparel produced the highest profit margin in all three years.

• Operating profit margin increased in 2013 in the sporting gear and equipment segment after a decline in 2012.

• Operating profit margin for footwear has improved in 2013 after generating a negative operating profit margin in 2012.





• Increase in investment in sporting gear and equipment, especially in 2013 Increased revenues, operating profit, and operating

profit margin

• Increased investment in the sporting apparel area Slightly higher operating profit margin in 2013

compared to 2012

• Significant investment in the footwear segment in 2011 and 2012 Did not result in better revenues or operating profit

Decreased capital expenditures in this area in 2013





• Sporting apparel consistently generates a solid ROI each year.

• Sporting gear and equipment generate significant (but decreasing) ROI. Capital expenditures in 2013 were

higher than in other segments.

This segment should be monitored to see if the increase in expenditures will result in higher returns.





• Sporting apparel is largest when considering total investment in assets. This segment generates the highest operating

profit margin and ROI with the least amount of capital expenditures required.

• Footwear does not produce impressive operating profit or ROI for the significant capital expenditures allocated to the segment.

• Sporting gear and equipment require the least investment in assets; however ROI is decreasing significantly.



Operating Segment – Definition

• An operating segment is defined by FASB as a component of a business enterprise that engages in business activities from

which it may earn revenues and incur expenses

whose operating results are regularly reviewed by the company’s chief operating decision maker to make decisions about resources allocated to the segment and assess its performance

for which discrete financial information is available



Operating Segment – Definition

• A segment is considered to be reportable if any one of three criteria is met: Revenue is 10% or more of combined

revenue, including intersegment revenue.

Operating profit (loss) is 10% or more of the greater of combined profit of all segments with profit or combined loss of all segments with loss.

Segment assets exceed 10% or more of combined assets of all segments.



Disclosure Requirements

• The following information must be disclosed according to FASB General Information

Information about Profit or Loss

Information about Assets


Copyright Notice

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

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Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Chapter 5 The Analysis of Financial Statements 5-1