Analyzing Financial Statements Chapter 22 2

Preparing comparative Learning Objective 1 Preparing comparative balance sheets. 4

Users of Financial Reports Investors Creditors Management

Learning Unit 22-1 (Horizontal and Vertical Analysis) Current assets: Cash Accounts receivable, net Merchandise inventory Prepaid expenses Total current assets Plant and equipment: Office equipment, net Total assets $ 3,040 20,000 24,160 80,000 $ 48,000 $125,200 $173,200 $ 4,080 16,000 26,120 60,000 $ 46,800 $116,800 $163,600 $(1,040) 4,000 (1,960) 200 $ 1,200 $ 8,400 $ 9,600 (25.5) 25 (7.5) 33.3 2.6 7.2 5.9 Scrupper Supply Company Comparative Balance Sheet As of December 31, 20x8, and December 31, 20x7 Assets December 31 20x8 20x7 Incr. or Dec. 20x8 % Incr.

Learning Unit 22-1 (Horizontal and Vertical Analysis) Current liabilities: Notes payable Accounts payable Total current liabilities Long-term liabilities: Mortgage payable Total liabilities $ 20,960 240 $ 21,200 $ 60,000 $ 81,200 $3,640 (40) $3,600 -0- 21 (14.3) 20.5 4.6 $ 17,320 280 $ 17,600 $ 77,600 Scrupper Supply Company Comparative Balance Sheet As of December 31, 20x8, and December 31, 20x7 Liabilities December 31 20x8 20x7 Incr. or Dec. 20x8 % Incr.

Learning Unit 22-1 (Horizontal and Vertical Analysis) Stockholders’ equity: Common stock, $10 par Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity $ 60,000 32,000 $ 92,000 $173,200 -0- $6,000 $9,600 23.1 7.0 5.9 26,000 $ 86,000 $163,600 Scrupper Supply Company Comparative Balance Sheet As of December 31, 20x8, and December 31, 20x7 Stockholders’ Equity December 31 20x8 20x7 Incr. or Dec. 20x8 % Incr.

Using horizontal and vertical Learning Objective 2 Using horizontal and vertical analysis techniques. 4

Learning Unit 22-1 (Horizontal and Vertical Analysis) Horizontal Analysis 20x8 20x7 Difference Cash $3,040 $4,080 $(1,040) $1,040 ÷ $4,080 = 0.2549, or 25.5%

Learning Unit 22-1 (Horizontal and Vertical Analysis) Vertical analysis compares each item on a report to a base number set to 100%. The base will be either total assets or total liabilities and stockholders’ equity on a balance sheet.

Learning Unit 22-1 (Horizontal and Vertical Analysis) Assets 20x8 % Current assets: Cash $ 3,040 1.8 Accounts receivable net 20,000 11.5 Merchandise inventory 24,160 13.9 Prepaid expenses 800 .5 Total current assets $ 48,000 27.7 Plant and equipment Office equipment, net $125,200 72.3 Total assets $173,200 100.0

Learning Unit 22-2 (Trend Analysis) 20x8 % Net sales $317,600 100.0 Cost of goods sold 198,000 62.3 Gross profit from sales $119,600 37.7 Total operating expenses 83,600 26.3 Operating income $ 36,000 11.3 Less interest expense 4,200 1.3 Income before taxes $ 31,800 10.0 Income taxes 15,900 5.0 Net income $ 15,900 5.0

Learning Unit 22-2 (Trend Analysis) What is trend analysis? It is a special type of horizontal analysis that deals with the percentage of changes in certain key items over several years. Trend % = Any year $ ÷ Base year $

Learning Unit 22-2 (Trend Analysis) Year 20x8 20x7 20x5 Sales $317,600 $302,000 $270,000 Cost of Goods Sold 198,000 194,000 142,000 Gross Profit $119,600 $108,000 $128,000 20x5 is the base year. What are the trend percentages?

Learning Unit 22-2 (Trend Analysis) Year 20x8 20x7 20x5 Sales 118% 112% 100% Cost of Goods Sold 139% 137% 100% Gross Profit 93% 84% 100% %

Calculating the four different types of ratios: liquidity ratios, Learning Objective 3 Calculating the four different types of ratios: liquidity ratios, asset management ratios, debt management ratios, and profitability ratios. 4

Learning Unit 22-3 (Ratio Analysis) A ratio is the relationship of two quantities or numbers, one divided by the other. Ratio analysis looks at the relationship of figures on the financial statements.

Learning Unit 22-3 (Ratio Analysis) Liquidity Ratios Current ratio = Total current assets ÷ Total current liabilities Acid test ratio = (Current assets – Merchandise inventory – Prepaid expenses) ÷ Current liabilities

Learning Unit 22-3 (Ratio Analysis) Asset Management Ratios Accounts receivable turnover = Net credit sales ÷ Average accounts receivable Average collection period = 365 days ÷ Accounts receivable turnover

Learning Unit 22-3 (Ratio Analysis) Accounts receivable turnover shows how many times accounts receivable is converted to cash in one year.

Learning Unit 22-3 (Ratio Analysis) Inventory turnover = Cost of goods sold ÷ Average inventory Asset turnover = Net sales ÷ Total assets

Learning Unit 22-3 (Ratio Analysis) The inventory turnover calculates the number of times inventory turns over in one period. The asset turnover indicates whether or not assets have been used efficiently to generate sales.

Learning Unit 22-3 (Ratio Analysis) Debt Management Ratios Debt to total assets = Total liabilities ÷ Total assets Debt to stockholders’ equity = Total liabilities ÷ Stockholders’ equity

Learning Unit 22-3 (Ratio Analysis) The debt-to-total-assets ratio indicates the amount of assets that are financed by creditors. The debt-to-stockholders’-equity ratio shows stockholders’ risk compared to creditors’ risk.

Learning Unit 22-3 (Ratio Analysis) Times interest earned = Income before taxes and interest expense ÷ Interest expense It reveals ability to meet interest payment due dates.

Learning Unit 22-3 (Ratio Analysis) Profitability Ratios Gross profit rate = Gross profit ÷ Net sales Return on sales = Net income before taxes ÷ Net sales

Learning Unit 22-3 (Ratio Analysis) Rate of return on total assets = Net income before interest and taxes ÷ Total assets Rate of return on common stockholders’ equity = (Net income before taxes – Preferred dividends) ÷ Common stockholders’ equity

Learning Unit 22-3 (Ratio Analysis) The rate of return on total assets indicates earning power. The rate of return on common stockholders’ equity shows the amount of the net income share that remains for the common stockholders (after preferred dividends are deducted).

End of Chapter 22