Financial Analysis – Part 2 Professor Eric Carstensen MiraCosta College http://www.miracosta.edu/instruction/accounting/index.html

Methods of Financial Analysis Trend Analysis Horizontal Analysis Vertical Analysis Common Size Statements Comparison to Budget Comparison to Industry Data Ratio Analysis Liquidity Measures Profitability Measures Asset Utilization Measures Solvency Measures Market Prospects Measures

Financials for Ratio Analyses EJ Company's Year 2 Income Statement: Comparative Balance Sheets for Two (2) Years: Sales $ 890,000 Assets Year 1 Year 2 COGS 570,000 Cash $ 20,000 $ 40,000 Gross Margin 320,000 A/R 110,000 130,000 Op. Expenses 210,000 Inventory 190,000 170,000 Op. Income Prepaids 20,000 10,000 Loss on Disposal Total Current Assets 340,000 350,000 Income Before Taxes 90,000 Taxes 30,000 Long Term Investments Net Income $ 60,000 Property, Plant & Equipment 420,000 550,000 EJ Company's Year 2 RE Statement: Accum. Depreciation (110,000) (120,000) Net Property, Plant & Equipment 310,000 430,000 Year 1 Retained Earnings $ 110,000 add: Net Income 60,000 Total Assets $ 680,000 $ 810,000 less: Dividends equals: Year 2 Retained Earnings $ 160,000 Liabilities A/P $ 140,000 $ 120,000 Unearned Revenue Other Information: Total Current Liabilities 160,000 150,000 a. Equipment that had cost $90,000 and on which Long Term Note Payable there was $40,000 of accumulated deprec- iation was sold in Year 2 for $30,000 cash. Total Liabilities 300,000 b. Replacement equipment was purchased for $220,000 in cash. Equity c. Year 2 depreciation expense was $50,000. Common Stock 250,000 d. Cash dividends of $10,000 were paid in Retained Earnings the current year. Total Owners' Equity 360,000 510,000 Total Liabilities & Equity

Ratio Analysis - Liquidity Year 1 Year 2 Total Current Assets 340,000 350,000 - Total Current Liabilities 160,000 150,000 = Working Capital 180,000 200,000 Current Ratio 2.1 2.3 (cash + A/R + s.t. invest) 130,000 170,000 Quick Ratio 0.8 1.1

Ratio Analysis - Profitability Year 1 Year 2 Sales $ 836,000 $ 890,000 COGS 585,000 570,000 Gross Margin 251,000 320,000 Op. Expenses 190,000 210,000 Op. Income 61,000 110,000 Loss on Disposal - 20,000 Income Before Taxes 90,000 Taxes 19,000 30,000 Net Income $ 42,000 $ 60,000 GM% = 30.0% 36.0% 836,000 890,000 Op. Inc. % = 7.3% 12.4% Profit Margin = 42,000 5.0% 60,000 6.7%

Ratio Analysis – Profitability Cont’d Year 2 Return on Investment (ROI) Net Income = 60,000 8.1% Average Assets ** (680,000+810,000)/2 Return on Equity (ROE) 13.8% Average Equity *** (360,000+510,000)/2 Earnings Per Share (EPS) 0.20 Weighted Average (250,000+350,000)/2 Shares Outstanding **** ** Average Assets = (beginning assets + ending assets) / 2 *** Average Owners' Equity = (beginning equity + ending equity) / 2 **** Assume Common Stock is $1 par and there is no additional paid in capital

Ratio Analysis – Asset Utilization Year 2 A/R Turnover Net Credit Sales = 890,000 7.4 Average A/R ** (110,000+130,000)/2 # Days Uncollected Ending A/R * 365 130,000 * 365 53 Inventory Turnover COGS 570,000 3.2 Average Inventory *** (190,000+170,000)/2 # Days Sales in End. Inv. Ending Inv. * 365 (170,000 * 365) 109 ** Average A/R = (beginning A/R + ending A/R) / 2 *** Average Inventory = (beginning inventory + ending inventory) / 2

Ratio Analysis - Solvency Debt Ratio Year 1 Year 2 Total Liabilities 320,000 47.1% 300,000 37.0% Total Assets 680,000 810,000 Equity Ratio Total Owners' Equity 360,000 52.9% 510,000 63.0% Equity 88.9% 58.8%

Ratio Analysis – Market Prospects Year 2 Price-Earnings Ratio Market Price per Share = 10.00 5.8 Earnings per Share* 1.71 Dividend Yield Dividends per Share* .29 2.9% Market Price per Share** * assumes 35,000 shares of common stock ** assumes $10 market price per share

Financial Analysis Part 2 - Concluded We looked at several Ratio Analysis measures as part of this presentation. Accounting, Managerial Accounting and Finance textbooks contain additional ratios that can be applied, depending on the type of business. Some companies tailor these standard ratios for use in their own unique business.