1. Financial Statement Analysis15
Financial Statement Analysis
Student Version

2. Describe basic financial statement analytical methods.1
Describe basic financial statement analytical methods.
15-2

3. 1
Horizontal Analysis
The percentage analysis of increases and decreases in related items using comparative financial statements is called horizontal analysis.

4. 1 Exhibit 1 Comparative Balance Sheet—Horizontal Analysis
Difference $17,000
Base year (2009) $533,000
= 3.2%

5. 1 Comparative Schedule of Current Assets—Horizontal Analysis Exhibit 2
Difference $25,800
Base year (2009) $64,700
= 39.9%

6. 1 Comparative Income Statement—Horizontal Analysis Exhibit 3
Increase amount $296,500
Base year (2009) $1,234,000
= 24.0%

7. 1 Comparative Retained Earnings Statement—Horizontal Analysis
Exhibit 4
Horizontal Analysis:
Increase amount $37,500
Base year (2009) $100,000
= 37.5%

8. 1
Vertical Analysis
A percentage analysis used to show the relationship of each component to the total within a single statement is called vertical analysis.

9. Vertical Analysis of Balance Sheet1
Vertical Analysis of Balance Sheet
In a vertical analysis of the balance sheet, each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity.

10. 1 Exhibit 5 Compar-ative Balance Sheet—Vertical Analysis
Current assets $550,000
Total assets $1,139,500
= 48.3%

11. Vertical Analysis of the Income Statement1
Vertical Analysis of the Income Statement
In a vertical analysis of the income statement, each item is stated as a percent of net sales.

12. 1 Comparative Income Statement—Vertical Analysis Exhibit 6
Selling expenses $191,000
Net sales $1,498,000
= 12.8%

13. Common-Size Statements1
Common-Size Statements
In a common-sized statements, all items are expressed as a percentage. Common-sized statements are useful in comparing the current period with prior periods, individual businesses, or one business with with industry percentages.

14. 1
Exhibit 7
Common-Sized Income Statement

15. Use financial statement analysis to assess the solvency of a business.2
Use financial statement analysis to assess the solvency of a business.
15-15

16. 2
Working Capital
The excess of current assets of a business over its current liabilities is called working capital. The working capital is often used in evaluating a company’s ability to pay current liabilities.

17. Working Capital = Current Assets – Current Liabilities2
Working Capital = Current Assets – Current Liabilities
Current assets $550,000 $533,000
Current liabilities –210,000 –243,000
Working capital $340,000 $290,000

18. 2
Current Ratio
The current ratio, sometimes called the working capital ratio or bankers’ ratio measures a company’s ability to pay its current liabilities.

19. 2 Current Assets Current Liabilities Current Ratio = 2010 2009
Current assets $550,000 $533,000
Current liabilities $210,000 $243,000
Current ratio
$550,000
$210,000
$533,000
$243,000

20. 2
Quick Ratio
A ratio that measures the “instant” debt-paying ability of a company is called the quick ratio or acid-test ratio.

21. 2
Quick assets are cash and other current assets that can be quickly converted to cash.
Quick assets:
Cash $ 90,500 $ 64,700
Temporary Investments 75,000 60,000
Accounts receivable (net) 115, ,000
a. Total quick assets $280,500 $244,700
b. Current liabilities $210,000 $243,000
Quick ratio (a ÷ b)

22. Accounts Receivable Turnover2
Accounts Receivable Turnover
The relationship between sales and accounts receivable may be stated as the accounts receivable turnover. Collecting accounts receivable as quickly as possible improves a company’s solvency.

23. Average Accounts Receivable2
Accounts Receivable Turnover =
Net Sales
Average Accounts Receivable
a. Net sales $1,498,000 $1,200,000
Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000
End of year , ,000
Total $ 235,000 $ 260,000
Average (Total ÷ 2) $ 117,500 $ 130,000
Accounts receivable turnover
(a ÷ b)

24. Number of Days’ Sales in Receivables2
Number of Days’ Sales in Receivables
The number of days’ sales in receivables is an estimate of the length of time (in days) the accounts receivable have been outstanding.
Number of Days’ Sales in Receivables
Average Accounts Receivable
Average Daily Sales =
Net Sales
365

25. 2 2010 2009 Average accounts receivable (Total accounts
Average accounts receivable
(Total accounts
receivable ÷ 2) $ 117,500 $ 130,000
Net sales $1,498,000 $1,200,000
Average daily sales
(Sales ÷ 365) $ ,104 $ ,288
Number of days’ sales in
receivables (a ÷ b)

26. 2
Inventory Turnover
The relationship between the volume of goods (merchandise) sold and inventory may be stated as the inventory turnover. The purpose of this ratio is to assess the efficiency of the firm in managing its inventory.

27. 2 Cost of Goods Sold Average Inventory Inventory Turnover = 2010 2009
a. Cost of goods sold $1,043,000 $ 820,000
Inventories:
Beginning of year $ 283,000 $ 311,000
End of year , ,000
Total $ 547,000 $ 594,000
Average (Total ÷ 2) $ 273,500 $ 297,000
Inventory turnover (a ÷ b)

28. Number of Days’ Sales in Inventory2
Number of Days’ Sales in Inventory
The number of days’ sales in inventory is a rough measure of the length of time it takes to purchase, sell, and replace the inventory.

