2 Application of analytical tools Involves transforming data Basics of AnalysisApplication of analytical toolsReduces uncertaintyInvolves transforming data
3 Financial statement analysis helps users make better decisions. Purpose of AnalysisFinancial statement analysis helps users make better decisions.Internal UsersExternal UsersManagersOfficersInternal AuditorsShareholdersLendersCustomers
4 Building Blocks of Analysis Ability to meet short-term obligations and to efficiently generate revenuesAbility to generate future revenues and meet long-term obligationsLiquidity and EfficiencySolvencyAbility to provide financial rewards sufficient to attract and retain financingAbility to generate positive market expectationsMarket ProspectsProfitability
5 Information for Analysis Income StatementNotesBalance SheetStatement ofChanges in Stockholders’ EquityStatement of Cash Flows
6 Standards for Comparison To help me interpret our financial statements, I use several standards of comparison.IntracompanyCompetitorIndustryGuidelines
7 Comparing a company’s financial condition and performance across time Tools of AnalysisHorizontal AnalysisComparing a company’s financial condition and performance across timeTime
8 Tools of Analysis V e r t i c a l Comparing a company’s financial condition and performance to a base amount
9 Using key relations among financial statement items Tools of AnalysisUsing key relations among financial statement itemsRatio Analysis
10 Now, let’s look at some ways to use horizontal analysis. Time
12 Comparative Statements Calculate Change in Dollar AmountDollarChangeAnalysis PeriodAmountBase PeriodAmount=–Since we are measuring the amount of the change between 2003 and 2004, the dollar amounts for 2003 become the “base” period amounts.
13 Comparative Statements Calculate Change as a PercentPercentChangeDollar ChangeBase Period Amount×=100%
35 Liquidity and Efficiency CurrentRatioInventory TurnoverAcid-testRatioDays’ Sales UncollectedAccounts Receivable TurnoverDays’ Sales in InventoryTotal Asset Turnover
36 Use this information to calculate the liquidity and efficiency ratios for Norton Corporation.
37 Working CapitalWorking capital represents current assets financed from long-term capital sources that do not require near-term repayment.
38 This ratio measures the short-term debt-paying ability of the company. Current RatioCurrentRatioCurrent AssetsCurrent Liabilities=CurrentRatio$65,000 $42,000=1.55 : 1This ratio measures the short-term debt-paying ability of the company.
39 Quick Assets Current Liabilities Acid-Test RatioQuick Assets Current Liabilities=Acid-TestRatioQuick assets are Cash, Short-Term Investments, and Current Receivables.$50,000$42,000=1.19 : 1Acid-TestRatioThis ratio is like the currentratio but excludes current assets such as inventories and prepaid expenses that may be difficult to quickly convert into cash.
40 Accounts Receivable Turnover Sales on AccountAverage Accounts ReceivableAccounts ReceivableTurnover== times$494,000($17,000 + $20,000) ÷ 2Accounts ReceivableTurnover=This ratio measures how many times a company converts its receivables into cash each year.
41 This ratio measures the number is sold and replaced during the year. Inventory TurnoverCost of Goods SoldAverage InventoryInventoryTurnover== times$140,000($10,000 + $12,000) ÷ 2=InventoryTurnoverThis ratio measures the numberof times merchandiseis sold and replaced during the year.
42 Days’ Sales Uncollected Accounts ReceivableNet Sales=´ 365Days’ Sales Uncollected$20,000$494,000=´ = daysThis ratio measures the liquidity of receivables.
43 Days’ Sales in Inventory =Ending InventoryCost of Goods Sold´ 365Days’ Sales in Inventory=$12,000$140,000´ = daysThis ratio measures the liquidity of inventory.
44 This ratio measures the efficiency of assets in producing sales. Total Asset TurnoverTotal Asset Turnover=Net SalesAverage Total Assets= 1.53 times$494,000($300,000 + $346,390) ÷ 2=Total AssetTurnoverThis ratio measures the efficiency of assets in producing sales.
45 Pledged Assets to Secured Liabilities SolvencyDebtRatioEquityRatioPledged Assets to Secured LiabilitiesTimes Interest Earned
46 Use this information to calculate the solvency ratios for Norton Corporation.
47 Debt Ratio Total Liabilities = Debt Ratio Total Assets $112,000 $346,390Debt Ratio= 32.3%This ratio measures what portion of a company’s assets are contributed by creditors.
48 Equity Ratio Total Equity Equity Ratio = Total Assets $234,390 $346,390Equity Ratio= 67.7%This ratio measures what portion of a company’s assets are contributed by owners.
49 Pledged Assets to Secured Liabilities Book Value of Pledged Assets=Book Value of Secured LiabilitiesPledged Assets to Secured LiabilitiesThis ratio measures the protection to secured creditors.
50 Net Income before Interest Expense Times Interest EarnedTimes Interest EarnedNet Income before Interest Expenseand Income TaxesInterest Expense=Times Interest Earned$84,000$7,300==This is the most common measure of the ability of a firm’s operations to provide protection to the long-term creditor.
51 Profitability Profit Margin Basic Earnings per Share Gross Margin Book Value per Common ShareReturn on Total AssetsReturn on Common Stockholders’ Equity
52 Use this information to calculate the profitability ratios for Norton Corporation.
53 Profit Margin Profit Margin Net Income Net Sales = = 10.87% Profit $53,690$494,000=This ratio describes a company’s ability to earn a net income from sales.
54 Net Sales - Cost of Sales Gross MarginGrossMarginNet Sales - Cost of SalesNet Sales== 71.66%GrossMargin$494,000 - $140,000$494,000=This ratio measures the amount remaining from $1 in sales that is left to cover operating expenses and a profit after considering cost of sales.
55 Return on Total Assets Return on Total Assets Net Income Average Total Assets== 16.61%$53,690($300,000 + $346,390) ÷ 2=Return on Total AssetsThis ratio is generally consideredthe best overall measure of acompany’s profitability.
56 Return on Common Stockholders’ Equity Net Income - Preferred Dividends Average Common Stockholders’ Equity== 25.9%$53,($180,000 + $234,390) ÷ 2=Return on Common Stockholders’ EquityThis measure indicates how well the company employed the owners’ investments to earn income.
57 Book Value per Common Share Shareholders’ Equity Applicable to Common SharesNumber of Common Shares Outstanding=This ratio measures liquidation at reported amounts.
58 Basic Earnings per Share Net Income - Preferred DividendsWeighted-Average Common Shares Outstanding=Basic EarningsperShare$53,27,400== $1.96 per shareThis measure indicates how muchincome was earned for each share of common stock outstanding.
60 Market ProspectsUse this information to calculate the market ratios for Norton Corporation.
61 Price-Earnings Ratio Price-Earnings Ratio Market Price Per Share Earnings Per Share=Price-EarningsRatio$15.00$1.96== 7.65 timesThis measure is often used by investors as a general guideline in gauging stock values. Generally, the higher the price-earnings ratio, the more opportunity a company has for growth.
62 Annual Dividends Per Share Dividend YieldDividendYieldAnnual Dividends Per ShareMarket Price Per Share=$2.00$15.00= 13.3%This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.