1. Financial Statement Analysis
Power Notes
Chapter F15
Financial Statement Analysis
Learning Objectives
1. Basic Analytical Procedures
2. Solvency Analysis
3. Profitability Analysis
4. Summary of Analytical Measures
5. Corporate Annual Reports
C15

2. Financial Statement Analysis
Power Notes
Chapter F15
Financial Statement Analysis
Slide # Power Note Topics 3 10 28 43
Horizontal and Vertical Analysis
Solvency Analysis
Profitability Analysis
Annual Reports
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3. Lincoln Company Comparative Balance Sheet December 31, 2003 and 2002
Increase (Decrease)
Amount Percent
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
$1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
$ 829,500 $ 787,500 $42, %
$1,139,500 $1230,500 $(91,000) (7.4%)

4. Lincoln Company Comparative Balance Sheet December 31, 2003 and 2002
Increase (Decrease)
Amount Percent
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
$1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
$ 829,500 $ 787,500 $42, %
$1,139,500 $1230,500 $(91,000) (7.4%)
Horizontal Analysis:
Current year (2003) $550,000
Base year (2002) $533,000
= %
Increase amount $17,000
Base year (2002) $533,000
= 3.2%

5. Lincoln Company Comparative Income Statement December 31, 2003 and 2002
Increase (Decrease)
Amount Percent
Sales $1,530,500 $1,234,000 $296, %
Sales returns 32,500 34,000 (1,500) (4.4%)
Net sales $1,498,000 $1,200,000 $298,000) 24.8%
Cost of goods sold 1,043, , , %
Gross profit $ 455,000 $ 380,000 $ 75, %
Selling expenses $ 191,000 $ 147,000 $ 44, %
Administrative expenses 104,000 97,400 6, % Total operating expenses $ 295,000 $ 244,400 $ 50, %
Operating income $ 160,000 $ 135,600 $ 24, %
Other income 8,500 11,000 (2,500) (22.7%)
$ 168,500 $ 146,600 $ 21, %
Other expense 6,000 12,000 (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600 $ 27, %
Income tax 71,500 58,100 13, %
Net income $ 91,000 $ 76,500 $ 14, %

6. Lincoln Company Comparative Income Statement December 31, 2003 and 2002
Increase (Decrease)
Amount Percent
Sales $1,530,500 $1,234,000 $296, %
Sales returns 32,500 34,000 (1,500) (4.4%)
Net sales $1,498,000 $1,200,000 $298,000) 24.8%
Cost of goods sold 1,043, , , %
Gross profit $ 455,000 $ 380,000 $ 75, %
Selling expenses $ 191,000 $ 147,000 $ 44, %
Administrative expenses 104,000 97,400 6, % Total operating expenses $ 295,000 $ 244,400 $ 50, %
Operating income $ 160,000 $ 135,600 $ 24, %
Other income 8,500 11,000 (2,500) (22.7%)
$ 168,500 $ 146,600 $ 21, %
Other expense 6, ,000 (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600 $ 27, %
Income tax 71,500 58,100 13, %
Net income $ 91,000 $ 76,500 $ 14, %
Horizontal Analysis:
Current year (2003) $1,498,000
Base year (2002) $1,200,000
= %
Increase amount $298,000
Base year (2002) $1,200,000
= 24.8%

7. Lincoln Company Comparative Balance Sheets
December 31, December 31, 2002 Amount Percent Amount Percent
Assets
Current assets $ 550, % $ 533, %
Long-term investments 95, ,
Fixed assets (net) 444, ,
Intangible assets 50, , $1,139, % $1,230, %
Liabilities
Current liabilities $ 210, % $ 243, %
Long-term liabilities 100, ,
$ 310, % $ 443, %
Stockholders’ Equity
Preferred stock, $100 par $ 150, % $ 150, % Common stock, $10 par 500, ,
Retained earnings 179, ,
$ 829, % $ 787, %
$1,139, % $1230, %

8. Lincoln Company Comparative Balance Sheets
December 31, December 31, 2002 Amount Percent Amount Percent
Assets
Current assets $ 550, % $ 533, %
Long-term investments 95, ,
Fixed assets (net) 444, ,
Intangible assets 50, , $1,139, % $1,230, %
Liabilities
Current liabilities $ 210, % $ 243, %
Long-term liabilities 100, ,
$310, % $ 443, %
Stockholders’ Equity
Preferred stock, $100 par $ 150, % $ 150, % Common stock, $10 par 500, ,
Retained earnings 179, ,
$829, % $787, %
$1,139, % $1230, %
Vertical Analysis:
Current liabilities $210,000
Total assets $1,139,500
= 18.4%

9. Lincoln Company Comparative Balance Sheets
December 31, December 31, 2002 Amount Percent Amount Percent
Common-Size Statements
Assets
Current assets $ 550, % $ 533, %
Long-term investments 95, ,
Fixed assets (net) 444, ,
Intangible assets 50, , $1,139, % $1,230, %
Liabilities
Current liabilities $ 210, % $ 243, %
Long-term liabilities 100, ,
$310, % $ 443, %
Stockholders’ Equity
Preferred stock, $100 par $ 150, % $ 150, % Common stock, $10 par 500, ,
Retained earnings 179, ,
$829, % $787, %
$1,139, % $1230, %

10. Solvency Analysis
Solvency is the ability of a business to meet its financial obligations (debts) as they are due.
Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities.
This ability is normally assessed by examining balance sheet relationships.

