© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 1 of 49 Earnings Per Share (EPS) EPS tells investors how much of a period’s net income “belongs to” each share of common stock Investors should predict a company’s future EPS before deciding whether to buy the company’s common shares Net Income Average number of shares outstanding EPS =

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 2 of 49 Price-Earnings (P-E) Ratio The P-E ratio measures how much the investing public is willing to pay for a chance to share the company’s potential earnings A high P-E ratio indicates that investors predict the company’s net income will grow rapidly Market price per share of common stock Earnings per share of common stock P-E Ratio =

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 3 of 49 Dividend-Yield Ratio The dividend-yield ratio gauges dividend payouts Investors in common stock who seek regular cash returns of their investments pay particular attention to dividend-yield ratios Current market price of stock Common dividends per share Dividend-Yield Ratio =

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 4 of 49 Dividend-Payout Ratio The dividend-payout ratio shows what proportion of net income a company elects to pay in cash dividends to its shareholders Many companies elect to pay a reasonably constant dollar amount in dividends, even if this means variations in its dividend-payout ratio Common dividends per share Earnings per share Dividend-Payout Ratio =

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 5 of 45 Classified Balance Sheet

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 6 of 45 Current Ratio Liquidity is a company’s ability to pay its immediate financial obligations with cash and near-cash assets The current ratio evaluates a company’s liquidity Chan Audio’s current ratio is Current Ratio = Current assets Current liabilities $532,600 $235,300 = 2.3

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 7 of 45 Current Ratio The quick ratio removes Inventory (and other less liquid assets such as Prepaid Expenses) from the numerator of the calculation Chan Audio’s quick ratio is The current ratio should be greater than 2.0 The quick ratio should be greater than 1.0 $532,600 - $250,200 $235,300 = 1.2

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 8 of 45 Multiple-Step Income Statement

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 9 of 45 Profitability Evaluation Ratios Profitability measures affect the investment decisions of investors, creditors, and managers The four basic profitability ratios are –Gross profit margin –Return on sales –Return on common stockholders’ investment –Return on assets

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 10 of 45 Gross Profit Margin The Chan Audio Company’s gross profit percentage is presented below: Gross profit percentages vary greatly by industry Gross profit percentage = Gross profit / Sales = $60,000 / $160,000 = 37.5%

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 11 of 45 Return on Sales or Net Profit Margin The return on sales ratio (also known as the net profit margin ratio) gauges a company’s ability to control the level of all its expenses relative to the level of its sales The return on sales percentage tends to vary by industry

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 12 of 45 Return on Sales or Net Profit Margin Chan Audio’s return on sales ratio is Return on sales = Net income / sales = $11,200 / $160,000 = 7%

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 13 of 45 Return on Common Stockholders’ Equity Return on common stockholders’ equity ratio (ROE or ROCE) compares net income with invested capital The return on common stockholders’ equity for Chan Audio is Return on common stockholders’ equity = Net income / Average common stockholders’ equity = $11,200 / ½ ($400,000 + $411,200) = $11,200 / $405,600 = 2.8% (for 1 month)

© 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e © 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 14 of 45 Return on Assets The return on assets ratio –Compares net income with invested capital as measured by average total assets –Measures how effectively those assets generate profits The return on assets ratio for Chan Audio for the month of January is Return on assets = Net income / Average total assets = $11,200 / ½ ($620,000 + $646,500) = $11,200 / $633,250 = 1.8% (for 1 month)