29. Average Daily Cost of Goods Sold2
Average Inventory
Average Daily Cost of Goods Sold
Number of Days’ Sales in Inventory =
Cost of Goods Sold
365
a. Average inventory (Total ÷ 2) $ 273,500 $ 297,000
Cost of goods sold $1,043,000 $ 820,000
Average daily cost of goods
sold (COGS ÷ 365 days) $2,858 $2,247
Number of days’ sales in
inventory (a ÷ b)

30. Ratio of Fixed Assets to Long-Term Liabilities2
Ratio of Fixed Assets to Long-Term Liabilities
The ratio of fixed assets to long-term liabilities is a solvency measure that indicates the margin of safety of the noteholders or bondholders. It also indicates the ability of the business to borrow additional funds on a long-term basis.

31. Long-Term Liabilities2
Ratio of Fixed Assets to Long-Term Liabilities
Fixed Assets (net)
Long-Term Liabilities =
a. Fixed assets (net) $444,500 $470,000
b. Long-term liabilities $100,000 $200,000
Ratio of fixed assets to
long-term liabilities (a ÷ b)

32. Ratio of Liabilities to Stockholders’ Equity2
Ratio of Liabilities to Stockholders’ Equity
The relationship between the total claims of the creditors and owners—the ratio of liabilities to stockholders’ equity—is a solvency measure that indicates the margin of safety for creditors.

33. Total Stockholders’ Equity2
Total Liabilities
Total Stockholders’ Equity
Ratio of Liabilities to Stockholders’ Equity =
a. Total liabilities $310,000 $443,000
b. Total stockholders’ equity $829,500 $787,500
Ratio of liabilities to
stockholders’ equity ( a÷ b)

34. Number of Times Interest Charges Earned2
Number of Times Interest Charges Earned
Corporations in some industries normally have high ratios of debt to stockholders’ equity. For such corporations, the relative risk of the debtholders is normally measured as the number of times interest charges are earned (during the year), sometimes called the fixed charge coverage ratio.

35. 2 Income Before Income Tax + Interest Expense
Number of Times Interest Charges Earned =
Income before income tax $162,500 $134,600
a. Add interest expense , ,000
Amount available to meet
interest charges $168,500 $146,600
Number of times interest
charges earned (b ÷ a)

36. Number of Times Preferred Dividends Are Earned2
Number of Times Preferred Dividends Are Earned
The number of times interest charges are earned can be adapted for use with dividends on preferred stock.
Number of Times Preferred Dividends Are Earned
Net Income
Preferred Dividends =

37. 3
Use financial statement analysis to assess the profitability of a business.
15-37

38. Profitability Analysis3
Profitability Analysis
Profitability analysis focuses primarily on the relationship between operating results and the resources available to a business.

39. Ratio of Net Sales to Assets3
Net Sales
Average Total Assets
Ratio of Net Sales to Assets =
a. Net sales $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044, ,053,000
Total $2,097,500 $2,063,000
b. Average (Total ÷ 2) $1,048,750 $1,031,500
Excludes long-term investments

40. Ratio of Net Sales to Assets3
Net Sales
Average Total Assets
Ratio of Net Sales to Assets =
a. Net sales $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044, ,053,000
Total $2,097,500 $2,063,000
b. Average (Total ÷ 2) $1,048,750 $1,031,500
Ratio of net sales to assets (a ÷ b)

41. 3 Net Income + Interest Expense Average Total Assets
Rate Earned on Total Assets =
Net income $ ,000 $ ,500
Plus interest expense , ,000
a. Total $ ,000 $ ,500
Total assets:
Beginning of year $1,230,500 $1,187,500
End of year 1,139, ,230,500
Total $2,370,000 $2,418,000
b. Average (Total ÷ 2) $1,185,000 $1,209,000
Rate earned on total
assets (a ÷ b) % %

42. 3 Net Income Rate Earned on Stockholders’ Equity
Average Total Stockholders’ Equity
Rate Earned on Stockholders’ Equity =
a. Net income $ ,000 $ ,500
Stockholders’ equity:
Beginning of year $ 787,500 $ 750,000
End of year , ,500
Total $1,617,000 $1,537,500
b. Average (Total ÷ 2) $ 808,500 $ 768,750
Rate earned on stockholders’
equity (a ÷ b) % %

43. 3 Net Income – Preferred Dividends Average Common Stockholders’ Equity
Rate Earned on Common Stockholders’ Equity =
Net income $ ,000 $ ,500
Less preferred dividends , ,000
a. Remainder—common stock $ ,000 $ ,500
Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000
End of year , ,500
Total $1,317,000 $1,237,500
b. Average (Total ÷ 2) $ 658,500 $ 618,750
Rate earned on common
stockholders’ equity (a ÷ b) % %

44. 3 Net Income – Preferred Dividends Shares of Common Stock Outstanding
Earnings per Share (EPS) on Common Stock =
Net income $91,000 $76,500
Preferred dividends 9, ,000
Remainder—identified with
common stock $82,000 $67,500
b. Shares of common stock 50,000 50,000
Earnings per share on common
stock (a ÷ b) $ $1.35

45. 3 Market Price per Share of Common Stock
Earnings per Share on Common Stock
Price-earnings (P/E) ratio =
Market price per share of
common stock $41.00 $27.00
Earnings per share on common
stock ÷ ÷ 1.35
Price-earnings ratio on
common stock

46. Shares of Common Stock Outstanding3
Dividends
Shares of Common Stock Outstanding
Dividends per Share =
a. Dividends $40,000 $30,000
b. Shares of common stock outstanding 50,000 50,000
Dividends per share of common stock
(a ÷ b) $ $0.60

47. 3 Dividend yield on Dividends per Share of Common Stock
Market Price per Share of Common Stock
Dividend Yield =
a. Dividends per share of
common stock $ 0.80 $ 0.60
b. Market price per share of
common stock
Dividend yield on
common stock % %