1. 1 of 52Visit UMT online at www.umtweb.edu© South-Western 2004 Survey of Accounting, 2/eChapter 9, ACCT125 ACCOUNTING FUNDAMENTALS FOR MANAGERS University of Management and Technology 1901 North Fort Myer Drive Arlington, VA 22209 Voice: (703) 516-0035 Fax: (703) 516-0985 Website: www.umtweb.edu

2. Visit UMT online at www.umtweb.edu2 of 52 Chapter 9, ACCT125 Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

3. 3 of 52Visit UMT online at www.umtweb.edu© South-Western 2004 Survey of Accounting, 2/eChapter 9, ACCT125 Chapter 9 Financial Statement Analysis

4. Visit UMT online at www.umtweb.edu4 of 52 Chapter 9, ACCT125 After studying this chapter, you should be able to: Learning Objectives 1.Describe basic financial statement analytical procedures. 2.Apply financial statement analysis to assess the solvency of a business. 3.Apply financial statement analysis to assess the profitability of a business. 4.Summarize the uses and limitations of analytical measures. 5.Describe the contents of corporate annual reports.

5. Visit UMT online at www.umtweb.edu5 of 52 Chapter 9, ACCT125 1 Describe basic financial statement analytical procedures. Learning Objective

6. Visit UMT online at www.umtweb.edu6 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Balance Sheet December 31, 2004 and 2003 Assets Current assets$ 550,000$ 533,000$ 17,000 3.2% Long-term investments95,000177,500(82,500)(46.5%) Fixed assets (net)444,500470,000(25,500)(5.4%) Intangible assets50,00050,000 $1,139,500$1,230,500$ (91,000)(7.4%) Liabilities Current liabilities$ 210,000$ 243,000$ (33,000)(13.6%) Long-term liabilities100,000200,000(100,000)(50.0%) $ 310,000$ 443,000$(133,000)(30.0%) Stockholders Equity Preferred stock, $100 par$ 150,000$ 150,000 Common stock, $10 par500,000500,000 Retained earnings179,500137,500$42,000 30.5% $ 829,500$ 787,500$42,000 5.3% $1,139,500$1230,500$(91,000)(7.4%) Increase (Decrease) 20042003AmountPercent

7. Visit UMT online at www.umtweb.edu7 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Balance Sheet December 31, 2004 and 2003 Assets Current assets$ 550,000$ 533,000$ 17,000 3.2% Long-term investments95,000177,500(82,500)(46.5%) Fixed assets (net)444,500470,000(25,500)(5.4%) Intangible assets50,00050,000 $1,139,500$1,230,500$ (91,000)(7.4%) Liabilities Current liabilities$ 210,000$ 243,000$ (33,000)(13.6%) Long-term liabilities100,000200,000(100,000)(50.0%) $ 310,000$ 443,000$(133,000)(30.0%) Stockholders Equity Preferred stock, $100 par$ 150,000$ 150,000 Common stock, $10 par500,000500,000 Retained earnings179,500137,500$42,000 30.5% $ 829,500$ 787,500$42,000 5.3% $1,139,500$1230,500$(91,000)(7.4%) Increase (Decrease) 20042003AmountPercent Horizontal Analysis: Horizontal Analysis: Current year (2004)$550,000 Base year (2003)$533,000 = 103.2% Increase amount$17,000 Base year (2003)$533,000 = 3.2%

8. Visit UMT online at www.umtweb.edu8 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Income Statement December 31, 2004 and 2003 Sales$1,530,500$1,234,000$296,500 24.0% Sales returns32,50034,000(1,500)(4.4%) Net sales$1,498,000$1,200,000$298,000)24.8% Cost of goods sold1,043,000820,000223,000 27.2% Gross profit $ 455,000$ 380,000$ 75,000 19.7% Selling expenses$ 191,000$ 147,000$ 44,000 29.9% Administrative expenses104,00097,4006,600 6.8% Total operating expenses$ 295,000$ 244,400$ 50,600 20.7% Operating income$ 160,000$ 135,600$ 24,400 18.0% Other income8,50011,000(2,500)(22.7%) $ 168,500$ 146,600$ 21,900 14.9% Other expense6,00012,000(6,000)(50.0%) Income before income tax$ 162,500$ 134,600$ 27,900 20.7% Income tax71,50058,10013,400 23.1% Net income$ 91,000$ 76,500$ 14,500 19.0% Increase (Decrease) 20042003AmountPercent

