1. Fundamental Managerial Accounting Concepts
Fifth Edition
Fundamental Managerial Accounting Concepts
Thomas P. Edmonds
Bor-Yi Tsay
Philip R. Olds
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin

2. Financial Statement Analysis
CHAPTER 13
Financial Statement Analysis

3. Describe factors associated with communicating useful information.
Learning Objective
Describe factors associated with communicating useful information.
LO1

4. Factors in Communicating Useful Information
The primary objective of accounting is to provide information useful for decision making. To provide information that supports this objective, accountants must consider the following:
Users
Types of Decisions
Means of Analysis

5. Differentiate between horizontal and vertical analysis.
Learning Objective
Differentiate between horizontal and vertical analysis.
LO2

6. Methods of Analysis Horizontal Analysis Vertical Analysis
Ratio Analysis

7. Milavec Company Financial Statements

8. Milavec Company Financial Statements

9. Horizontal Analysis
Horizontal analysis (or trend analysis) refers to studying the behavior of individual financial statement items over several accounting periods.
Absolute Amounts
Percentage Analysis

10. Milavec Company Horizontal Analysis

11. Vertical Analysis
Vertical analysis uses percentages to compare individual components of financial statements to a key statement figure. A common-size financial statement is a vertical analysis in which each financial statement item is expressed as a percentage.

12. Vertical Analysis of Income Statement
In income statements, all items are usually expressed as a percentage of sales.

13. Milavec Company Vertical Analysis

14. Vertical Analysis of Balance Sheet
In balance sheets, all items are usually expressed as a percentage of total assets.

16. Explain ratio analysis.
Learning Objective
Explain ratio analysis.
LO3

17. Ratio Analysis
Ratio analysis involves studying various relationships between different items reported in a set of financial statements.

18. Calculate ratios for assessing a company’s liquidity.
Learning Objective
Calculate ratios for assessing a company’s liquidity.
LO4

19. Liquidity Ratios
Liquidity ratios indicate a company’s ability to pay short-term debts. They focus on current assets and current liabilities.
Working Capital
Current Ratio
Quick Ratio
Accounts Receivable Ratios
Inventory Ratios

20. Working Capital
The excess of current assets over current liabilities is known as working capital.

21. The current ratio measures a company’s short-term debt paying ability.
Current Assets
Current Liabilities =
The current ratio measures a company’s short-term debt paying ability.
A declining ratio may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories.

22. Current Ratio

23. Quick (Acid-Test) Ratio
Quick Assets
Current Liabilities =
Acid-Test
Ratio
Quick assets include Cash,
Current Marketable Securities, and Accounts Receivable. This ratio measures a company’s ability to meet obligations without having to liquidate inventory.

24. Quick (Acid-Test) Ratio

25. Accounts Receivable Turnover
Net Credit Sales
Average Accounts Receivable
Accounts Receivable
Turnover =
This ratio measures how many times a company converts its receivables into cash each year.

26. Accounts Receivable Turnover
*The beginning receivables balance was drawn from the 2008 financial statements, which are not included in the illustration.

27. Average Days to Collect Receivables
Average Collection Period =
365 Days
Accounts Receivable Turnover
= 21 days
Average Collection Period =
365 Days
16.98 Times
This ratio measures, on average, how many days it takes to collect an accounts receivable.

28. Inventory Turnover
Cost of Goods Sold
Average Inventory
Inventory
Turnover =
This ratio measures how many times a company’s inventory has been sold and replaced during the year.

29. Inventory Turnover
*The beginning inventory balance was drawn from the company’s 2008 financial statements, which are not included in the illustration.

30. Average Days to Sell Inventory
Average Sale Period =
365 Days
Inventory Turnover
= 34 days
Average Sale Period =
365 Days
10.80 Times
This ratio measures how many days, on average, it takes to sell the inventory.

