C16- 1 Learning Objectives 1.Basic Analytical Procedures 2.Solvency Analysis 3.Profitability Analysis 4.Summary of Analytical Measures 5.Corporate Annual Reports Chapter 16 Chapter 16 Financial Statement Analysis

C16- 2 Lincoln Company Comparative Balance Sheet December 31, 2003 and 2002 Assets Current assets$ 550,000$ 533,000$ 17, % Long-term investments95,000177,500(82,500)(46.5%) Fixed assets (net)444,500470,000(25,500)(5.4%) Intangible assets50,00050,000— $1,139,500$1,230,500$ (91,000)(7.4%) Liabilities Current liabilities$ 210,000$ 243,000$ (33,000)(13.6%) Long-term liabilities100,000200,000(100,000)(50.0%) $ 310,000$ 443,000$(133,000)(30.0%) Stockholders’ Equity Preferred stock, $100 par$ 150,000$ 150,000— Common stock, $10 par500,000500,000— Retained earnings179,500137,500$42, % $ 829,500$ 787,500$42, % $1,139,500$1230,500$(91,000)(7.4%) Increase (Decrease) AmountPercent

C16- 3 Lincoln Company Comparative Balance Sheet December 31, 2003 and 2002 Assets Current assets$ 550,000$ 533,000$ 17, % Long-term investments95,000177,500(82,500)(46.5%) Fixed assets (net)444,500470,000(25,500)(5.4%) Intangible assets50,00050,000— $1,139,500$1,230,500$ (91,000)(7.4%) Liabilities Current liabilities$ 210,000$ 243,000$ (33,000)(13.6%) Long-term liabilities100,000200,000(100,000)(50.0%) $ 310,000$ 443,000$(133,000)(30.0%) Stockholders’ Equity Preferred stock, $100 par$ 150,000$ 150,000— Common stock, $10 par500,000500,000— Retained earnings179,500137,500$42, % $ 829,500$ 787,500$42, % $1,139,500$1230,500$(91,000)(7.4%) Increase (Decrease) AmountPercent Horizontal Analysis: Horizontal Analysis: Current year (2003)$550,000 Base year (2002)$533,000 = 103.2% Increase amount$17,000 Base year (2002)$533,000 = 3.2%

C16- 4 Lincoln Company Comparative Income Statement December 31, 2003 and 2002 Sales$1,530,500$1,234,000$296, % Sales returns32,50034,000(1,500)(4.4%) Net sales$1,498,000$1,200,000$298,000)24.8% Cost of goods sold1,043,000820,000223, % Gross profit $ 455,000$ 380,000$ 75, % Selling expenses$ 191,000$ 147,000$ 44, % Administrative expenses104,00097,4006, % Total operating expenses$ 295,000$ 244,400$ 50, % Operating income$ 160,000$ 135,600$ 24, % Other income8,50011,000(2,500)(22.7%) $ 168,500$ 146,600$ 21, % Other expense6,00012,000(6,000)(50.0%) Income before income tax$ 162,500$ 134,600$ 27, % Income tax71,50058,10013, % Net income$ 91,000$ 76,500$ 14, % Increase (Decrease) AmountPercent

C16- 5 Lincoln Company Comparative Income Statement December 31, 2003 and 2002 Sales$1,530,500$1,234,000$296, % Sales returns32,50034,000(1,500)(4.4%) Net sales$1,498,000$1,200,000$298,000)24.8% Cost of goods sold1,043,000820,000223, % Gross profit $ 455,000$ 380,000$ 75, % Selling expenses$ 191,000$ 147,000$ 44, % Administrative expenses104,00097,4006, % Total operating expenses$ 295,000$ 244,400$ 50, % Operating income$ 160,000$ 135,600$ 24, % Other income8,50011,000(2,500)(22.7%) $ 168,500$ 146,600$ 21, % Other expense6,000 12,000(6,000)(50.0%) Income before income tax$ 162,500$ 134,600$ 27, % Income tax71,50058,10013, % Net income$ 91,000$ 76,500$ 14, % Increase (Decrease) AmountPercent Horizontal Analysis: Horizontal Analysis: Current year (2003)$1,498,000 Base year (2002)$1,200,000 = 124.8% Increase amount$298,000 Base year (2002)$1,200,000 = 24.8%

