Download presentation

1
**ANALYSIS AND FINANCIAL STATEMENTS**

CHAPTER 17 ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS

2
**Financial Statement Analysis**

Non-accounting majors, especially, should relate well to this chapter It looks at accounting information from users’ perspective Relates very closely to topics you will study in your finance course Therefore, we will use a somewhat broader brush on this chapter What is financial statement analysis? ”Tearing apart” the financial statements and looking at the relationships

3
**Financial Statement Analysis**

625 Who analyzes financial statements? Internal users (i.e., management) External users (emphasis of chapter) Examples? Investors, creditors, regulatory agencies & … stock market analysts and auditors

4
**Financial Statement Analysis**

What do internal users use it for? Planning, evaluating and controlling company operations What 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 management First sentence in chapter says...

5
**Financial Statement Analysis**

Information is available from Published 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 analysis Reports filed with the government e.g., Form 10-K, Form 10-Q and Form 8-K

6
**Financial Statement Analysis**

Information is available from Other 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

7
**Methods of Financial Statement Analysis**

Horizontal Analysis Vertical Analysis Common-Size Statements Trend Percentages Ratio Analysis

8
Horizontal Analysis Using comparative financial statements to calculate dollar or percentage changes in a financial statement item from one period to the next

9
Vertical Analysis For 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 Percentages Show changes over time in given financial statement items (can help evaluate financial information of several years)

12
Ratio Analysis Expression 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 Amounts Dollar Change Current Year Figure Base Year Figure = –

16
**Horizontal Analysis Example**

Calculating Change in Dollar Amounts Dollar Change Current Year Figure Base Year Figure = – 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 Percentage Percentage Change Dollar Change Base Year Figure × = 100%

18
**Horizontal Analysis Example**

$12,000 – $23,500 = $(11,500)

19
**Horizontal Analysis Example**

($11,500 ÷ $23,500) × 100% = 48.9%

20
**Horizontal Analysis Example**

21
**Horizontal Analysis Example**

Let’s apply the same procedures to the liability and stockholders’ equity sections of the balance sheet.

23
**Horizontal Analysis Example**

Now, let’s apply the procedures to the income statement.

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.

28
**Vertical Analysis Example**

29
**Vertical Analysis Example**

$82,000 ÷ $483,000 = 17% rounded $30,000 ÷ $387,000 = 8% rounded

30
**Vertical Analysis Example**

$76,000 ÷ $483,000 = 16% rounded

31
**Trend Percentages Example**

Wheeler, Inc. provides you with the following operating data and asks that you prepare a trend analysis.

32
**Trend Percentages Example**

Wheeler, Inc. provides you with the following operating data and asks that you prepare a trend analysis. $1, $1,820 = $171

33
**Trend Percentages Example**

Using 1995 as the base year, we develop the following percentage relationships. $1, $1,820 = $171 $171 ÷ $1,820 = 9% rounded

34
Trend line for Sales

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 ability Equity (Long-Term Solvency) Ratios Show relationship between debt and equity financing in a company Profitability Tests Relate income to other variables Market Tests Help assess relative merits of stocks in the marketplace

37
**10 Ratios You Must Know Liquidity Ratios**

Current (working capital) ratio Acid-test (quick) ratio Cash flow liquidity ratio Accounts receivable turnover Number of days’ sales in accounts receivable Inventory turnover Total assets turnover 651

38
**Equity (Long-Term Solvency) Ratios**

10 Ratios You Must Know Equity (Long-Term Solvency) Ratios Equity (stockholders’ equity) ratio Equity to debt

39
**10 Ratios You Must Know Profitability Tests $**

Return on operating assets Net income to net sales (return on sales or “profit margin”) Return on average common stockholders’ equity (ROE) Cash flow margin Earnings per share Times interest earned Times preferred dividends earned $

40
**10 Ratios You Must Know Market Tests Earnings yield on common stock**

Price-earnings ratio Payout ratio on common stock Dividend yield on common stock Dividend yield on preferred stock Cash 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 will use this information to 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**

#1 Current Ratio Current Assets Current Liabilities = Current Ratio $65,000 $42,000 = 1.55 : 1 Measures the ability of the company to pay current debts as they become due.

49
**Acid-Test (Quick) Ratio**

#2 Quick Assets Current Liabilities = Acid-Test Ratio Quick assets are Cash, Marketable Securities, Accounts Receivable (net) and current Notes Receivable.

50
**Acid-Test (Quick) Ratio**

#2 Quick Assets Current Liabilities = Acid-Test Ratio Norton Corporation’s quick assets consist of cash of $30,000 and accounts receivable of $20,000.

51
**Acid-Test (Quick) Ratio**

#2 Quick Assets Current Liabilities = Acid-Test Ratio $50,000 $42,000 = 1.19 : 1 Acid-Test Ratio

52
**Accounts Receivable Turnover**

#3 Net, credit sales Average, net accounts receivable Sales on Account Average Accounts Receivable Accounts Receivable Turnover = = times $494,000 ($17,000 + $20,000) ÷ 2 Accounts Receivable Turnover = This ratio measures how many times a company converts its receivables into cash each year.

