1. Chapter 18 Financial Statement Analysis
Prepared by:
Debbie Musil
Kwantlen University College

2. Agenda Learning goals Vocabulary
Tools for Financial Statement Analysis
Horizontal Analysis
Vertical Analysis
Ratio Analysis
Limitation of Financial Analysis

3. Learning Goals Explain and apply horizontal analysis
Explain an apply vertical analysis
Identify and use ratios to analyze a company’s liquidity, profitability and solvency
Recognize and illustrate the limitations of financial statement analysis

4. Vocabulary Discontinued operations Identifiable business segment
Liquidity ratios
Earnings power
Profitability ratios
Horizontal analysis
Ratio analysis
Solvency ratios
Vertical analysis

5. Tools of Financial Statement Analysis
Comparing financial statement information of a company can be done:
On an intracompany basis: compare current year with prior years
On an intercompany basis: with other competing companies
Based on industry averages: the averages are determined and published by financial ratings organizations, such as Bloomberg…

6. Tools of Financial Statement Analysis
Important to also review other financial and non-financial information
Company's mission statement, objectives and goals
It’s market positions, people, and products.
Economic situation

7. Tools of Financial Statement Analysis
Three commonly used tools follow:
Horizontal analysis: this tool evaluates a series of financial statement data over a period of time.
Vertical analysis: This tool evaluates financial statement data by expressing each item in a financial statement as a percentage of a based amount that covers the same period of time as the items
Ratio analysis: this tool expresses the relationship among selected items of financial statement data

8. Horizontal Analysis (Trend Analysis)
Compares a series of financial data over a period of time
Use financial statements/annual reports: provide comparison data for one or more years
To determine the increase or decrease that has taken place in specific accounts
Comparisons can also be made between accounts
For example, the change in sales to the change in accounts receivable over the same time period
Indicates where further analysis is required
Such as vertical or ratio analysis

9. Horizontal Analysis: Balance Sheet

10. Horizontal Analysis : Income Statement

11. Check for understanding
Selected, condensed information (in thousands) from Bonora Ltd.’s income statement for four years ended June 30 follows: (pg927)
Calculate the percentage of the base-year amount for each year, assuming that 2005 is the base year
Calculate the percentage change between the following years: 2005 & 2006; 2006 & 2007; 2007& 2008
2008
2007
2006
2005
Revenue
$5,035
$6,294
$9,468
$8,646
Gross profit
936
1,077
2,146
1,900
Net Income
251
110
546
428

12. Vertical Analysis (Common Size Analysis)
Expresses financial statement data as a percentage of a base amount
Commonly used base amounts are:
Balance sheet: total assets; total liabilities and shareholders’ equity
Income statement: net sales
Useful for intracompany and intercompany comparisons

13. Vertical Analysis: Balance Sheet

14. Vertical Analysis: Income Statement

15. Vertical Analysis: Intercompany Comparison
A benefit of vertical analysis is that it makes it possible to compare companies of different sizes.

17. Check for understanding
Summary financial information for Boyko Corporation at May 31 is as follows: (pg931) Calculate the percentage size of each category, for each year, using vertical analysis
2008
2007
Current Assets
$234,000
$180,000
Property, plan and equipment
756,000
420,000
Total Assets
$990,000
$600,000

18. Practice Questions
Self study questions 1, 2, 3 Questions: 1, 4 BE 18-1 5 B 18-1  4

19. Ratio Analysis
Expresses the relationship between selected financial statement items
Classified into:
Liquidity ratios: measure short-term ability to meet obligations and unexpected cash needs
Solvency ratios: measure ability to survive over long periods of time
Profitability ratios: measure operating success for a specific time period

20. Ratio Analysis Liquidity Ratios

21. Ratio Analysis Solvency Ratios

22. Ratio Analysis Profitability Ratios

23. Check for understanding
Read pages Do demonstration problem

24. Practice Questions
BE 18-6  11 E  11

25. Limitations of Financial Analysis
Inflation: Revenue might show growth from previous year however, prices went up.
Estimates: if inaccurate or biased, the financial analysis will also be inaccurate or biased
Alternative accounting principles: reduces intercompany comparability. Different companies use different accounting methods.

26. Limitations of Financial Analysis
Diversification: affects classification and intercompany comparability. So many companies these day do more than one thing or sell more than one kind of product
Quality of earnings: full and transparent reporting aids in accurate financial analysis. Some companies may limit what they disclose or make it confusing to try to hide information and mislead users of the financial statement.

27. Earning Power
Users are interested in the normal level of income of a company (its “earning power”)
Net income must be adjusted for any irregular, non-typical items
In order to ensure comparability
Therefore, adjust for irregular items:
Change in accounting principle (Ch. 14)
Discontinued operations
Extraordinary items: rare in Canada

28. Discontinued Operations
Disposal of an identifiable operating segment of business
Clearly distinguished from the rest of the company for financial reporting and operating purposes
A segment can be a separate subsidiary company, an operating division within the company, or even a groups of assets.
It has to be a separate business that can be clearly distinguished from the company as a whole

29. Discontinued Operations
Reported separately on the income statement

30. Check for understanding
In its 2008 income statement , Qu Ltd. reported income before income tax of $400,000; a pre-tax loss on discontinued operations of $75,000; and a pre-tax gain on the disposal of the assets from the discontinued operations of $30,000. The company has a 25% income tax rate; Prepare an income statement, beginning with income before income tax (pg 938)

31. Practice Questions
BE  14 E