C16- 6 Lincoln Company Comparative Balance Sheets Assets Current assets$ 550, %$ 533, % Long-term investments95, , Fixed assets (net)444, , Intangible assets50, , $1,139, %$1,230, % Liabilities Current liabilities$ 210, %$ 243, % Long-term liabilities100, , $ 310, %$ 443, % Stockholders’ Equity Preferred stock, $100 par$ 150, %$ 150, % Common stock, $10 par500, , Retained earnings179, , $ 829, %$ 787, % $1,139, %$1230, % December 31, 2003 December 31, 2002 AmountPercentAmountPercent

C16- 7 Lincoln Company Comparative Balance Sheets Assets Current assets$ 550, %$ 533, % Long-term investments95, , Fixed assets (net)444, , Intangible assets50, , $1,139, %$1,230, % Liabilities Current liabilities$ 210, %$ 243, % Long-term liabilities100, , $310, %$ 443, % Stockholders’ Equity Preferred stock, $100 par$ 150, %$ 150, % Common stock, $10 par500, , Retained earnings179, , $829, %$787, % $1,139, %$1230, % December 31, 2003 December 31, 2002 AmountPercentAmountPercent Vertical Analysis: Vertical Analysis: Current liabilities$210,000 Total assets$1,139,500 = 18.4%

C16- 8 Lincoln Company Comparative Balance Sheets Assets Current assets$ 550, %$ 533, % Long-term investments95, , Fixed assets (net)444, , Intangible assets50, , $1,139, %$1,230, % Liabilities Current liabilities$ 210, %$ 243, % Long-term liabilities100, , $310, %$ 443, % Stockholders’ Equity Preferred stock, $100 par$ 150, %$ 150, % Common stock, $10 par500, , Retained earnings179, , $829, %$787, % $1,139, %$1230, % December 31, 2003 December 31, 2002 AmountPercentAmountPercent Common-Size Statements

C16- 9 Solvency Analysis Solvency is the ability of a business to meet its financial obligations (debts) as they are due. Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities. This ability is normally assessed by examining balance sheet relationships.

C Solvency Measures — The Short-Term Creditor Current assets $550,000$533,000 Current liabilities 210, ,000 Working capital$340,000$290,000 Current ratio Working Capital and Current Ratio Use:To indicate the ability to meet currently maturing obligations. Divide current assets by current liabilities

C Solvency Measures — The Short-Term Creditor Acid-Test Ratio Use:To indicate instant debt-paying ability Quick assets: Cash$ 90,500$ 64,700 Marketable securities 75,00060,000 Accounts receivable (net)115,000120,000 Total$280,500$244,700 Current liabilities$210,000$243,000 Acid-test ratio

C Solvency Measures — The Short-Term Creditor Accounts Receivable Turnover Use:To assess the efficiency in collecting receivables and in the management of credit. Net sales on account$1,498,000$1,200,000 Accounts receivable (net): Beginning of year$ 120,000$ 140,000 End of year 115,500120,000 Total$ 235,000$ 260,000 Average$ 117,500$ 130,000 Accts. receivable turnover

C Solvency Measures — The Short-Term Creditor Number of Days’ Sales in Receivables Use:To assess the efficiency in collecting receivables and in the management of credit Accounts receivable (net) end of year$ 115,000$ 120,000 Net sales on account$1,498,000$1,200,000 Average daily sales on on account (sales  365)$ 4,104$ 3,288 Number of days’ sales in receivables

C Solvency Measures — The Short-Term Creditor Inventory Turnover Use:To assess the efficiency in the management of inventory Cost of goods sold$1,043,000$ 820,000 Inventories: Beginning of year$ 283,000$ 311,000 End of year 264,000283,000 Total$ 547,000$ 594,000 Average$ 273,500$ 297,000 Inventory turnover

C Solvency Measures — The Short-Term Creditor Number of Days’ Sales in Inventory Use:To assess the efficiency in the management of inventory Inventories, end of year$ 264,000$283,000 Cost of goods sold$1,043,000$820,000 Average daily cost of goods sold (COGS  365)$ 2,858$ 2,247 Number of days’ sales in inventory

