1. 1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor of Accounting Bryant University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. FINANCIAL ACCOUNTING 2 ND EDITION BY DUCHAC, REEVE, & WARREN 14 Financial Statement Analysis

2. 2 HORIZONTAL, VERTICAL ANALYSES Basic financial statement analysis begins with –Evaluating relative size of changes in account balances (horizontal) –Evaluating relative size of account balances (vertical) Basic financial statement analysis begins with –Evaluating relative size of changes in account balances (horizontal) –Evaluating relative size of account balances (vertical) LG 1

3. 3 HORIZONTAL ANALYSIS: Assets Total assets increased $273 million (27.2%) Largest $ increase Largest % increase

4. 4 HORIZONTAL ANALYSIS: Equity

5. 5 VERTICAL ANALYSIS On the balance sheet –Each item is expressed as a % of total assets On the income statement –Each item is expressed as a % of net sales LG 1

6. 6 COMMON-SIZED STATEMENTS Starts with horizontal, vertical analysis –Shows comparisons in percentages –Shows 2 or more years of data –Allows for $ & % comparisons LG 1

7. 7 PROFITABILITY ANALYSIS Rate earned on stockholders’ equity –Stockholders’ rate of return Rate earned on total assets –Rate of return earned by what is invested in assets Comprehensive profitability analysis –Detailed analysis of rate of return on stockholders’ equity LG 2

8. 8 RATE EARNED ON STOCKHOLDERS’ EQUITY Return on Stockholders’ Equity (ROE) = Net Income / Ave. Stockholders’ Equity LG 2

9. 9 PIXAR vs. DREAMWORKS: ROE PixarDreamworks Net Income $141.7$333 Beginning Stockholders Equity 940.5 Ending Stockholders Equity 1,220.1826.9 ROE 13.1% ? Pixar ROE: 141.7 / {(940.5 + 1220.1)/2} LG 2

10. 10 RATE EARNED ON TOTAL ASSETS Return on Total Assets (ROA) = Net Income / Ave. Total Assets LG 2

11. 11 PIXAR vs. DREAMWORKS: ROA PixarDreamworks Net Income $141.7$333 Beginning Total Assets 1,002.0681.4 Ending Total Assets 1275.01,200.0 ROA ? 35.4% Dreamworks ROA: 333 / {(681.4 + 1200.0)/2} LG 2

12. 12 COMPREHENSIVE ROE Rate Earned on Stockholders’ Equity (ROE) = ROA * Leverage {Net Income/ Ave TA} * {Ave TA/Ave Stockholders’ Equity} LG 2

13. 13 PIXAR vs. DREAMROWKS: Comprehensive ROE ROE =ROALeverage Pixar12.4%1.05 Dreamworks35.4%2.31 13.1% 81.8% LG 2

14. 14 MARGIN & ASSET EFFICIENCY ANALYSIS Margin & efficiency analyses examine –Profit margins –Efficient use of assets LG 3

15. 15 DUPONT FORMULA ROA = Profit Margin * Asset Turnover = Net Income/Ave TA = Net Income/Net Sales * Net Sales/Ave TA LG 3

16. 16 EXHIBIT 6 $1 assets generates $x sales $1 sales generates x cents profits LG 3

17. 17 PIXAR vs. DREAMROWKS: Dupont Analysis ROA = Profit Margin Asset Turnover Pixar51.8%0.24 Dreamworks30.9%1.15 12.4% 35.4% LG 3

18. 18 ASSET EFFICIENCY: Components Asset efficiency –Examine major asset accounts Accounts receivable turnover Inventory turnover Fixed asset turnover LG 3

19. 19 ACCOUNTS RECEIVABLE ANALYSIS Measures efficiency of collection Reflects liquidity Accounts receivable turnover = Net Sales / (Ave. AR) Days sales in Receivables = Ave AR/Ave Daily Sales LG 3

20. 20 PIXAR vs. DREAMWORKS: Accounts Receivable Turnover LG 3 PixarDreamworks Net Sales $273.5$1078.2 Beginning AR 204.9132.3 Ending AR 82.0386.1 Accounts Receivable Turnover 1.91 4.16 Pixar Turnover: 273.5 / {(204.9 + 82.0)/2}

21. 21 LG 3 Dreamworks collects its accounts receivable more than twice as fast as Pixar measured in terms of the number of times receivables are collected within the year.

22. 22 PIXAR vs. DREAMWORKS: Days Sales in Receivables PixarDreamworks Beginning AR 204.9132.3 Ending AR 82.0386.1 Average AR $143.45$259.20 Net Sales $273.5$1078.2 Average daily sales (Sales/365) $0.75$2.95 Days Sales in Receivables 191.387.9 LG 3

23. 23 LG 3 Dreamworks collects its accounts receivable more than twice as fast as Pixar measured in days receivables have been outstanding.

24. 24 INVENTORY ANALYSIS Measures inventory efficiency –Avoid tying up funds in inventory –Avoid obsolescence Reflects liquidity Inventory Turnover = CGS / (Ave. Inventory) Days Sales in Inventory = Ave Inventory/ (CGS/365) LG 3

25. 25 PIXAR vs. DREAMWORKS: Inventory Turnover LG 3 PixarDreamworks Cost merchandise sold $29.9$566.2 Beginning Inventory 107.7427.5 Ending Inventory 140.0519.9 Inventory Turnover 0.24 1.2 Pixar Turnover: 29.9 / {(107.7 + 140.0)/2}

26. 26 LG 3 Dreamworks turns its inventory 5 times as fast as Pixar measured in terms of the number of times inventory turns over within the year.

