1. HOW TO READ, ANALYZE, AND INTERPRET FINANCIAL REPORTS
Chapter Sixteen
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning unit objectives
LU16-1: Balance Sheet -- Report as of a Particular Date
Explain the purpose and the key items on the balance sheet.
Explain and complete vertical and horizontal analysis.
LU 16-1: Income Statement -- Report for a Specific Period of Time
Explain the purpose and the key items on the income statement.
Explain and complete vertical and horizontal analysis.
LU 16-3: Trend and Ratio Analysis
Explain and complete a trend analysis.
List, explain, and calculate key financial ratios.
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3. Assets = Liabilities + Owner’s Equity
Accounting Equation
Accounting Equation:
Assets = Liabilities + Owner’s Equity

4. Balance Sheet
Gives a financial picture of what a company is worth as of a particular date. =
Assets
Liabilities + Owner’s Equity
(How much the owner is worth)
(How much the company owns)
(How much the company owes)

5. Elements of the Balance Sheet (Figure 16.1)
Assets broken down into current assets and plant and equipment
Liabilities broken down into current and long-term
MOOL COMPANY
Balance Sheet
December 31, 2014
Assets Liabilities
a. Current assets: a. Current liabilities:
b. Cash $ 7, b. Accounts payable $ 80,000
c Accounts receivable , c. Salaries payable ,000
d. Merchandise inventory , d Total current liabilities $ 92,000
e. Prepaid expenses , e. Long-term liabilities:
f Total current assets $61, f Mortgage note payable ,000
g. Plant and equipment: g Total liabilities $150,000
h Building (net) $60,000
i Land , Stockholders’ Equity
j Total plant and equipment , a. Common stock $ 20,000
b. Retained earnings ,000
c Total stockholders’ equity ,000
k. Total assets $205,000 d. Total liab. and stkhlds’ equity $205,000
Total of current assets and plant and equipment.
(Total is double-ruled)
Total of all liabilities and stockholders’ equity.

6. Preparing a Vertical Analysis of a Balance Sheet
Step 1. Divide each asset (the portion) as a percent of total assets (the base). Round as indicated.
Step 2. Round each liability and stockholders’ equity (the portions) as a percent of total liabilities and stockholders’ equity (the base). Round as indicated.

7. Comparative Balance Sheet: Vertical Analysis (Figure 16.2)
ROGER COMPANY
Comparative Balance Sheet
December 31, 2013 and 2014
Amount Percent Amount Percent
Assets
Current Assets:
Cash $22, $18,
Accounts Receivable , ,
Merchandise inventory , ,
Prepaid rent , ,
Total current assets $43, $39, *
Plant and equipment:
Building (net) $18, $18,
Land , ,
Total plant and equipment $42, * $42,
Total assets $85, $81,
* Due to rounding

8. Comparative Balance Sheet: Vertical Analysis (Figure 16.2)
ROGER COMPANY
Comparative Balance Sheet
December 31, 2013 and 2014
Amount Percent Amount Percent
Liabilities
Current liabilities:
Accounts payable $14, $8,
Salaries payable , ,
Total current liabilities $32, $25, *
Long-term liabilities:
Mortgage note payable $12, $20,
Total liabilities $44, * $25, *
Stockholders’ Equity
Common stock $20, $20,
Retained earnings , ,
Total stockholders’ equity $41, $36,
Total liabilities and stockholders’ equity $85, $81,
* Due to rounding

9. Preparing a Horizontal Analysis of a Comparative Balance Sheet
Step 1. Calculate the increase or decrease (portion) in each item from the base year.
Step 2. Divide the increase or decrease in Step 1 by the old or base year.
Step 3. Round as indicated.

10. Comparative Balance Sheet: Horizontal Analysis (Figure 16.3)
ABBY ELLEN COMPANY
Comparative Balance Sheet
December 31, 2013 and 2014
Increase (decrease)
Amount Percent
Assets
Current Assets:
Cash $ 6,000 $ 4,000 $ 2,
Accounts receivable , , (1,000)
Merchandise inventory , , ,
Prepaid rent , , (2,000)
Total current assets $25,000 $21,000 $ 4,
Plant and equipment:
Building (net) $12,000 $12,
Land , ,
Total plant and equipment $30,000 $30,
Total assets $55,000 $51,000 $4,