C Solvency Measures — The Long-Term Creditor Use:To indicate the margin of safety to long-term creditors Fixed assets (net)$444,500$470,000 Long-term liabilities$100,000$200,000 Ratio of fixed assets to long-term liabilities Ratio of Fixed Assets to Long-Term Liabilities

C Solvency Measures — The Long-Term Creditor Ratio of Liabilities to Stockholders’ Equity Use:To indicate the margin of safety to creditors Total liabilities$310,000$443,000 Total stockholders’ equity$829,500$787,500 Ratio of liabilities to stockholders’ equity

C Solvency Measures — The Long-Term Creditor Number of Times Interest Charges Earned Use:To assess the risk to debtholders in terms of number of times interest charges were earned Income before income tax$ 900,000$ 800,000 Add interest expense 300, ,000 Amount available for interest$1,200,000$1,050,000 Number of times earned

C Profitability Analysis Profitability is the ability of an entity to earn profits. This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available. Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet.

C Profitability Measures — The Common Stockholder Ratio of Net Sales to Assets Net sales $1,498,000$1,200,000 Total assets: Beginning of year$1,053,000$1,010,000 End of year 1,044,5001,053,000 Total$2,097,500$2,063,000 Average$1,048,750$1,031,500 Excludes long-term investments

C Profitability Measures — The Common Stockholder Ratio of Net Sales to Assets Use:To assess the effectiveness of the use of assets Net sales on account$1,498,000$1,200,000 Total assets: Beginning of year$1,053,000$1,010,000 End of year 1,044,5001,053,000 Total$2,097,500$2,063,000 Average$1,048,750$1,031,500 Ratio of net sales to assets

C Profitability Measures — The Common Stockholder Rate Earned on Total Assets Use:To assess the profitability of the assets Net income$ 91,000$ 76,500 Plus interest expense6,00012,000 Total$ 97,000$ 88,500 Total assets: Beginning of year$1,230,500$1,187,500 End of year 1,139,5001,230,500 Total$2,370,000$2,418,000 Average$1,185,000$1,209,000 Rate earned on total assets8.2% 7.3%

C Profitability Measures — The Common Stockholder Rate Earned on Stockholders’ Equity Use:To assess the profitability of the investment by stockholders. Net income$ 91,000$ 76,500 Stockholders’ equity: Beginning of year$ 787,500$ 750,000 End of year 829,500787,500 Total$1,617,000$1,537,500 Average$ 808,500$ 768,750 Rate earned on equity11.3% 10.0%

C Profitability Measures — The Common Stockholder Rate Earned on Common Stockholders’ Equity Use:To assess the profitability of the investment by common stockholders Net income$ 91,000$ 76,500 Less preferred dividends9,0009,000 $ 82,000$ 67,500 Remainder—common stock$ 82,000$ 67,500 Common stockholders’ equity: Beginning of year$ 637,500$ 600,000 End of year 679,500637,500 Total$1,317,000$1,237,500 $ 658,500$ 618,750 Average$ 658,500$ 618,750 Rate earned on common equity12.5% 10.9%

C Profitability Measures — The Common Stockholder Earnings Per Share on Common Stock Net income$ 91,000$ 76,500 Less preferred dividends9,0009,000 Remainder—common stock$ 82,000$ 67,500 Shares of common stock50,00050,000 Earnings per share on common$1.64 $1.35 Use:To assess the profitability of the investment by common stockholders.

C Profitability Measures — The Common Stockholder Price-Earnings Ratio Use:To indicate future earnings prospects, based on the relationship between market value of common stock and earnings Market price per share of common$41.00$27.00 Earnings per share on common$ 1.64$ 1.35 Price-earnings ratio on common25 20

C Profitability Measures — The Common Stockholder Dividend Yield Use:To indicate the rate of return to common stockholders in terms of dividends Dividends per share of common$ 0.80$ 0.60 Market price per share of common$41.00$27.00 Dividend yield on common stock1.95%2.22%

C Corporate Annual Reports 1. Financial Highlights 2.President’s Letter to the Stockholders 3.Management Report 4.Independent Auditors’ Report 5.Historical Summary In addition to financial statements, the annual report includes:

C HOME WORK READING: 1.Illustrative problem 2.Self- examination questions 3.Multiple choice Writing: 1.Exercise: 2.Problem : 16-4B Discussion:

C This is the end of Chapter 16