Presentation on theme: "ANALYSIS AND FINANCIAL STATEMENTS"— Presentation transcript:
1 ANALYSIS AND FINANCIAL STATEMENTS CHAPTER 17ANALYSIS ANDINTERPRETATION OFFINANCIAL STATEMENTS
2 Financial Statement Analysis Non-accounting majors, especially, should relate well to this chapterIt looks at accounting information from users’ perspectiveRelates very closely to topics you will study in your finance courseTherefore, we will use a somewhat broader brush on this chapterWhat is financial statement analysis?”Tearing apart” the financial statements and looking at the relationships
4 Financial Statement Analysis What do internal users use it for?Planning, evaluating and controlling company operationsWhat do external users use it for?Assessing past performance and current financial position and making predictions about the future profitability and solvency of the company as well as evaluating the effectiveness of managementFirst sentence in chapter says...
5 Financial Statement Analysis Information is available fromPublished annual reports(1) Financial statements(2) Notes to financial statements(3) Letters to stockholders(4) Auditor’s report (Independent accountants)(5) Management’s discussion and analysisReports filed with the governmente.g., Form 10-K, Form 10-Q and Form 8-K
6 Financial Statement Analysis Information is available fromOther sources(1) Newspapers (e.g., Wall Street Journal )(2) Periodicals (e.g. Forbes, Fortune)(3) Financial information organizations such as: Moody’s, Standard & Poor’s, Dun & Bradstreet, Inc., and Robert Morris Associates(4) Other business publications
8 Horizontal AnalysisUsing comparative financial statements to calculate dollar or percentage changes in a financial statement item from one period to the next
9 Vertical AnalysisFor a single financial statement, each item is expressed as a percentage of a significant total, e.g., all income statement items are expressed as a percentage of sales
10 Common-Size Statements Financial statements that show only percentages and no absolute dollar amounts
11 Trend PercentagesShow changes over time in given financial statement items (can help evaluate financial information of several years)
12 Ratio AnalysisExpression of logical relationships between items in a financial statement of a single period (e.g., percentage relationship between revenue and net income)
13 Horizontal Analysis Example The management of Clover Company provides you with comparative balance sheets of the years ended December 31, 1999 and Management asks you to prepare a horizontal analysis on the information.
15 Horizontal Analysis Example Calculating Change in Dollar AmountsDollarChangeCurrent YearFigureBase YearFigure=–
16 Horizontal Analysis Example Calculating Change in Dollar AmountsDollarChangeCurrent YearFigureBase YearFigure=–Since we are measuring the amount of the change between 1998 and 1999, the dollar amounts for 1998 become the “base” year figures.
17 Horizontal Analysis Example Calculating Change as a PercentagePercentageChangeDollar ChangeBase Year Figure×=100%
18 Horizontal Analysis Example $12,000 – $23,500 = $(11,500)
25 Sales increased by 8.3% while net income decreased by 21.9%.
26 There were increases in both cost of goods sold (14 There were increases in both cost of goods sold (14.3%) and operating expenses (2.1%). These increased costs more than offset the increase in sales, yielding an overall decrease in net income.
27 Vertical Analysis Example The management of Sample Company asks you to prepare a vertical analysis for the comparative balance sheets of the company.
35 Ratios Ratios can be expressed in three different ways: CAUTION! 1. Ratio (e.g., current ratio of 2:1)2. % (e.g., profit margin of 2%)3. $ (e.g., EPS of $2.25)CAUTION!“Using ratios and percentages without considering the underlying causes may be hazardous to your health!”lead to incorrect conclusions.”
36 Categories of Ratios Liquidity Ratios Indicate a company’s short-term debt-paying abilityEquity (Long-Term Solvency) RatiosShow relationship between debt and equity financing in a companyProfitability TestsRelate income to other variablesMarket TestsHelp assess relative merits of stocks in the marketplace
37 10 Ratios You Must Know Liquidity Ratios Current (working capital) ratioAcid-test (quick) ratioCash flow liquidity ratioAccounts receivable turnoverNumber of days’ sales in accounts receivableInventory turnoverTotal assets turnover651
38 Equity (Long-Term Solvency) Ratios 10 Ratios You Must KnowEquity (Long-Term Solvency) RatiosEquity (stockholders’ equity) ratioEquity to debt
39 10 Ratios You Must Know Profitability Tests $ Return on operating assetsNet income to net sales (return on sales or “profit margin”)Return on average common stockholders’ equity (ROE)Cash flow marginEarnings per shareTimes interest earnedTimes preferred dividends earned$
40 10 Ratios You Must Know Market Tests Earnings yield on common stock Price-earnings ratioPayout ratio on common stockDividend yield on common stockDividend yield on preferred stockCash flow per share of common stock
41 Now, let’s look at Norton Corporation’s 1999 and 1998 financial statements.
45 Now, let’s calculate the 10 ratios based on Norton’s financial statements.
46 to calculate the liquidity ratios for Norton. We willuse thisinformationto calculate the liquidity ratios for Norton.
47 The excess of current assets over current liabilities. Working Capital*The excess of current assets over current liabilities.* While this is not a ratio, it does give an indication of a company’s liquidity.
48 Current (Working Capital) Ratio #1CurrentRatioCurrent AssetsCurrent Liabilities=CurrentRatio$65,000$42,000=1.55 : 1Measures the abilityof the company to pay currentdebts as they become due.
49 Acid-Test (Quick) Ratio #2Quick AssetsCurrent Liabilities=Acid-TestRatioQuick assets are Cash,Marketable Securities, Accounts Receivable (net) andcurrent Notes Receivable.
