1. Financial Statement Analysis
Chapter 13

2. Learning Objective 1
Perform a horizontal analysis of comparative financial statements.

3. Horizontal Analysis
Study of percentage changes in comparative statements
1. Compute the dollar amount of the change
from the base period to the later period.
2. Divide the dollar amount of change
by the base-period amount.

4. Trend % = Any year $ ÷ Base year $
Trend Percentages
Computed by selecting a base year whose amounts are set equal to 100%.
Trend % = Any year $ ÷ Base year $

5. Learning Objective 2
Perform a vertical analysis of financial statements.

6. Vertical Analysis
Reveals the relationship of each statement item to a specified base, which is the 100% figure.
Every other item on the financial statement is then reported as a percentage of that base.

7. Learning Objective 3
Prepare and use common-size financial statements.

8. Common-Size Statements
On a common-size income statement, each item is expressed as a percentage of net sales.
In the balance sheet, the common size is total assets.
A common-size statement eases the comparison of different companies.

9. Benchmarking Practice of comparing a company to other companies
Common-size statements are also used to compare the company to a specific company

10. Learning Objective 4
Use the statement of cash flows for decisions.

11. Statement of Cash Flows
Cash-flow signs of a healthy company:
Operations are a major source of cash.
Investing activities include more purchases than sales of long-term assets.
Financing activities are not dominated by borrowing.

12. Learning Objective 5
Compute the standard financial ratios.

13. Ratio Classification 1. Measure ability to pay current liabilities
2. Measure ability to sell inventory and
collect receivables
3. Measure ability to pay long-term debt
4. Measure profitability
5. Analyze stock as an investment

14. Working Capital
Measures ability to pay current liabilities with current assets
Current assets – Current liabilities

15. Current assets ÷ Current liabilities
Current Ratio
Measures company’s ability to pay current liabilities with current assets
Current assets ÷ Current liabilities

16. Acid-Test Ratio
Shows the company’s ability to pay all current liabilities if they come due immediately.
(Cash + Short-term investments
+ Net current receivables)
÷ Current liabilities

17. Measuring Ability to Sell Inventory
Inventory turnover – measure of the number of times the average level of inventory is sold during a year
Cost of goods sold ÷ Average inventory

18. Measuring Ability to Collect Receivables
Accounts receivable turnover measures a company’s ability to collect cash from credit customers.
Net credit sales ÷ Average accounts receivable

19. Measuring Ability to Collect Receivables
Days’ sales in receivables ratio measures how many day’s sales remain in Accounts Receivable.
One day’s sales = Net sales ÷ 365 days
Days’ sales in receivable =
Avg net accounts receivable ÷ One day’s sales

20. Measuring Ability to Pay Debt
The debt ratio indicates the proportion of assets financed with debt.
Total liabilities ÷ Total assets

21. Measuring Ability to Pay Debt
Times-interest-earned ratio measures the number of times operating income can cover interest expense.
Income from operations ÷ Interest expense

22. Measuring Profitability
Rate of return on net sales shows the percentage of each sales dollar earned as net income.
Net income ÷ Net sales

23. Measuring Profitability
Rate of return on total assets measures how profitably a company uses its assets.
(Net income + Interest expense)
÷ Average total assets

24. Measuring Profitability
Rate of Return on Common Stockholders’ Equity:
Net income – Preferred dividends ÷ Average common stockholders’ equity

25. Measuring Profitability
Earnings per share of common stock
(Net income – Preferred dividends) ÷ Number of shares of common stock outstanding

26. Objective 6
Use ratios in decision making

27. Analyzing Stock Investments
Price/earning ratio - ratio of market price per share to earnings per share
Dividend yield - percentage of stock’s market value returned as dividends to stockholders each period
Dividend per share of common stock ÷
Market price per share of common stock

28. Analyzing Stock Investments
Book value per share of common stock
(Total stockholders’ equity – Preferred equity)
÷ Number of shares of common
stock outstanding
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

29. Learning Objective 7
Measure the economic value added by operations.

30. Net income + Interest expense – Capital charge
Economic Value Added
Combines concepts of accounting income and corporate finance to measure whether the company’s operations have increased stockholder wealth.
EVA® =
Net income + Interest expense – Capital charge

31. Economic Value Added Capital charge Notes payable Loans Long-term debt
Stockholders’
equity + = ×
Cost of capital
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

32. Economic Value Added
Capital charge - amount that stockholders, lenders charge a company for use of their money
Cost of capital – weighted average of the returns demanded by company’s stockholders and lenders.
A positive EVA® amount indicates an increase in stockholder wealth