11. Solvency Measures — The Short-Term Creditor
Working Capital and Current Ratio
Current assets $550,000 $533,000
Current liabilities 210, ,000

12. Solvency Measures — The Short-Term Creditor
Working Capital and Current Ratio
Current assets $550,000 $533,000
Current liabilities 210, ,000
Working capital $340,000 $290,000
Use: To indicate the ability to meet currently maturing obligations.

13. Solvency Measures — The Short-Term Creditor
Working Capital and Current Ratio
Current assets $550,000 $533,000
Current liabilities , ,000
Working capital $340,000 $290,000
Current ratio
Divide current assets by current liabilities
Use: To indicate the ability to meet currently maturing obligations.

14. Solvency Measures — The Short-Term Creditor
Acid-Test Ratio
Quick assets:
Cash $ 90,500 $ 64,700
Marketable securities 75,000 60,000
Accounts receivable (net) 115, ,000
Total $280,500 $244,700
Current liabilities $210,000 $243,000

15. Solvency Measures — The Short-Term Creditor
Acid-Test Ratio
Quick assets:
Cash $ 90,500 $ 64,700
Marketable securities 75,000 60,000
Accounts receivable (net) 115, ,000
Total $280,500 $244,700
Current liabilities $210,000 $243,000
Acid-test ratio
Use: To indicate instant debt-paying ability.

16. Solvency Measures — The Short-Term Creditor
Accounts Receivable Turnover
Net sales on account $1,498,000 $1,200,000
Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000
End of year 115, ,000
Total $ 235,000 $ 260,000
Average $ 117,500 $ 130,000

17. Solvency Measures — The Short-Term Creditor
Accounts Receivable Turnover
Net sales on account $1,498,000 $1,200,000
Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000
End of year 115, ,000
Total $ 235,000 $ 260,000
Average $ 117,500 $ 130,000
Accts. receivable turnover
Use: To assess the efficiency in collecting receivables and in the management of credit.

18. Solvency Measures — The Short-Term Creditor
Number of Days’ Sales in Receivables
Accounts receivable (net)
end of year $ 115,000 $ 120,000
Net sales on account $1,498,000 $1,200,000
Average daily sales on
on account (sales  365) $ ,104 $ ,288
Number of days’ sales in
receivables
Use: To assess the efficiency in collecting receivables and in the management of credit.

19. Solvency Measures — The Short-Term Creditor
Inventory Turnover
Cost of goods sold $1,043,000 $ 820,000
Inventories:
Beginning of year $ 283,000 $ 311,000
End of year 264, ,000
Total $ 547,000 $ 594,000
Average $ 273,500 $ 297,000

20. Solvency Measures — The Short-Term Creditor
Inventory Turnover
Cost of goods sold $1,043,000 $ 820,000
Inventories:
Beginning of year $ 283,000 $ 311,000
End of year 264, ,000
Total $ 547,000 $ 594,000
Average $ 273,500 $ 297,000
Inventory turnover
Use: To assess the efficiency in the management of inventory.

21. Solvency Measures — The Short-Term Creditor
Number of Days’ Sales in Inventory
Inventories, end of year $ 264,000 $283,000
Cost of goods sold $1,043,000 $820,000
Average daily cost of
goods sold
(COGS  365) $ ,858 $ 2,247
Number of days’ sales
in inventory
Use: To assess the efficiency in the management of inventory.

22. Solvency Measures — The Long-Term Creditor
Ratio of Plant Assets to Long-Term Liabilities
Fixed assets (net) $444,500 $470,000
Long-term liabilities $100,000 $200,000

23. Solvency Measures — The Long-Term Creditor
Ratio of Fixed Assets to Long-Term Liabilities
Fixed assets (net) $444,500 $470,000
Long-term liabilities $100,000 $200,000
Ratio of fixed assets to
long-term liabilities
Use: To indicate the margin of safety to long-term creditors.

24. Solvency Measures — The Long-Term Creditor
Ratio of Liabilities to Stockholders’ Equity
Total liabilities $310,000 $443,000
Total stockholders’ equity $829,500 $787,500

25. Solvency Measures — The Long-Term Creditor
Ratio of Liabilities to Stockholders’ Equity
Total liabilities $310,000 $443,000
Total stockholders’ equity $829,500 $787,500
Ratio of liabilities to
stockholders’ equity
Use: To indicate the margin of safety to creditors.