9. Visit UMT online at www.umtweb.edu9 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Income Statement December 31, 2004 and 2003 Sales$1,530,500$1,234,000$296,500 24.0% Sales returns32,50034,000(1,500)(4.4%) Net sales$1,498,000$1,200,000$298,000)24.8% Cost of goods sold1,043,000820,000223,000 27.2% Gross profit $ 455,000$ 380,000$ 75,000 19.7% Selling expenses$ 191,000$ 147,000$ 44,000 29.9% Administrative expenses104,00097,4006,600 6.8% Total operating expenses$ 295,000$ 244,400$ 50,600 20.7% Operating income$ 160,000$ 135,600$ 24,400 18.0% Other income8,50011,000(2,500)(22.7%) $ 168,500$ 146,600$ 21,900 14.9% Other expense6,000 12,000(6,000)(50.0%) Income before income tax$ 162,500$ 134,600$ 27,900 20.7% Income tax71,50058,10013,400 23.1% Net income$ 91,000$ 76,500$ 14,500 19.0% Increase (Decrease) 20042003AmountPercent Horizontal Analysis: Horizontal Analysis: Current year (2004)$1,498,000 Base year (2003)$1,200,000 = 124.8% Increase amount$298,000 Base year (2003)$1,200,000 = 24.8%

10. Visit UMT online at www.umtweb.edu10 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Balance Sheets Assets Current assets$ 550,00048.3%$ 533,00043.3% Long-term investments95,0008.3177,50014.4 Fixed assets (net)444,50039.0470,00038.2 Intangible assets50,0004.450,0004.1 $1,139,500100.0%$1,230,500100.0% Liabilities Current liabilities$ 210,00018.4%$ 243,00019.7% Long-term liabilities100,0008.8200,00016.3 $ 310,00027.2%$ 443,00036.0% Stockholders Equity Preferred stock, $100 par$ 150,00013.2%$ 150,00012.2% Common stock, $10 par500,00043.9500,00040.6 Retained earnings179,50015.7137,50011.2 $ 829,50072.8%$ 787,50064.0% $1,139,500100.0%$1230,500100.0% December 31, 2004 December 31, 2003 AmountPercentAmountPercent

11. Visit UMT online at www.umtweb.edu11 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Balance Sheets Assets Current assets$ 550,00048.3%$ 533,00043.3% Long-term investments95,0008.3177,50014.4 Fixed assets (net)444,50039.0470,00038.2 Intangible assets50,0004.450,0004.1 $1,139,500100.0%$1,230,500100.0% Liabilities Current liabilities$ 210,00018.4%$ 243,00019.7% Long-term liabilities100,0008.8200,00016.3 $310,00027.2%$ 443,00036.0% Stockholders Equity Preferred stock, $100 par$ 150,00013.2%$ 150,00012.2% Common stock, $10 par500,00043.9500,00040.6 Retained earnings179,50015.7137,50011.2 $829,50072.8%$787,50064.0% $1,139,500100.0%$1230,500100.0% December 31, 2004 December 31, 2003 AmountPercentAmountPercent Vertical Analysis: Vertical Analysis: Current liabilities$210,000 Total assets$1,139,500 = 18.4%

12. Visit UMT online at www.umtweb.edu12 of 52 Chapter 9, ACCT125 Lincoln Company Comparative Balance Sheets Assets Current assets$ 550,00048.3%$ 533,00043.3% Long-term investments95,0008.3177,50014.4 Fixed assets (net)444,50039.0470,00038.2 Intangible assets50,0004.450,0004.1 $1,139,500100.0%$1,230,500100.0% Liabilities Current liabilities$ 210,00018.4%$ 243,00019.7% Long-term liabilities100,0008.8200,00016.3 $310,00027.2%$ 443,00036.0% Stockholders Equity Preferred stock, $100 par$ 150,00013.2%$ 150,00012.2% Common stock, $10 par500,00043.9500,00040.6 Retained earnings179,50015.7137,50011.2 $829,50072.8%$787,50064.0% $1,139,500100.0%$1230,500100.0% December 31, 2004 December 31, 2003 AmountPercentAmountPercent Common-Size Statements

13. Visit UMT online at www.umtweb.edu13 of 52 Chapter 9, ACCT125 2 Apply financial statement analysis to assess the solvency of a business. Learning Objective

14. Visit UMT online at www.umtweb.edu14 of 52 Chapter 9, ACCT125 Solvency Analysis Solvency is the ability of a business to meet its financial obligations (debts) as they are due. Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities. This ability is normally assessed by examining balance sheet relationships.

