1. Principles of Accounting II Lesson #5 Financial Statement Analysis By Laurie L. Swanson Nashville State Community College Click the button below to navigate to the next slide.

2. Financial Statement Analysis The process of analyzing businesses to determine if the business is financially stable, solvent, and profitable.

3. Horizontal Analysis Comparison of income statements or balance sheets to determine both dollar change and percent change. The comparison may be between accounting periods within the same company or between competitor companies.

4. Dollar Change Analysis Dollar change analysis is horizontal analysis in which the amount of dollar change is calculated between the analysis period (usually the current period) and the base period (the beginning point used for comparison purposes). Dollar Change = Analysis Period Amount – Base Period Amount

5. Percent Change Analysis Percent change analysis is horizontal analysis in which the change is calculated as a percentage of the base period. Financial statements prepared in percents are also known as common-size financial statements. Preparing common-size financial statements provides for more accurate data comparison by using a common base. Percent Change = (Analysis Period Amount – Base Period Amount) Base Period Amount X 100

6. Vertical Analysis Vertical analysis is used to assess individual items on financial statements as a proportion of a specific base amount. Vertical analysis is most frequently used in the preparation of common-size financial statements.

7. Common-Size Financial Statements Financial statements in which each item is shown as a percent of a whole are known as common-size financial statements. Preparing common-size financial statements provides for more accurate data comparison by using a common base and helps to emphasize the relative importance of each item on the financial statement out of the base. Common-size percent = (Analysis Amount/Base Amount) X 100.

8. Common-Size Financial Statements When preparing common-size income statements, the base is Net Income. When preparing common-size balance sheets, the base is Total Assets. The base amount is always shown as 100% in common size statements.

9. Example of Common-Size Balance Sheet Below is an example of a common-size balance sheet based on data from Exercise 17-7 in your Fundamental Accounting Principles text. Both the dollar value and percent are shown in the example as well as the calculation of the percentage. Notice that each line item is calculated as a percentage of total assets and that total assets (the base) is shown as 100%. Sanderson Company Common-Size Balance Sheet December 31, 2012 Dollar Value Common- Size Calculations Assets Cash 30,8005.9% ($30,800/$518,000) X 100 Accounts receivable, net 88,50017.1 ($88,500/$518,000) X 100 Merchandise inventory 111,50021.5 ($111,500/$518,000) X 100 Prepaid expenses 9,7001.9 ($9,700/$518,000) X 100 Plant assets, net 277,50053.6 ($277,500/$518,000) X 100 Total assets $518,000100.0% ($518,000/$518,000) X 100 Liabilities and Equity Accounts payable 128,90024.90% ($128,900/$518,000) X 100 Long-term notes payable secured by mortgages on plant assets 97,50018.8 ($97,500/$518,000) X 100 Common stock, $10 par value 162,50031.4 ($162,500/$518,000) X 100 Retained earnings 129,10024.9 ($129,100/$518,000) X 100 Total liabilities and equity $518,000100.0% ($518,000/$518,000) X 100

10. Ratio Analysis Ratio analysis is one of the most valuable tools in financial analysis. Ratios are calculated using data from financial statements. Various ratios can be computed to provided data on a company’s liquidity, solvency, profitability, and market prospects. Having financial data in ratio format makes comparisons within a company as well as between companies more meaningful.

11. Ratio Analysis: Formulas and Interpretations See page 705 of you textbook for the formulas used for common ratio calculations. Information on interpreting the ratios can be found in the Ratio Analysis section of Chapter 17 of your text as well as on the Ratio Analysis handout attached to Lesson 5.

12. End of Lesson 5 Presentation Financial Statement Analysis By Laurie L. Swanson