31. Calculate ratios for assessing a company’s solvency.
Learning Objective
Calculate ratios for assessing a company’s solvency.
LO5

32. Solvency Ratios
Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure.
Debt to Assets Ratio
Debt to Equity Ratio
Number of Times Interest Earned
Plant Assets to Long-Term Liabilities

33. Debt to Assets Ratio
Total Liabilities
Total Assets
Debt to Assets Ratio =
This ratio measures the percentage of a company’s assets that are financed by debt.

34. Debt to Equity Ratio Debt to Equity Ratio Total Liabilities =
Stockholders’ Equity
Debt to Equity Ratio =
This ratio indicates the relative proportions of debt to equity on a company’s balance sheet.
Stockholders like a lot of debt if the company can take advantage of positive financial leverage.
Creditors prefer less debt and more equity because equity represents a buffer of protection.

35. Debt to Assets and Debt to Equity Ratios

36. Number of Times Interest is Earned Ratio
Earnings before Interest Expense
and Income Taxes
Interest Expense
Times Interest Earned =
This is the most common measure of a company’s ability to provide protection for its long-term creditors.

37. Number of Times Interest Earned Ratio
*Interest on bonds: $100,000 x .08 = $8,000

38. Plant Assets to Long-Term Liabilities
Net Plant Assets
Long-Term Liabilities =
This ratio suggests how well long-term debt is managed to finance long-term assets.

39. Plant Assets to Long-Term Liabilities

40. Calculate ratios for assessing company management’s effectiveness.
Learning Objective
Calculate ratios for assessing company management’s effectiveness.
LO6

41. Profitability ratios measure a company’s ability to generate earnings.
Net Margin (or Return on Sales)
Asset Turnover Ratio
Return on Investment
Return on Equity

42. Net Margin Net Margin Net Income Net Sales =
This measure describes the percent remaining of each sales dollar after subtracting other expenses as well as cost of goods sold.

43. Net Margin

44. Asset Turnover Ratio
Net Sales
Average Total Assets
Asset
Turnover =
This ratio measures how many sales dollars were generated for each dollar of assets invested.

45. Asset Turnover Ratio

46. Return on Investment (ROI)
Net Income
Average Total Assets =
This is the ratio of wealth generated (net income) to the amount invested (average total assets).

47. Return on Investment (ROI)
For Milavec, ROI was as follows.
2010
$25,000 ÷ $481,500* = %.19%
2009
$22,000 ÷ $437,500* = 5.03%
* The computation of average assets is calculated as beginning assets plus ending assets divided by 2.

48. Average Total Stockholders’ Equity
Return on Equity
Return on Equity
Net Income
Average Total Stockholders’ Equity =
This measure is often used to measure the profitability of the stockholders’ investment.

49. Return on Equity

50. Learning Objective
Calculate ratios for assessing a company’s position in the stock market.
LO7

51. Stock market ratios analyze the earnings and dividends of a company.
Earnings Per Share
Book Value
Price-Earnings (PE) Ratio
Dividend Yield

52. Average Number of Outstanding Common Shares
Earnings Per Share
Earnings per Share
Net Earnings Available for Common Stock
Average Number of Outstanding Common Shares =
This measure indicates how much
income was earned for each share of common stock outstanding.

53. Earnings Per Share

54. Stockholders’ Equity - Preferred Dividends Outstanding Common Shares
Book Value Per Share
Book Value per Share
Stockholders’ Equity - Preferred Dividends
Outstanding Common Shares =
This ratio measures the amount that would be distributed to holders of each share of common stock if all assets were sold at their balance sheet carrying amounts and if all creditors were paid off.

55. Book Value Per Share

56. Price-Earnings Ratio Price-Earnings Ratio Market Price Per Share
Earnings Per Share =
This ratio compares the earnings of a company to the market price for a share of the company’s stock.

57. Dividend Yield Dividend Yield Dividends Per Share
Market Price Per Share =
This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.

58. Explain the limitations of financial statement analysis.
Learning Objective
Explain the limitations of financial statement analysis.
LO8

59. Limitations of Financial Statement Analysis
Different Industries
Changing Economic Environment
Accounting Principles

60. End of Chapter 13