15. Visit UMT online at www.umtweb.edu15 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Current assets $550,000$533,000 Current liabilities 210,000 243,000 Working Capital and Current Ratio 20042003

16. Visit UMT online at www.umtweb.edu16 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Working Capital and Current Ratio Use:To indicate the ability to meet currently maturing obligations. 20042003 Current assets $550,000$533,000 Current liabilities 210,000 243,000 Working capital$340,000$290,000

17. Visit UMT online at www.umtweb.edu17 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Current assets $550,000$533,000 Current liabilities 210,000 243,000 Working capital$340,000$290,000 Current ratio2.6 2.2 Working Capital and Current Ratio Use:To indicate the ability to meet currently maturing obligations. Divide current assets by current liabilities 20042003

18. Visit UMT online at www.umtweb.edu18 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Quick assets: Cash$ 90,500$ 64,700 Marketable securities 75,00060,000 Accounts receivable (net)115,000120,000 Total$280,500$244,700 Current liabilities$210,000$243,000 Acid-Test Ratio 20042003

19. Visit UMT online at www.umtweb.edu19 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Acid-Test Ratio Use:To indicate instant debt-paying ability. 20042003 Quick assets: Cash$ 90,500$ 64,700 Marketable securities 75,00060,000 Accounts receivable (net)115,000120,000 Total$280,500$244,700 Current liabilities$210,000$243,000 Acid-test ratio1.3 1.0

20. Visit UMT online at www.umtweb.edu20 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Accounts Receivable Turnover Net sales on account$1,498,000$1,200,000 Accounts receivable (net): Beginning of year$ 120,000$ 140,000 End of year 115,000120,000 Total$ 235,000$ 260,000 Average$ 117,500$ 130,000 20042003

21. Visit UMT online at www.umtweb.edu21 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Accounts Receivable Turnover Use:To assess the efficiency in collecting receivables and in the management of credit. Net sales on account$1,498,000$1,200,000 Accounts receivable (net): Beginning of year$ 120,000$ 140,000 End of year 115,500120,000 Total$ 235,000$ 260,000 Average$ 117,500$ 130,000 Accts. receivable turnover12.7 9.2 20042003

22. Visit UMT online at www.umtweb.edu22 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Number of Days Sales in Receivables Use:To assess the efficiency in collecting receivables and in the management of credit. 20042003 Accounts receivable (net) end of year$ 115,000$ 120,000 Net sales on account$1,498,000$1,200,000 Average daily sales on on account (sales 365)$ 4,104$ 3,288 Number of days sales in receivables28 36.5

23. Visit UMT online at www.umtweb.edu23 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Inventory Turnover 20042003 Cost of goods sold$1,043,000$ 820,000 Inventories: Beginning of year$ 283,000$ 311,000 End of year 264,000283,000 Total$ 547,000$ 594,000 Average$ 273,500$ 297,000

24. Visit UMT online at www.umtweb.edu24 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Inventory Turnover Use:To assess the efficiency in the management of inventory. 20042003 Cost of goods sold$1,043,000$ 820,000 Inventories: Beginning of year$ 283,000$ 311,000 End of year 264,000283,000 Total$ 547,000$ 594,000 Average$ 273,500$ 297,000 Inventory turnover3.8 2.8

25. Visit UMT online at www.umtweb.edu25 of 52 Chapter 9, ACCT125 Solvency Measures The Short-Term Creditor Number of Days Sales in Inventory Use:To assess the efficiency in the management of inventory. 20042003 Inventories, end of year$ 264,000$283,000 Cost of goods sold$1,043,000$820,000 Average daily cost of goods sold (COGS 365)$ 2,858$ 2,247 Number of days sales in inventory92.4 125.9

26. Visit UMT online at www.umtweb.edu26 of 52 Chapter 9, ACCT125 Solvency Measures The Long-Term Creditor Ratio of Plant Assets to Long-Term Liabilities Fixed assets (net)$444,500$470,000 Long-term liabilities$100,000$200,000 20042003

