Chapter 14

 To make informed decisions about a company  Generally based on comparative financial data 2Copyright (c) 2009 Prentice Hall. All rights reserved.

Perform a horizontal analysis of financial statements

 Compares two financial statements to determine dollar and percentage changes ◦ Compute dollar changes ◦ Compute percentage changes 4 Current year balancePrior year balance Dollar changeBase period Prior year balance Copyright (c) 2009 Prentice Hall. All rights reserved.

5

 Form of horizontal analysis  Base year selected and set equal to 100% 6 Trend % Base year $ Any year $ Copyright (c) 2009 Prentice Hall. All rights reserved.

Perform a vertical analysis of financial statements

 Shows relationship of each item to a base amount on financial statements 8Copyright (c) 2009 Prentice Hall. All rights reserved.

Prepare and use common-size financial statements

10Copyright (c) 2009 Prentice Hall. All rights reserved.

 Comparing a company with another leading company 11Copyright (c) 2009 Prentice Hall. All rights reserved.

Compute the standard financial ratios

13 Ability to pay current liabilities Ability to sell inventory and collect receivables Ability to pay long-term debt Measure profitability Analyzing stock as an investment Copyright (c) 2009 Prentice Hall. All rights reserved.

14 Working capital Current ratio Acid- test ratio Copyright (c) 2009 Prentice Hall. All rights reserved.

15 Working capital Current assets Current liabilities Current ratio Current assets Current liabilities Acid-test ratio Current liabilities Cash + short-term investments + net current receivables Results in a dollar amount Both result in a ratio Copyright (c) 2009 Prentice Hall. All rights reserved.

16 Inventory turnover Accounts receivable turnover Days’- sales-in- receivables Copyright (c) 2009 Prentice Hall. All rights reserved.

17 Inventory turnover Cost of goods sold Average inventory Accounts receivable turnover Net credit sales Average accounts receivable The higher the turnover, the quicker it’s selling The higher the turnover, the quicker the collections Copyright (c) 2009 Prentice Hall. All rights reserved.

18 Days’ sales in receivables Net sales 365 Average day’s sales Average net accounts receivable Copyright (c) 2009 Prentice Hall. All rights reserved.

19 Current ratio Current assets Current liabilities $173,000$129,000 ? ? Copyright (c) 2009 Prentice Hall. All rights reserved.

20 Acid-test ratio Cash + short-term investments + net current receivables Current liabilities $18, , ,000 $129,000 $81,000 ? ? Copyright (c) 2009 Prentice Hall. All rights reserved.

21 Inventory turnover Cost of goods sold Average inventory $319,000 $75, ,000 2 $74,000 $319,000 ? ? Copyright (c) 2009 Prentice Hall. All rights reserved.

22 Days’ sales in receivables Net sales 365 Average day’s sales Average net accounts receivable $463, $1,268 $53, ,000 2 $64,000 $1,268 ? days Copyright (c) 2009 Prentice Hall. All rights reserved.

23 Debt ratio Times-interest- earned ratio Copyright (c) 2009 Prentice Hall. All rights reserved.

24 Debt ratio Total liabilities Total assets Times interest earned Operating income Interest expense Copyright (c) 2009 Prentice Hall. All rights reserved.

25 Return on net sales Return on total assets Return on common stockholders’ equity Earnings per share Copyright (c) 2009 Prentice Hall. All rights reserved.

26 Return on sales Net income Net sales Return on assets Net income + interest expense Average total assets Copyright (c) 2009 Prentice Hall. All rights reserved.

27 Return on equity Net income – preferred dividends Average common equity Earnings per share Net income – preferred dividends Number of common shares outstanding Copyright (c) 2009 Prentice Hall. All rights reserved.

 Trading on the equity  Increases profits during good times 28 Return on equity Return on assets is greater than Copyright (c) 2009 Prentice Hall. All rights reserved.

29 Price/earnings ratio (P/E) Dividend yield Book value Copyright (c) 2009 Prentice Hall. All rights reserved.

30 P/E ratio Market price per share Earnings per share Dividend yield Dividends per share Book value Common shares outstanding Common equity Market price per share Copyright (c) 2009 Prentice Hall. All rights reserved.

 Suspect movement of sales, inventory, and receivables  Earnings problems  Decreased cash flow  Too much debt  Inability to collect receivables  Inventory buildup 31Copyright (c) 2009 Prentice Hall. All rights reserved.