50 Acid-Test (Quick) Ratio #2Quick AssetsCurrent Liabilities=Acid-TestRatioNorton Corporation’s quick assets consist of cash of $30,000 and accounts receivable of $20,000.
51 Acid-Test (Quick) Ratio #2Quick AssetsCurrent Liabilities=Acid-TestRatio$50,000$42,000=1.19 : 1Acid-TestRatio
52 Accounts Receivable Turnover #3Net, credit salesAverage, net accounts receivableSales on AccountAverage Accounts ReceivableAccounts ReceivableTurnover== times$494,000($17,000 + $20,000) ÷ 2Accounts ReceivableTurnover=This ratio measures how many times a company converts its receivables into cash each year.
53 Number of Days’ Sales in Accounts Receivable #4Days’ Salesin AccountsReceivables365 DaysAccounts Receivable Turnover== days=365 Days26.70 TimesDays’ Salesin AccountsReceivablesMeasures, on average, how many days it takes to collect an account receivable.
54 Number of Days’ Sales in Accounts Receivable #4Days’ Salesin AccountsReceivables365 DaysAccounts Receivable Turnover== days=365 Days26.70 TimesDays’ Salesin AccountsReceivablesIn practice, would 45 days be a desirable number of days in receivables?
55 Measures the number of times replaced during the year. Inventory Turnover#5Cost of Goods SoldAverage InventoryInventoryTurnover== times$140,000($10,000 + $12,000) ÷ 2InventoryTurnover=Measures the number of timesinventory is sold andreplaced during the year.
56 Would 5 be a desirable number of times for inventory to turnover? Inventory Turnover#5Cost of Goods SoldAverage InventoryInventoryTurnover== times$140,000($10,000 + $12,000) ÷ 2InventoryTurnover=Would 5 be a desirable number of times for inventory to turnover?
57 Equity, or Long–Term Solvency Ratios This is part of the information to calculate the equity, or long-term solvency ratios of Norton Corporation.
59 Measures the proportion of total assets provided by Equity Ratio#6EquityRatio=Stockholders’ EquityTotal AssetsEquityRatio=$234,390$346,39067.7%Measures the proportionof total assets provided bystockholders.
60 Net Income to Net Sales A/K/A Return on Sales or Profit Margin #7Net IncometoNet SalesNet IncomeNet Sales=Net IncometoNet Sales=$53,690$494,000= 10.9%Measures the proportion of the sales dollar which is retained as profit.
61 Net Income to Net Sales A/K/A Return on Sales or Profit Margin #7Net IncometoNet SalesNet IncomeNet Sales=Net IncometoNet Sales$53,690$494,000== 10.9%Would a 1% return on sales be good?
62 Return on Average Common Stockholders’ Equity (ROE) #8Return onStockholders’EquityNet IncomeAverage CommonStockholders’ Equity==$53,690($180,000 + $234,390) ÷ 2= 25.9%Return onStockholders’EquityImportant measure of theincome-producing abilityof a company.
63 Earnings Per Share #9 Earnings Available to Common Stockholders Weighted-Average Number of Common Shares OutstandingEarningsper Share=Earningsper Share$53,690(17, ,400) ÷ 2== $2.42The financial press regularly publishesactual and forecasted EPS amounts.
64 Earnings Per Share What’s new from Chap. 15? Weighted-average calculation644EPS of common stock = _______________________Earnings available tocommon stockholdersWeighted-average number ofcommon shares outstandingThree alternatives for calculating weighted-average number of shares
65 Earnings Per Share What’s new from Chap. 15? Weighted-average calculation645EPS of common stock = _______________________Earnings available tocommon stockholdersWeighted-average number ofcommon shares outstandingAlternate #1
67 Earnings Per Share ¶ EPS and Stock Dividends or Splits 646¶ EPS and Stock Dividends or SplitsWhy restate all prior calculations of EPS?Comparability - i.e., no additional capital was generated by the dividend or split¶ Primary EPS and Fully Diluted EPSAPB Opinion No. 15I mentioned this 17-page pronouncement that required a 100-page explanation in the lecture for chapter 13.
68 Price-Earnings Ratio A/K/A P/E Multiple #10Price-EarningsRatioMarket Price Per ShareEPS=Price-EarningsRatio=$20.00$ 2.42= 8.3 : 1Provides some measure of whether the stock is under or overpriced.
69 Important Considerations Need for comparable dataData is provided by Dun & Bradstreet, Standard & Poor’s etc.Must compare by industryIs EPS comparable?Influence of external factorsGeneral business conditionsSeasonal nature of business operationsImpact of inflation
70 QuestionThe current ratio is a measure of liquidity that is computed by dividing total assets by total liabilities.a. Trueb. False
71 QuestionThe current ratio is a measure of liquidity that is computed by dividing total assets by total liabilities.a. Trueb. FalseThe current ratio is a measure ofliquidity, but is computed bydividing current assets bycurrent liabilities
72 QuestionQuick assets are defined as Cash, Marketable Securities and net receivables.a. Trueb. False
73 QuestionQuick assets are defined as Cash, Marketable Securities and net receivables.a. Trueb. False
75 About Test #1Will be challenging because the material covered is challengingAll questions are T/F or M/CQuestions are 5-pt., 3-pt. & 1-pt.No tricks such as patterns in answersOrder of answers is randomCoverage is even over the 4 chaptersTime allowed: 75 minutes
76 About Test #1 Best way to study Calculators will be provided Notes firstStudy guide and/or Hermanson tutorialsCalculators will be providedMust wait outside classroomHave your questions ready for next actual classSee course home page for office hours