INTRODUCTION TO FINANCIAL ANALYSIS Copyright © Texas Education Agency, All rights reserved.

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Accounting Defined Planning, recording, analyzing, and interpreting financial information Copyright © Texas Education Agency, All rights reserved. 3

Accounting System A planned process for providing financial information that will be useful to management Copyright © Texas Education Agency, All rights reserved. 4

Three Types of Ownership Proprietorship - a business owned by one person Partnership - a business in which two or more persons combine their assets and skills Corporation - an organization with the legal rights of a person and which may be owned by many persons Copyright © Texas Education Agency, All rights reserved. 5

Three Types of Businesses Service Business - a business that performs an activity for a fee Merchandising Business - a business that purchases and sells goods Manufacturing Business - a business which produces goods for use or sale using labor, machines, and tools Copyright © Texas Education Agency, All rights reserved. 6

Accounting Equation Asset - anything of value that is owned Liability - an amount owed by a business Owner’s Equity - the amount remaining after the value of all liabilities is subtracted from the value of all assets ASSETS LIABILITIES OWNER’S EQUITY Copyright © Texas Education Agency, All rights reserved. 7

Accounts Which Affect Income Revenue - an increase in owner’s equity resulting from the operation of the business Expense - a decrease in owner’s equity resulting from the operation of the business REVENUE EXPENSES NET INCOME Copyright © Texas Education Agency, All rights reserved. 8

Balance Sheet Balance Sheet - a financial statement that reports assets, liabilities, and owner’s equity on a specific date Long-term Liabilities - liabilities owed for more than one year Withdrawal - an asset taken out of a business for the owner’s personal use Copyright © Texas Education Agency, All rights reserved. 9

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Balance Sheet Continued Copyright © Texas Education Agency, All rights reserved. 11

Analyzing a Balance Sheet Vertical Analysis: A percentage method of analyzing financial statements where each item is expressed as a percentage of a base amount. In a Balance Sheet, everything is expressed as a percent of total assets. Horizontal Analysis: A method of analyzing financial statements where each item of the current period is compared in dollars and percent with the corresponding item from a previous period. Copyright © Texas Education Agency, All rights reserved. 12

Balance Sheet with Vertical Analysis All items are divided by Total Assets Copyright © Texas Education Agency, All rights reserved. 13

Balance Sheet with Horizontal Analysis Compares Current Year to Prior Year Copyright © Texas Education Agency, All rights reserved. 14

Income Statement Income Statement - a financial statement showing the revenue and expenses over a period of time Component Percentage - the percentage relationship between one financial statement item and the total that includes that item Cost of Merchandise Sold - the total original price of all merchandise sold during a fiscal period Gross Profit on Sales - the revenue remaining after cost of merchandise sold has been deducted Copyright © Texas Education Agency, All rights reserved. 15

Income Statement Copyright © Texas Education Agency, All rights reserved. 16

Income Statement Continued Copyright © Texas Education Agency, All rights reserved. 17

Analyzing an Income Statement Vertical Analysis: A percentage method of analyzing financial statements where each item is expressed as a percentage of a base amount. In an Income Statement, everything is expressed as a percent of net sales. Horizontal Analysis: A method of analyzing financial statements where each item of the current period is compared in dollars and percent with the corresponding item from a previous period. Copyright © Texas Education Agency, All rights reserved. 18

Income Statement with Vertical Analysis All items are divided by Net Sales Copyright © Texas Education Agency, All rights reserved. 19

Balance Sheet with Horizontal Analysis Compares Current Year to Prior Year Copyright © Texas Education Agency, All rights reserved. 20

Why Analyze? Why would a business complete a vertical analysis of a balance sheet? A horizontal analysis? Why would a business complete a vertical analysis of an income statement? A horizontal analysis? Copyright © Texas Education Agency, All rights reserved. 21

Reasons for Analyzing A comparison with the industry average is helpful. Changes in the percentages might reveal situations that need investigation. It is helpful to make comparisons with several years to detect trends. It is valuable when trying to determine whether a company is conservative or excessive in spending on certain items—especially if you are a creditor of the business. It aids in determining the effects of outside influences on the company, such as increasing gas prices or a reduction in the cost of materials. Copyright © Texas Education Agency, All rights reserved. 22