1. Prepared by: Carole Bowman, Sheridan College
Accounting Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by: Carole Bowman, Sheridan College

2. FINANCIAL STATEMENT ANALYSIS
CHAPTER 19
FINANCIAL STATEMENT ANALYSIS

3. BASICS OF FINANCIAL STATEMENT ANALYSIS
Analysing financial statements involves evaluating three characteristics of a company:
1. its liquidity
2. its profitability
3. its solvency

4. COMPARATIVE ANALYSIS Three types of comparisons: Intracompany basis
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COMPARATIVE ANALYSIS
Three types of comparisons:
Intracompany basis
Intercompany basis
Industry averages 30

5. COMPARATIVE ANALYSIS Three tools: Horizontal analysis
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COMPARATIVE ANALYSIS
Three tools:
Horizontal analysis
Vertical analysis
Ratio analysis 34

6. Change since base period For the Year Ended December 31 (in millions)
HORIZONTAL ANALYSIS
Change since base period
27% % % % Base Year
ANY COMPANY INC.
Assumed Net Sales
For the Year Ended December 31 (in millions)
2003
2002
2001
2000
1999
$ 6,562.8
$ 6,295.4
$ 6,190.6
$ 5,786.6
$ 5,181.4

7. Condensed Balance Sheets (Partial) December 31 (in millions)
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VERTICAL ANALYSIS
Expresses each item in a financial statement as a percent of a base amount (total assets or net sales)
ANY COMPANY, INC.
Condensed Balance Sheets (Partial)
December 31 (in millions)
Assets Amount Percent Amount Percent
Current assets $1, $1,
Capital assets 2, ,
Other assets
Total assets $5, % $4, % 46

8. - = RATIO ANALYSIS Liquidity Ratios Profitability Ratios Net Income
Measure short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.
Profitability Ratios
Measure the income or operating success of an enterprise for a given period of time.
Revenues
Expenses - =
Net Income
Solvency Ratios
Measure the ability of the enterprise to survive over a long period of time.
XYZ Co.
Since 1892

9. LIQUIDITY RATIOS Current ratio Acid test ratio
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LIQUIDITY RATIOS
Current ratio
Acid test ratio
Cash current debt coverage ratio
Receivables turnover
Collection period
Inventory turnover
Days sales in inventory 61

10. (Discussed in Chapter 4)
CURRENT RATIO
Measures short-term debt-paying ability
Current ratio =
Current assets
Current liabilities
(Discussed in Chapter 4) 32

11. ACID TEST RATIO Measures immediate short-term debt-paying ability
Cash + temporary investments + net receivables
Current liabilities
(Discussed in Chapter 9) 32

12. CASH CURRENT DEBT COVERAGE RATIO
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CASH CURRENT DEBT COVERAGE RATIO
Measures short-term debt-paying ability (cash basis)
Cash current debt coverage ratio =
Cash provided by operating activities
Average current liabilities
(Discussed in Chapter 18) 92

13. Receivables turnover = Average net receivables
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RECEIVABLES TURNOVER
Measures liquidity of receivables
Receivables turnover =
Net credit sales
Average net receivables
(Discussed in Chapter 9) 28

14. (Discussed in Chapter 9)
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COLLECTION PERIOD
Measures number of days receivables are outstanding
Collection period =
365 days
Receivables turnover
(Discussed in Chapter 9) 28

15. (Discussed in Chapter 5)
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INVENTORY TURNOVER
Measures liquidity of inventory
Inventory turnover =
Cost of goods sold
Average inventory
(Discussed in Chapter 5) 73

16. DAYS SALES IN INVENTORY
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DAYS SALES IN INVENTORY
Measures number of days inventory is on hand
Days in inventory =
365 days
Inventory turnover
(Discussed in Chapter 5) 35

17. PROFITABILITY RATIOS Profit margin Book value per share
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PROFITABILITY RATIOS
Profit margin
Gross profit margin
Cash return on sales
Asset turnover
Return on assets
Return on common shareholders’ equity
Book value per share
Cash flow per share
Earnings per share (EPS)
Price-earnings (PE) ratio
Payout ratio
Dividend yield 61