53
**Number of Days’ Sales in Accounts Receivable**

#4 Days’ Sales in Accounts Receivables 365 Days Accounts Receivable Turnover = = days = 365 Days 26.70 Times Days’ Sales in Accounts Receivables Measures, on average, how many days it takes to collect an account receivable.

54
**Number of Days’ Sales in Accounts Receivable**

#4 Days’ Sales in Accounts Receivables 365 Days Accounts Receivable Turnover = = days = 365 Days 26.70 Times Days’ Sales in Accounts Receivables In practice, would 45 days be a desirable number of days in receivables?

55
**Measures the number of times replaced during the year.**

Inventory Turnover #5 Cost of Goods Sold Average Inventory Inventory Turnover = = times $140,000 ($10,000 + $12,000) ÷ 2 Inventory Turnover = Measures the number of times inventory is sold and replaced during the year.

56
**Would 5 be a desirable number of times for inventory to turnover?**

Inventory Turnover #5 Cost of Goods Sold Average Inventory Inventory Turnover = = times $140,000 ($10,000 + $12,000) ÷ 2 Inventory Turnover = 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.

58
Here is the rest of the information we will use.

59
**Measures the proportion of total assets provided by**

Equity Ratio #6 Equity Ratio = Stockholders’ Equity Total Assets Equity Ratio = $234,390 $346,390 67.7% Measures the proportion of total assets provided by stockholders.

60
**Net Income to Net Sales A/K/A Return on Sales or Profit Margin**

#7 Net Income to Net Sales Net Income Net Sales = Net Income to Net 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**

#7 Net Income to Net Sales Net Income Net Sales = Net Income to Net Sales $53,690 $494,000 = = 10.9% Would a 1% return on sales be good?

62
**Return on Average Common Stockholders’ Equity (ROE)**

#8 Return on Stockholders’ Equity Net Income Average Common Stockholders’ Equity = = $53,690 ($180,000 + $234,390) ÷ 2 = 25.9% Return on Stockholders’ Equity Important measure of the income-producing ability of a company.

63
**Earnings Per Share #9 Earnings Available to Common Stockholders**

Weighted-Average Number of Common Shares Outstanding Earnings per Share = Earnings per Share $53,690 (17, ,400) ÷ 2 = = $2.42 The financial press regularly publishes actual and forecasted EPS amounts.

64
**Earnings Per Share What’s new from Chap. 15?**

Weighted-average calculation 644 EPS of common stock = _______________________ Earnings available to common stockholders Weighted-average number of common shares outstanding Three alternatives for calculating weighted-average number of shares

65
**Earnings Per Share What’s new from Chap. 15?**

Weighted-average calculation 645 EPS of common stock = _______________________ Earnings available to common stockholders Weighted-average number of common shares outstanding Alternate #1

66
Earnings Per Share 645 Alternate #2 Alternate #3

67
**Earnings Per Share ¶ EPS and Stock Dividends or Splits**

646 ¶ EPS and Stock Dividends or Splits Why restate all prior calculations of EPS? Comparability - i.e., no additional capital was generated by the dividend or split ¶ Primary EPS and Fully Diluted EPS APB Opinion No. 15 I 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**

#10 Price-Earnings Ratio Market Price Per Share EPS = Price-Earnings Ratio = $20.00 $ 2.42 = 8.3 : 1 Provides some measure of whether the stock is under or overpriced.

69
**Important Considerations**

Need for comparable data Data is provided by Dun & Bradstreet, Standard & Poor’s etc. Must compare by industry Is EPS comparable? Influence of external factors General business conditions Seasonal nature of business operations Impact of inflation

70
Question The current ratio is a measure of liquidity that is computed by dividing total assets by total liabilities. a. True b. False

71
Question The current ratio is a measure of liquidity that is computed by dividing total assets by total liabilities. a. True b. False The current ratio is a measure of liquidity, but is computed by dividing current assets by current liabilities

72
Question Quick assets are defined as Cash, Marketable Securities and net receivables. a. True b. False

73
Question Quick assets are defined as Cash, Marketable Securities and net receivables. a. True b. False

74
No more ratios, please!

75
About Test #1 Will be challenging because the material covered is challenging All questions are T/F or M/C Questions are 5-pt., 3-pt. & 1-pt. No tricks such as patterns in answers Order of answers is random Coverage is even over the 4 chapters Time allowed: 75 minutes

76
**About Test #1 Best way to study Calculators will be provided**

Notes first Study guide and/or Hermanson tutorials Calculators will be provided Must wait outside classroom Have your questions ready for next actual class See course home page for office hours

Similar presentations

© 2019 SlidePlayer.com Inc.

All rights reserved.

To make this website work, we log user data and share it with processors. To use this website, you must agree to our Privacy Policy, including cookie policy.

Ads by Google