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23-2 Financial Statement Analysis Section 1: Vertical Analysis Chapter 23 Section Objectives 1.Use vertical analysis techniques to analyze a comparative income statement and balance sheet.

23-3 Phases of Statement Analysis 1.Computation Phase: Vertical analysis Horizontal analysis Ratio analysis 2.Interpretation Phase: Comparison of ratios Budgeted ratios Industry Averages

23-4 Comparative Statement

23-5 Common-size Statement

23-6 Each item is expressed as either a percentage of total assets or of total liabilities plus stockholders’ equity. Vertical Analysis of the Balance Sheet Cash Total assets = \$115,231 \$555,711 = 20.7% Accounts payable Total liabilities plus Stkhldrs’ equity = \$ 71,000 \$ 555,711 = 12.8% Total stockholders’ equity Total liabilities plus Stkhldrs’ equity = \$316,306 \$ 555,711 = 56.9%

23-7 Financial Statement Analysis Section 2: Horizontal Analysis Chapter 23 Section Objectives 2.Use horizontal analysis techniques to analyze a comparative income statement and balance sheet. 3.Use trend analysis to evaluate financial statements. 4.Interpret the results of statement analyses by comparison with industry averages.

23-8 Evaluates financial statements for two or more periods. Compares items in each line to determine the change in dollar amounts. Uses the same method for both the income statement and the balance sheet. Horizontal Analysis A percentage change can be shown by using the earlier figure as the base Use horizontal analysis techniques to analyze a comparative income statement and balance sheet Objective 2

23-9 Trend analysis compares selected ratios and percentages over a period of time. ANSWER: QUESTION: What is trend analysis? Often the time period is five years Use trend analysis to evaluate financial statements Objective 3

23-10 Trend Analysis The percentage of gross profit on sales to net sales decreased from 41.7 percent in 2012 to 41.0 percent in 2013. 2009 2010 2011 2012 2013

23-11 Using Industry Averages Trade associations survey their members to obtain financial information and other data. Data is converted to a uniform presentation, usually in common-size statements arranged by company size. Individual companies compare their results to industry averages. Interpret the results of the statement analyses by comparison with industry averages Objective 4

23-12 Financial Statement Analysis Section 3: Ratios Chapter 23 Section Objectives 5.Compute and interpret financial ratios that measure profitability, operating results, and efficiency. 6.Compute and interpret financial ratios that measure financial strength. 7.Compute and interpret financial ratios that measure liquidity 8.Recognize shortcomings in financial statement analysis.

23-13 Ratio Analysis Financial ratios have three classifications: 1.Profitability, operating results, and efficiency 2.Financial strength 3.Liquidity

23-14 Rate of return on sales. Rate of return on common stockholders’ equity. Earnings per share of common stock (EPS). Price-earnings ratio. Yield on common stock. Rate of return on total assets. Asset turnover. Ratios Measuring Profitability, Operating Results, and Efficiency Compute and interpret financial ratios that measure profitability, operating results, and efficiency Objective 5

23-15 Number of times bond interest earned. Ratio of stockholders’ equity to total equities. Ratio of stockholders’ equity to total liabilities. Book value per share of stock. Ratios Measuring Financial Strength Compute and interpret financial ratios that measure financial strength Objective 6

23-16 Working capital Current ratio Acid-test ratio Inventory turnover Accounts receivable turnover Ratios Measuring Liquidity Compute and interpret financial ratios that measure liquidity Objective 7

23-17 Financial statements use book values. Book value depends on accounting policies and procedures. Businesses have choices about certain things, such as depreciation methods and useful lives. Financial statements assume that the dollar is a stable monetary unit. No two companies are exactly the same: Different legal entities Different product mixes Different financing methods Precautionary Notes on Statement Analysis Financial statement analysis is useful only if these limitations are understood Recognize shortcomings in financial statement analysis Objective 8