18. (Discussed in Chapter 5)
PROFIT MARGIN
Measures net income generated by each dollar of sales
Profit margin =
Net income
Net sales
(Discussed in Chapter 5) 19

19. (Discussed in Chapter 5)
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GROSS PROFIT MARGIN
Measures margin between selling price and cost of goods sold generated by each dollar of sales
Gross profit margin =
Gross profit
Net sales
(Discussed in Chapter 5) 45

20. Net cash provided by operating activities
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CASH RETURN ON SALES
Measures net cash flow generated by each dollar of sales
Cash return on sales =
Net cash provided by operating activities
Net sales
(Discussed in Chapter 18)
101

21. (Discussed in Chapter 10)
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ASSET TURNOVER
Measures how efficiently assets are used to generate sales
Asset turnover =
Net sales
Average total assets
(Discussed in Chapter 10) 45

22. (Discussed in Chapter 10)
RETURN ON ASSETS
Measures overall profitability of assets
Return on assets =
Net income
Average total assets
(Discussed in Chapter 10) 18

23. RETURN ON COMMON SHAREHOLDERS’ EQUITY
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RETURN ON COMMON SHAREHOLDERS’ EQUITY
Measures profitability of common shareholders’ investment
Return on common shareholders’ equity =
Net income
Average common shareholders’ equity
(Discussed in Chapter 14) 93

24. Common shareholders’ equity Number of common shares
BOOK VALUE PER SHARE
Measures the equity (net assets) per common share
Book value per share =
Common shareholders’ equity
Number of common shares
(Discussed in Chapter 14)

25. Net cash provided by all activities Number of common shares
CASH FLOW PER SHARE
Measures the net cash flow per common share
Cash flow per share =
Net cash provided by all activities
Number of common shares
(Discussed in Chapter 18)

26. EARNINGS PER SHARE (EPS)
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EARNINGS PER SHARE (EPS)
Measures net income earned on each common share
Earnings per share =
Net income
Number of common shares
(Discussed in Chapter 15)
101

27. PRICE-EARNINGS (PE) RATIO
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PRICE-EARNINGS (PE) RATIO
Measures relationship between market price per share and earnings per share
Price-earnings ratio =
Share price
Earnings per share
(Discussed in Chapter 15)
101

28. (Discussed in Chapter 15)
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PAYOUT RATIO
Measures % of earnings distributed in the form of cash dividends
Payout ratio =
Cash dividends
Net income
(Discussed in Chapter 15)
101

29. Cash dividends per share
DIVIDEND YIELD
Measures rate of return earned from dividends
Dividend yield =
Cash dividends per share
Share price
(Discussed in Chapter 15)

30. SOLVENCY RATIOS Debt to total assets Interest coverage
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SOLVENCY RATIOS
Debt to total assets
Interest coverage
Cash interest coverage
Cash total debt coverage 61

31. (Discussed in Chapter 16)
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DEBT TO TOTAL ASSETS
Measures % of total assets provided by creditors
Debt to total assets =
Total liabilities
Total assets
(Discussed in Chapter 16) 79

32. PowerPoint Slides
INTEREST COVERAGE
Measures ability to meet interest payments as they come due
Interest coverage =
Income before interest expense
and income tax expense (EBIT)
Interest expense
(Discussed in Chapter 16) 79

33. CASH INTEREST COVERAGE
Measures cash available to meet interest payments as they come due (cash basis)
Cash interest coverage =
Income before interest expense, income tax
expense, and amortization expense (EBITDA)
Interest expense
(Discussed in Chapter 16)

34. CASH TOTAL DEBT COVERAGE
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CASH TOTAL DEBT COVERAGE
Measures long-term debt-paying ability (cash basis)
Cash total debt coverage ratio =
Net cash provided by operating activities
Average total liabilities
(Discussed in Chapter 18) 92

35. LIMITATIONS OF FINANCIAL ANALYSIS
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LIMITATIONS OF FINANCIAL ANALYSIS
Estimates
Historical cost
Alternative accounting methods
Atypical data
Diversification
107

36. COPYRIGHT
Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.