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Analysis of Financial StatementsChapter 13
PowerPoint Editor:Beth Kane, MBA, CPA
Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition
Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition
13-C1: Purpose of Analysis
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17 - 3
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 13
17 - 4
Building Blocks of Analysis
C 1
Liquidity and efficiency
Solvency
Market prospects
Profitability
4
17 - 5
Information for Analysis
C 1
1. Income Statement2. Balance Sheet 3. Statement of
Stockholders’ Equity4. Statement of Cash Flows5. Notes to the Financial
Statements
5
13-C2: Standards for Comparisons
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17 - 7
Intracompany
Competitors
Industry
Guidelines
Standards for Comparison
C 2
When we interpret our analysis, it is essential to compare the results we obtained to other
standards or benchmarks.
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17 - 8
Horizontal Analysis
Comparing a company’s financial condition and performance across time.
Tools of Analysis
Vertical Analysis
Comparing a company’s financial condition and performance to a base amount.
Ratio Analysis
Measurement of key relations between financial statement items.C 2
8
13-P1: Comparative Statements
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17 - 10
Horizontal Analysis
P 1
Horizontal analysis refers to examination of financial statement data across time.
Horizontal analysis refers to examination of financial
statement data across time.
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17 - 11
Comparative StatementsCalculate 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
11
17 - 12
Comparative StatementsCalculate 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.
12
17 - 13
Horizontal Analysis
P 113
17 - 14
Horizontal Analysis
P 114
17 - 15
Trend Analysis
Trend analysis is used to reveal patterns in data covering successive periods.
Trendpercent
Analysis period amount Base period amount 100= ×
P 115
17 - 16
Using 2009 as the base year we will get the following trend information:
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 117
NEED-TO-KNOW
Compute trend percents for the following accounts, using 20X1 as the base year (round percents to wholenumbers). State whether the situation as revealed by the trends appears to be favorable or unfavorable foreach account.
($ in millions) 20X4 20X3 20X2 20X1Sales $500 $350 $250 $200Cost of goods sold 400 175 100 50
Sales trend percents 250% 175% 125% 100%$500/$200 $350/$200 $250/$200 $200/$200
Cost of goods sold trend percents 800% 350% 200% 100%$400/$50 $175/$50 $100/$50 $50/$50
P 118
13-P2: Common-Size Statements
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Vertical AnalysisCommon-Size Statements
Common-size percent
Analysis amountBase amount
100= ×
Financial Statement Base Amount
Balance Sheet Total Assets
Income Statement RevenuesP 2
20
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Common-Size Balance Sheet
P 221
17 - 22
Common-Size Income Statement
P 222
17 - 23
Common-Size Graphics
P 2
Common-Size Graphic ofAsset Components
Common-Size Graphic ofIncome Statement
23
NEED-TO-KNOWExpress the following comparative income statements in common-size percents and assess whether or notthis company’s situation has improved in the most recent year (round percents to whole numbers).
($ in millions) 20X2 20X1Sales $800 $500Total expenses 560 400Net income $240 $100
Common-size percentsSales 100% 100%
($800/$800) ($500/$500)Total expenses 70% 80%
($560/$800) ($400/$500)Net income 30% 20%
($240/$800) ($100/$500)
Each item is expressed as a % of current year’s sales
P 224
13-P3: Ratio Analysis
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Ratio Analysis
P 3
Liquidity and
efficiencySolvency
Market prospects
Profitability
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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 Efficiency
P 327
17 - 28
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
position and an ability to meet current obligations.
P 328
17 - 29
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 assets
Current liabilities
P 329
17 - 30
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
receivables
Current liabilities
Referred to as Quick Assets
P 330
17 - 31
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 331
17 - 32
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 332
17 - 33
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 333
17 - 34
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.
P 334
17 - 35
Total Asset Turnover
Total asset turnover = Net sales
Average 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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17 - 36
DebtRatio
EquityRatio
Pledged Assets to Secured Liabilities
Times Interest Earned
Solvency
P 336
17 - 37
Debt and Equity Ratios In Millions Amount RatioTotal liabilities $ 83,451 40.3% [Debt ratio]Total equity 123,549 59.7% [Equity ratio]Total liabilities and equity $ 207,000 100.0%
$83,451 ÷ $207,000 = 40.3%
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 337
17 - 38
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 338
17 - 39
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 339
17 - 40
Profit Margin
Return on Total Assets
Return on Common Stockholders’ Equity
Profitability
P 340
17 - 41
Profit Margin
Profit margin = Net income Net sales
This ratio describes a company’s ability to earn net income from each sales dollar.
P 341
17 - 42
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 342
17 - 43
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 343
17 - 44
Price-Earnings Ratio
Dividend Yield
Market Prospects
P 344
17 - 45
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 345
17 - 46
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 346
17 - 47
Summary of Ratios
P 347
NEED-TO-KNOW
For each ratio listed, identify whether the change in ratio value from 20X1 to 20X2 is regarded as favorable orunfavorable.
20X2 20X1 Change1. Profit margin ratio 6% 8% Unfavorable Lower % of net income in each sales dollar2. Debt ratio 50% 70% Favorable Fewer assets are claimed by creditors3. Gross margin ratio 40% 36% Favorable Higher % of gross margin in each sales dollar4. Accounts receivable turnover 8.8 9.4 Unfavorable Less efficiency in collection5. Basic earnings per share $2.10 $2.00 Favorable Higher net income per common share6. Inventory turnover 3.6 4.0 Unfavorable Less efficient inventory management
P 348
17 - 49
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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13-A1: Analysis Reporting
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Analysis Reporting
A1
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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13-A2: Sustainable Income
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Net Income
Appendix 13A: Sustainable Income
DiscontinuedSegments
ExtraordinaryItems
ContinuingOperations
A 253
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End of Chapter 13
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