1. 18-1

2. 18-2 CHAPTER18 Financial Statement Analysis

3. 18-3 PreviewofCHAPTER18

4. 18-4 Analyzing financial statements involves: Characteristics Comparison Bases Tools of Analysis  Liquidity  Profitability  Solvency  Intracompany  Industry averages  Intercompany  Horizontal  Vertical  Ratio SO 1 Discuss the need for comparative analysis. SO 2 Identify the tools of financial statement analysis. Basics of Financial Statement Analysis

5. 18-5 SO 3 Explain and apply horizontal analysis. Horizontal Analysis Horizontal analysis, also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time.  Purpose is to determine the increase or decrease that has taken place.  Commonly applied to the balance sheet, income statement, and statement of retained earnings.

6. 18-6 SO 3 Explain and apply horizontal analysis. Changes suggest that the company expanded its asset base during 2009 and financed this expansion primarily by retaining income rather than assuming additional long-term debt. Illustration 18-5 Horizontal analysis of balance sheets Horizontal Analysis

7. 18-7 SO 3 Explain and apply horizontal analysis. Overall, gross profit and net income were up substantially. Gross profit increased 17.1%, and net income, 26.5%. Quality’s profit trend appears favorable. Illustration 18-6 Horizontal analysis of Income statements Horizontal Analysis

8. 18-8 SO 3 Explain and apply horizontal analysis. In the horizontal analysis of the balance sheet the ending retained earnings increased 38.6%. As indicated earlier, the company retained a significant portion of net income to finance additional plant facilities. Illustration 18-7 Horizontal analysis of retained earnings statements Horizontal Analysis

9. 18-9 SO 4 Describe and apply vertical analysis. Vertical analysis, also called common-size analysis, is a technique that expresses each financial statement item as a percent of a base amount.  On an income statement, we might say that selling expenses are 16% of net sales.  Vertical analysis is commonly applied to the balance sheet and the income statement. Vertical Analysis

10. 18-10 These results reinforce the earlier observations that Quality is choosing to finance its growth through retention of earnings rather than through issuing additional debt. Illustration 18-8 Vertical analysis of balance sheets SO 4 Describe and apply vertical analysis. Vertical Analysis

11. 18-11 Quality appears to be a profitable enterprise that is becoming even more successful. Illustration 18-9 Vertical analysis of Income statements SO 4 Describe and apply vertical analysis. Vertical Analysis

12. 18-12 Enables a comparison of companies of different sizes. Illustration 18-10 Intercompany income statement comparison SO 4 Describe and apply vertical analysis. Vertical Analysis

13. 18-13 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Ratio analysis expresses the relationship among selected items of financial statement data. LiquidityProfitabilitySolvency Measures short- term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. Financial Ratio Classifications Measures the income or operating success of a company for a given period of time. Measures the ability of the company to survive over a long period of time. Ratio Analysis

14. 18-14 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. The discussion of ratios will include the following types of comparisons. A single ratio by itself is not very meaningful. Ratio Analysis

15. 18-15

16. 18-16 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Liquidity Ratios Measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.  Short-term creditors such as bankers and suppliers are particularly interested in assessing liquidity.  Ratios include the current ratio, the acid-test ratio, receivables turnover, and inventory turnover. Ratio Analysis

17. 18-17 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Ratio of 2.96:1 means that for every dollar of current liabilities, Quality has $2.96 of current assets. Ratio Analysis Liquidity Ratios 1. Current Ratio Illustration 18-12

18. 18-18 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Illustration 18-13 Ratio Analysis 2. Acid-Test / Quick Ratio Liquidity Ratios

19. 18-19 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Illustration 18-14 Ratio Analysis 2. Acid-Test Ratio Liquidity Ratios Acid-test ratio measures immediate liquidity.

20. 18-20

21. 18-21 SO 5 Illustration 18-15 Ratio Analysis 3. Receivables Turnover Liquidity Ratios Measures the number of times, on average, the company collects receivables during the period.

22. 18-22 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. A variant of the receivables turnover ratio is to convert it to an average collection period in terms of days. Receivables are collected on average every 36 days. $2,097,000 ($180,000 + $230,000) / 2 = 10.2 times 365 days / 10.2 times = every 35.78 days Receivables Turnover Ratio Analysis Liquidity Ratios

23. 18-23 SO 5 Illustration 18-16 Ratio Analysis 4. Inventory Turnover Liquidity Ratios Measures the number of times, on average, the inventory is sold during the period.

24. 18-24 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. A variant of inventory turnover is the days in inventory. Inventory turnover ratios vary considerably among industries. 365 days / 2.3 times = every 159 days $1,281,000 ($500,000 + $620,000) / 2 = 2.3 times Inventory Turnover Ratio Analysis Liquidity Ratios

25. 18-25 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Profitability Ratios Measure the income or operating success of a company for a given period of time.  Income, or the lack of it, affects the company’s ability to obtain debt and equity financing, liquidity position, and the ability to grow.  Ratios include the profit margin, asset turnover, return on assets, return on common stockholders’ equity, earnings per share, price-earnings, and payout ratio. Ratio Analysis

26. 18-26 Illustration 18-17 Ratio Analysis 5. Profit Margin Measures the percentage of each dollar of sales that results in net income. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Profitability Ratios

27. 18-27 Illustration 18-18 Ratio Analysis 6. Asset Turnover Measures how efficiently a company uses its assets to generate sales. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Profitability Ratios

28. 18-28 Illustration 18-19 Ratio Analysis 7. Return on Asset An overall measure of profitability. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Profitability Ratios

29. 18-29 Illustration 18-20 Ratio Analysis 8. Return on Common Stockholders’ Equity Shows how many dollars of net income the company earned for each dollar invested by the owners. Profitability Ratios SO 5

30. 18-30 Illustration 18-22 Ratio Analysis 9. Earnings Per Share (EPS) A measure of the net income earned on each share of common stock. Profitability Ratios SO 5

31. 18-31 Illustration 18-23 Ratio Analysis 10. Price-Earnings Ratio Measures the net income earned on each share of common stock. Profitability Ratios SO 5

32. 18-32 Illustration 18-24 Ratio Analysis 11. Payout Ratio Measures the percentage of earnings distributed in the form of cash dividends. Profitability Ratios SO 5

33. 18-33 SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Solvency Ratios Solvency ratios measure the ability of a company to survive over a long period of time.  Debt to Total Assets and  Times Interest Earned are two ratios that provide information about debt-paying ability. Ratio Analysis

34. 18-34 Illustration 18-25 Ratio Analysis 12. Debt to Total Assets Ratio Measures the percentage of the total assets that creditors provide. SO 5 Solvency Ratios

35. 18-35 Illustration 18-26 Ratio Analysis 13. Times Interest Earned Provides an indication of the company’s ability to meet interest payments as they come due. SO 5 Solvency Ratios

36. 18-36 Illustration 18-27 Ratio Analysis SO 5 Summary of Ratios

37. 18-37 Illustration 18-27 Summary of Ratios SO 5

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