27. Visit UMT online at www.umtweb.edu27 of 52 Chapter 9, ACCT125 Solvency Measures The Long-Term Creditor Use:To indicate the margin of safety to long-term creditors. 20042003 Fixed assets (net)$444,500$470,000 Long-term liabilities$100,000$200,000 Ratio of fixed assets to long-term liabilities4.4 2.4 Ratio of Fixed Assets to Long-Term Liabilities

28. Visit UMT online at www.umtweb.edu28 of 52 Chapter 9, ACCT125 Solvency Measures The Long-Term Creditor Ratio of Liabilities to Stockholders Equity 20042003 Total liabilities$310,000$443,000 Total stockholders equity$829,500$787,500

29. Visit UMT online at www.umtweb.edu29 of 52 Chapter 9, ACCT125 Solvency Measures The Long-Term Creditor Ratio of Liabilities to Stockholders Equity Use:To indicate the margin of safety to creditors. 20042003 Total liabilities$310,000$443,000 Total stockholders equity$829,500$787,500 Ratio of liabilities to stockholders equity0.37 0.56

30. Visit UMT online at www.umtweb.edu30 of 52 Chapter 9, ACCT125 Solvency Measures The Long-Term Creditor Number of Times Interest Charges Earned 20042003 Income before income tax$ 900,000$ 800,000 Add interest expense 300,000 250,000 Amount available for interest$1,200,000$1,050,000

31. Visit UMT online at www.umtweb.edu31 of 52 Chapter 9, ACCT125 Solvency Measures The Long-Term Creditor Number of Times Interest Charges Earned Use:To assess the risk to debtholders in terms of number of times interest charges were earned. 20042003 Income before income tax$ 900,000$ 800,000 Add interest expense 300,000 250,000 Amount available for interest$1,200,000$1,050,000 Number of times earned4.0 4.2

32. Visit UMT online at www.umtweb.edu32 of 52 Chapter 9, ACCT125 3 Apply financial statement analysis to assess the profitability of a business. Learning Objective

33. Visit UMT online at www.umtweb.edu33 of 52 Chapter 9, ACCT125 Profitability Analysis Profitability is the ability of an entity to earn profits. This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available. Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet.

34. Visit UMT online at www.umtweb.edu34 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Ratio of Net Sales to Assets 20042003 Net sales $1,498,000$1,200,000 Total assets: Beginning of year$1,053,000$1,010,000 End of year 1,044,5001,053,000 Total$2,097,500$2,063,000 Average$1,048,750$1,031,500 Excludes long-term investments

35. Visit UMT online at www.umtweb.edu35 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Ratio of Net Sales to Assets Use:To assess the effectiveness of the use of assets. 20042003 Net sales on account$1,498,000$1,200,000 Total assets: Beginning of year$1,053,000$1,010,000 End of year 1,044,5001,053,000 Total$2,097,500$2,063,000 Average$1,048,750$1,031,500 Ratio of net sales to assets1.4 1.2

36. Visit UMT online at www.umtweb.edu36 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Rate Earned on Total Assets 20042003 Net income$ 91,000$ 76,500 Plus interest expense6,00012,000 Total$ 97,000$ 88,500 Total assets: Beginning of year$1,230,500$1,187,500 End of year 1,139,5001,230,500 Total$2,370,000$2,418,000 Average$1,185,000$1,209,000

37. Visit UMT online at www.umtweb.edu37 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Rate Earned on Total Assets Use:To assess the profitability of the assets. 20042003 Net income$ 91,000$ 76,500 Plus interest expense6,00012,000 Total$ 97,000$ 88,500 Total assets: Beginning of year$1,230,500$1,187,500 End of year 1,139,5001,230,500 Total$2,370,000$2,418,000 Average$1,185,000$1,209,000 Rate earned on total assets8.2% 7.3%

38. Visit UMT online at www.umtweb.edu38 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Rate Earned on Stockholders Equity 20042003 Net income$ 91,000$ 76,500 Stockholders equity: Beginning of year$ 787,500$ 750,000 End of year 829,500787,500 Total$1,617,000$1,537,500 Average$ 808,500$ 768,750