11. Comparative Balance Sheet: Horizontal Analysis (Figure 16.3)
ABBY ELLEN COMPANY
Comparative Balance Sheet
December 31, 2013 and 2014
Increase (decrease)
Amount Percent
Liabilities
Current liabilities:
Accounts payable $ 3,200 $ 1,800 $ 1,
Salaries payable 2, , (300)
Total current liabilities $ 6, , ,
Long-term liabilities:
Mortgage note payable 17, ,000 2,
Total liabilities $ 23,100 20,000 3,
Owner’s Equity
Abby Ellen, capital $31,900 31,000 $
Total liabilities and owner’s equity $55, ,000 $4,

12. Income Statement
Income Statement - A financial report that tells how well a company is performing (its profitability or net profit) during a specific period of time.
Income Statement$
Service Business:
Revenues -- Operating expenses
= Net income
Retail Business:
Revenues (sales)
-- Cost of merchandise sold
= Gross profit from sales
-- Operating expenses
= Net income (profit)

13. Income Statement (Figure 16.4)
MOOL COMPANY
Income Statement
For Month Ended December 31, 2014
Revenues
a. Gross Sales $22,080
b. Less: Sales returns and allowances $ 1,082
c Sales discounts ,514
d. Net Sales
Cost of merchandise (goods) sold: $20,566
a. Merchandise Inventory 12/1/ ,248
b. Purchases 10,512
c. Less: Purchases returns and allowances $336
d. Less: Purchase discounts
e. Cost of net purchases 9,972
f. Cost of merchandise (goods available for sale) ,220
g. Less: Merchandise inventory 12/31/ ,600
h. Cost of merchandise (goods sold) 9,620
Gross profit from sales 10,946
Operating expenses:
a Salary ,200
b Insurance
c Utilities
d Plumbing
e Rent
f Depreciation
g. Total operating expenses 4,630
Net income $ 6,316

14. Key Calculations on Income Statement
Net sales = Gross sales -- Sales returns allowances -- Sales discounts
Cost of Net purchases
merchandise = Beginning (purchase less Ending
(goods) sold inventory returns & discounts) inventory
Gross profit from sales = Net sales -- Cost of merchandise (goods) sold
Net income = Gross profit -- Operating expenses

15. Income Statement Vertical Analysis (Figure 16.5)
ROYAL COMPANY
Comparative Income Statement
For Years Ended December 31, 2013 and 2014
Percent Percent
of net of net
Net Sales $45, $29,
Cost of merchandise sold 19, ,
Gross profit from sales $26, $17,
Operating expenses:
Depreciation $1, $
Selling and Advertising , ,
Research , ,
Miscellaneous
Total operating expenses $8, * $ 4,
Income before interest and taxes $17, $12,
Interest expense , ,
Income before taxes $11, * $ 9,
Provision for taxes , ,
Net income $ 5, $ 6, *
* Due to rounding

16. Horizontal Analysis Income Statement (Figure 16.6)
FLINT COMPANY
Comparative Income Statement
For Years Ended December 31, 2013 and 2014
Increase (decrease)
Amount Percent
Sale $ 90,000 $80,000 $10,000
Sales returns and allowances 2, ,
Net Sales $88, $78,000 $10,
Cost of merchandise sold 45, , ,
Gross profit from sales $43,000 $38,000 $ 5,
Operating expenses:
Depreciation $ 6,000 $ 5,000 $ 1,
Selling and Advertising 16, , ,
Research , (400)
Miscellaneous 1,
Total operating expenses $23,800 $18,500 $ 5,
Income before interest and taxes $19,200 $19,500 $ (300)
Interest expense 4, ,
Income before taxes $15,200 $15,500 $ (300)
Provision for taxes 3, ,000 (200)
Net income $11,400 $11,500 $ (100)

17. Completing a Trend Analysis
Analyzes the changes that occur by expressing each number as a percent of the base year.
Each Item
Base Amount
Step 1. Select the base year (100%).
Step 2. Express each amount as a percent of the base year amount (rounded to the nearest whole percent).

18. Trend Analysis Given (base year 2012) 2015 2014 2013 2012
Sales $621,000 $460,000 $340,000 $420,000
Gross Profit 182, , , ,000
Net Income , , , ,000
Trend Analysis
Sales* 148% 110% 81% 100%
Gross Profit
Net Income
$340,000
$420,000
* Round to nearest whole percent