26. Solvency Measures — The Long-Term Creditor
Number of Times Interest Charges Earned
Income before income tax $ 900,000 $ 800,000
Add interest expense , ,000
Amount available for interest $1,200,000 $1,050,000

27. Solvency Measures — The Long-Term Creditor
Number of Times Interest Charges Earned
Income before income tax $ 900,000 $ 800,000
Add interest expense , ,000
Amount available for interest $1,200,000 $1,050,000
Number of times earned
Use: To assess the risk to debtholders in terms of number of times interest charges were earned.

28. Profitability Analysis
Profitability is the ability of an entity to earn profits.
This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available.
Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet.

29. Profitability Measures — The Common Stockholder
Ratio of Net Sales to Assets
Net sales $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044,500 1,053,000
Total $2,097,500 $2,063,000
Average $1,048,750 $1,031,500
Excludes long-term investments

30. Profitability Measures — The Common Stockholder
Ratio of Net Sales to Assets
Net sales on account $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044,500 1,053,000
Total $2,097,500 $2,063,000
Average $1,048,750 $1,031,500
Ratio of net sales to assets
Use: To assess the effectiveness of the use of assets.

31. Profitability Measures — The Common Stockholder
Rate Earned on Total Assets
Net income $ 91,000 $ 76,500
Plus interest expense 6,000 12,000
Total $ 97,000 $ 88,500
Total assets:
Beginning of year $1,230,500 $1,187,500
End of year 1,139,500 1,230,500
Total $2,370,000 $2,418,000
Average $1,185,000 $1,209,000

32. Profitability Measures — The Common Stockholder
Rate Earned on Total Assets
Net income $ 91,000 $ 76,500
Plus interest expense 6,000 12,000
Total $ 97,000 $ 88,500
Total assets:
Beginning of year $1,230,500 $1,187,500
End of year 1,139,500 1,230,500
Total $2,370,000 $2,418,000
Average $1,185,000 $1,209,000
Rate earned on total assets 8.2% 7.3%
Use: To assess the profitability of the assets.

33. Profitability Measures — The Common Stockholder
Rate Earned on Stockholders’ Equity
Net income $ 91,000 $ 76,500
Stockholders’ equity:
Beginning of year $ 787,500 $ 750,000
End of year 829, ,500
Total $1,617,000 $1,537,500
Average $ 808,500 $ 768,750

34. Profitability Measures — The Common Stockholder
Rate Earned on Stockholders’ Equity
Net income $ 91,000 $ 76,500
Stockholders’ equity:
Beginning of year $ 787,500 $ 750,000
End of year 829, ,500
Total $1,617,000 $1,537,500
Average $ 808,500 $ 768,750
Rate earned on equity 11.3% %
Use: To assess the profitability of the investment by stockholders.

35. Profitability Measures — The Common Stockholder
Rate Earned on Common Stockholders’ Equity
Net income $ 91,000 $ 76,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ 82,000 $ 67,500
Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000
End of year 679, ,500
Total $1,317,000 $1,237,500
Average $ 658,500 $ 618,750

36. Profitability Measures — The Common Stockholder
Rate Earned on Common Stockholders’ Equity
Net income $ 91,000 $ 76,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ 82,000 $ 67,500
Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000
End of year 679, ,500
Total $1,317,000 $1,237,500
Average $ 658,500 $ 618,750
Rate earned on common equity 12.5% %
Use: To assess the profitability of the investment by common stockholders.

37. Profitability Measures — The Common Stockholder
Earnings Per Share on Common Stock
Net income $ 91,000 $ 76,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ 82,000 $ 67,500
Shares of common stock 50,000 50,000

38. Profitability Measures — The Common Stockholder
Earnings Per Share on Common Stock
Net income $ 91,000 $ 76,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ 82,000 $ 67,500
Shares of common stock 50,000 50,000
Earnings per share on common $1.64 $1.35
Use: To assess the profitability of the investment by common stockholders.

39. Profitability Measures — The Common Stockholder
Price-Earnings Ratio
Market price per share of common $20.50 $13.50
Earnings per share on common $ 1.64 $ 1.35

40. Profitability Measures — The Common Stockholder
Price-Earnings Ratio
Market price per share of common $20.50 $13.50
Earnings per share on common $ 1.64 $ 1.35
Price-earnings ratio on common
Use: To indicate future earnings prospects, based on the relationship between market value of common stock and earnings.

41. Profitability Measures — The Common Stockholder
Dividend Yield
Dividends per share of common $ $ 0.60
Market price per share of common $20.50 $13.50

42. Profitability Measures — The Common Stockholder
Dividend Yield
Dividends per share of common $ $ 0.60
Market price per share of common $20.50 $13.50
Dividend yield on common stock 3.9% 4.4%
Use: To indicate the rate of return to common stockholders in terms of dividends.

43. Corporate Annual Reports
In addition to financial statements, the annual report includes:
1. Financial Highlights
2. President’s Letter to the Stockholders
3. Management Report
4. Independent Auditors’ Report
5. Historical Summary

44. Financial Statement Analysis
Power Notes
Chapter F15
Financial Statement Analysis
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