27. 27 PIXAR vs. DREAMWORKS: Days Sales in Inventory PixarDreamworks Beginning Inventory 107.7427.5 Ending Inventory 140.0519.9 Average Inventory $123.85$473.7 Cost of goods sold $29.9$566.2 Average daily COGS (Sales/365) $0.082$1.55 Days Sales in Inventory 1,510306 LG 3

28. 28 LG 3 Dreamworks turns out its pictures more than 5 times as fast as Pixar measured in days pictures have been in production.

29. 29 FIXED ASSET ANALYSIS Measures efficiency in use of fixed assets –Measures dollars sales generated by $1 fixed assets Fixed Asset Turnover = Sales / (Ave. Fixed Assets) LG 3

30. 30 PIXAR vs. DREAMWORKS: Fixed Asset Turnover LG 3 PixarDreamworks Net Sales $273.5$1078.2 Beginning Fixed assets 115.089.8 Ending Fixed assets 125.686.0 Fixed Asset Turnover 2.27 12.27 Pixar Turnover: 273.5 / {(115.0 + 125.6)/2}

31. 31 LG 3 Dreamworks generates more than 5 times the sales dollars as Pixar during the year.

32. 32 LEVERAGE ANALYSIS Measures liquidity, solvency –Current ratio –Quick ratio –Fixed assets to long-term liabilities –Liabilities to equity –# Times interest charges earned LG 4

33. 33 PIXAR vs. DREAMWORKS: Current Ratio PixarDreamworks Current assets $939.0$727.8 Current liabilities 54.9152.9 Working capital (CA – CL) $884.1$574.9 Current ratio 17.14.76 LG 4

34. 34 LG 4 A current ratio > 2.0 shows excellent ability to pay short- term borrowings. Both Pixar & DreamWorks have high current ratios.

35. 35 PIXAR vs. DREAMWORKS: Quick Ratio PixarDreamworks Quick assets* $936.8$450.9 Current liabilities 54.9152.9 Quick ratio 17.062.95 LG 4 *Quick assets: cash, marketable securities, & receivables

36. 36 LG 4 If the standard measurement for the quick ratio is > 1.0, what can you say about the quick ratio for Pixar & DreamWorks?

37. 37 PIXAR vs. DREAMWORKS: Fixed Assets to Long-Term Liabilities PixarDreamworks Fixed assets $125.6$89.7 Long-term liabilities 0217.2 Fixed assets to Long-term liabilities NA0.41 LG 4

38. 38 LG 4 If DreamWorks finances 41% of its fixed assets with long term debt, what can you say about how Pixar finances its fixed assets?

39. 39 PIXAR vs. DREAMWORKS: Liabilities to Stockholders’ Equity PixarDreamworks Total liabilities $54.9$373.1 Total stockholders’ equity 1,220.1826.9 Ratio liabilities to stockholders’ equity 0.040.45 LG 4

40. 40 LG 4 Both Pixar & DreamWorks are conservative (< 1) in their use of liabilities to finance assets.

41. 41 PIXAR vs. DREAMWORKS: # Times Interest Charges Earned PixarDreamworks Net Income $141.7$333 + Tax expense 79.490.3 + Interest expense 015.0 Available for interest charges $221.1$438.3 # Times interest charges earned NA29.2 LG 4

42. 42 LG 4 DreamWorks can cover its interest charges more than 29 times. Interpret Pixar’s ratio.

43. 43 STOCKHOLDER RATIOS Earnings per share Price earnings ratio Dividend Yield LG 5

44. 44 PIXAR vs. DREAMWORKS: Earnings per Share PixarDreamworks Net Income $141.7$333 Shares common stock outstanding 56.7681.4 EPS $2.50$4.09 LG 5

45. 45 LG 5 A share of DreamWorks stock earned more than a share of Pixar’s stock. What is the importance of trends in EPS?

46. 46 PIXAR vs. DREAMWORKS: Price-Earnings Ratio PixarDreamworks Market price per share C/S $90.06$37.44 EPS 2.504.09 Price-Earnings ratio 36.02$9.15 LG 5

47. 47 LG 5 Investors are willing to pay 36 times Pixar’s earning for a share of stock? Compare with DreamWorks.

48. 48 DIVIDEND YIELD Dividend yield calculates the rate of return to common shareholders in terms of cash dividends Neither Pixar not DreamWorks pay dividends LG 5

49. 49 ANALYTICAL MEASURES: Summary Industry, capital structure, operations affect measures used Measures of financial position, operating results assess past performance –Industry, general economic trends should be considered Interrelationships among measures should be considered LG 6

50. 50 CONTENTS ANNUAL REPORTS Corporate annual reports must include –Management Discussion & Analysis Interprets financial statements Assesses future of company –Report on adequacy of internal control –Report on fairness of financial statements LG 7

51. 51 "My great concern is not whether you have failed, but whether you are content with your failure." - Abraham Lincoln (1809-1865)