© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-1 FINANCIAL STATEMENT ANALYSIS Chapter 14

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-2 Internal UsersExternal Users Financial statement analysis helps users make better decisions. Managers Officers Internal Auditors Shareholders Lenders Customers Purpose of Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-3 Purpose of Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-4 Financial Statements Are Designed for Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-5 Dollar & Percentage Changes Trend Percentages Component Percentages Ratios Tools of Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-6 Dollar Change: Analysis Period Amount Base Period Amount Dollar Change =– Percentage Change: Dollar Change Base Period Amount Percent Change = ÷ % Dollar and Percentage Changes

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-7 Dollar and Percentage Changes

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-8 Let’s look at the asset section of Clover, Inc. comparative balance sheet and income statement for 2005 and Compute the dollar change and the percentage change for cash. Let’s look at the asset section of Clover, Inc. comparative balance sheet and income statement for 2005 and Compute the dollar change and the percentage change for cash. Dollar and Percentage Changes

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-9

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin $12,000 – $23,500 = $(11,500)

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin ($11,500 ÷ $23,500) × 100% = 48.94% Complete the analysis for the other assets.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-12

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Trend analysis is used to reveal patterns in data covering successive periods. Trend Percent Analysis Period Amount Base Period Amount 100% = × Trend Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin is the base period so its amounts will equal 100%. Berry Products Income Information For the Years Ended December 31, Trend Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Examine the relative size of each item in the financial statements by computing component (or common-sized) percentages. Component Percent 100% Analysis Amount Base Amount = × Financial StatementBase Amount Balance SheetTotal Assets Income StatementRevenues Financial StatementBase Amount Balance SheetTotal Assets Income StatementRevenues Component Percentages

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin ($12,000 ÷ $315,000) × 100% = 3.8% ($23,500 ÷ $289,700) × 100% = 8.1%

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-17

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-18

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 14-19

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Ratios

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Use this information to calculate the liquidity ratios for Matrix, Inc.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Working capital Working capital is the excess of current assets over current liabilities. Working Capital

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Current Ratio Current Assets Current Liabilities = = 1.55 : 1 This ratio measures the short-term debt-paying ability of the company. Current Ratio Current Ratio $65,000 $42,000 =

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Quick assets are cash, marketable securities, and receivables. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. Quick Assets Current Liabilities = Quick Ratio Quick Ratio

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Quick Ratio Quick Assets Current Liabilities = Quick Ratio This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash. $50,000 $42,000 =1.19 : 1= Quick Ratio

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin A measure of creditor’s long-term risk. The smaller the percentage of assets that are financed by debt, the smaller the risk for creditors. A measure of creditor’s long-term risk. The smaller the percentage of assets that are financed by debt, the smaller the risk for creditors. Debt Ratio

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Uses and Limitations of Financial Ratios

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin An income statement can be prepared in either a multiple-step or single-step format. The single-step format is simpler. The multiple-step format provides more detailed information. The single-step format is simpler. The multiple-step format provides more detailed information. Measures of Profitability

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Proper Heading { Gross Margin { Operating Expenses { { Non- operating Items Income Statement (Multiple-Step) Remember to compute EPS.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Proper Heading { Income Statement (Single-Step) Expenses & Losses { Revenues & Gains { Remember to compute EPS.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Use this information to calculate the profitability ratios for Matrix, Inc.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin This ratio is generally considered the best overall measure of a company’s profitability. This ratio is generally considered the best overall measure of a company’s profitability. Return On Assets (ROA)

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin This measure indicates how well the company employed the owners’ investments to earn income. Return On Equity (ROE)

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin End of Chapter 14