39. Visit UMT online at www.umtweb.edu39 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Rate Earned on Stockholders Equity Use:To assess the profitability of the investment by stockholders. Net income$ 91,000$ 76,500 Stockholders equity: Beginning of year$ 787,500$ 750,000 End of year 829,500787,500 Total$1,617,000$1,537,500 Average$ 808,500$ 768,750 Rate earned on equity11.3% 10.0% 20042003

40. Visit UMT online at www.umtweb.edu40 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Rate Earned on Common Stockholders Equity 20042003 Net income$ 91,000$ 76,500 Less preferred dividends9,0009,000 Remaindercommon stock$ 82,000$ 67,500 Common stockholders equity: Beginning of year$ 637,500$ 600,000 End of year 679,500637,500 Total$1,317,000$1,237,500 Average$ 658,500$ 618,750

41. Visit UMT online at www.umtweb.edu41 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Rate Earned on Common Stockholders Equity Use:To assess the profitability of the investment by common stockholders. 20042003 Net income$ 91,000$ 76,500 Less preferred dividends9,0009,000 $ 82,000$ 67,500 Remaindercommon stock$ 82,000$ 67,500 Common stockholders equity: Beginning of year$ 637,500$ 600,000 End of year 679,500637,500 Total$1,317,000$1,237,500 $ 658,500$ 618,750 Average$ 658,500$ 618,750 Rate earned on common equity12.5% 10.9%

42. Visit UMT online at www.umtweb.edu42 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Earnings Per Share on Common Stock 20042003 Net income$ 91,000$ 76,500 Less preferred dividends9,0009,000 Remaindercommon stock$ 82,000$ 67,500 Shares of common stock50,00050,000

43. Visit UMT online at www.umtweb.edu43 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Earnings Per Share on Common Stock 20042003 Net income$ 91,000$ 76,500 Less preferred dividends9,0009,000 Remaindercommon stock$ 82,000$ 67,500 Shares of common stock50,00050,000 Earnings per share on common$1.64 $1.35 Use:To assess the profitability of the investment by common stockholders.

44. Visit UMT online at www.umtweb.edu44 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Price-Earnings Ratio 20042003 Market price per share of common$20.50$13.50 Earnings per share on common$ 1.64$ 1.35

45. Visit UMT online at www.umtweb.edu45 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Price-Earnings Ratio Use:To indicate future earnings prospects, based on the relationship between market value of common stock and earnings. 20042003 Market price per share of common$20.50$13.50 Earnings per share on common$ 1.64$ 1.35 Price-earnings ratio on common12.5 10.0

46. Visit UMT online at www.umtweb.edu46 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Dividend Yield 20042003 Dividends per share of common$ 0.80$ 0.60 Market price per share of common$20.50$13.50

47. Visit UMT online at www.umtweb.edu47 of 52 Chapter 9, ACCT125 4 Summarize the uses and limitations of analytical measures. Learning Objective

48. Visit UMT online at www.umtweb.edu48 of 52 Chapter 9, ACCT125 Solvency measures Working Capital Current ratio Acid-test ratio Accounts receivable turnover Number of days sales in receivables Inventory turnover Number of days sales in inventory Ratio of fixed assets to long-term liabilities Ratio of liabilities to stockholders equity Number of times interest charges earned Summary of Analytical Measures

49. Visit UMT online at www.umtweb.edu49 of 52 Chapter 9, ACCT125 Profitability measures Ratio of net sales to assets Rate earned on total assets Rate earned on stockholders equity Rate earned on common stockholders equity Earnings per share on common stock Price earnings ratio Dividends per share of common stock Dividend yield Summary of Analytical Measures

50. Visit UMT online at www.umtweb.edu50 of 52 Chapter 9, ACCT125 5 Describe the contents of corporate annual reports. Learning Objective

51. Visit UMT online at www.umtweb.edu51 of 52 Chapter 9, ACCT125 Profitability Measures The Common Stockholder Dividend Yield Use:To indicate the rate of return to common stockholders in terms of dividends. 20042003 Dividends per share of common$ 0.80$ 0.60 Market price per share of common$41.00$27.00 Dividend yield on common stock1.95%2.23%

52. Visit UMT online at www.umtweb.edu52 of 52 Chapter 9, ACCT125 Corporate Annual Reports 1. Financial Highlights 2.Presidents Letter to the Stockholders 3.Management Report 4.Independent Auditors Report 5.Historical Summary In addition to financial statements, the annual report includes: