1. FINANCIAL STATEMENT ANALYSIS

2. Statement Analysis - 2 FINANCIAL STATEMENT ANALYSIS Objectives Creditors Short term liquidity Long-term solvency Investors Profitability Dividends Stock price appreciation Prediction of future returns Assessment of risks associated with those returns

3. Statement Analysis - 3 HORIZONTAL ANALYSIS  Percentage changes in comparative statements –(Year to Year comparisons) –Establishment of “Base Period”  Trend percentages –Form of horizontal analysis –Series of years –Current year data / Base year data

4. Statement Analysis - 4 VERTICAL ANALYSIS  Relationship of statement items to a specified “Base Item” –Income statement = Net sales –Balance sheet = Total assets

5. Statement Analysis - 5 COMMON-SIZE STATEMENTS  Reports only percentages for statement items  “Base Items” normally same as vertical analysis  Allows comparison of firms of different size %

6. Statement Analysis - 6 BENCHMARKING  Comparison of a company to standards found in the environment  Against Industry Average  Against a Major Competitor  Against yourself (over time)

7. Statement Analysis - 7 FINANCIAL STATEMENT RATIOS Objectives  Ability to pay current liabilities (Liquidity)  Ability to sell inventory and collect receivables (Liquidity / Turnover)  Ability to pay long-term debt (Solvency)  Profitability of the company  Analysis of company’s stock as an investment

8. Statement Analysis - 8 FINANCIAL STATEMENT ANALYSIS Limitations  Statements are largely historical and involve many estimates  Comparability between firms may be difficult  Financial ratios are only indicators –Specific reasons for problems must still be identified  External factors will often impact the financial results of a company  Users must look at the entire picture when using financial statement analysis

9. Statement Analysis - 9 Return on Sales (ROS)  A profitability measure  Also known as profit margin ratio  Considers relative firm size @Cambridge Business Publishers, 2009 Net Income Sales Revenue ROS = = $39,700 $305,000 = 13.0%  Cup-A-Jo expects to generate 13 cents of bottom line profit for every dollar of sales revenue.

10. Statement Analysis - 10 Return on Assets (ROA)  A profitability measure  Considers relative firm size @Cambridge Business Publishers, 2009 [Net income + Interest expense × (1 – Tax rate)] Total assets ROA = = $39,700 + [$6,300 × (62.3%)] $472,450 = 9.2%  Cup-A-Jo has earnings of 9.2% available for its business capital providers. *Effective Tax rate = $24,000/$63,700 = 37.7%

11. Statement Analysis - 11 Return on Equity (ROE)  A profitability measure  Also known as return on shareholders’ equity  Considers relative firm size @Cambridge Business Publishers, 2009 Net income Shareholders’ equity ROE == $39,700 $371,700 = 10.7%  Cup-A-Jo is expected to generate about 10.7 cents of profit for every dollar of shareholders’ investment in the company.

12. Statement Analysis - 12 Return on Equity Paradigm Reveals four ways to improve ROE 1.Improve return on sales 2.Improve asset turnover 3.Improve use of financial leverage 4.Some combination of 1, 2, and 3 @Cambridge Business Publishers, 2009 Return on Shareholders’ Equity Return on Sales Asset Turnover Financial Leverage

13. Statement Analysis - 13 Asset Turnover  How effective a business’s assets are being used by management to generate sales revenue  Key performance indictor @Cambridge Business Publishers, 2009 Sales revenue Total assets Asset Turnover = $305,000 $472,450 = 0.646  For every dollar invested in the company’s assets. Cup-A-Jo generated 64.6 cents of sales. =

14. Statement Analysis - 14 Financial Leverage  Relative mix of debt versus equity financing used by a business @Cambridge Business Publishers, 2009 Total assets Shareholders’ equity Financial Leverage = $472,450 $371,700 = 1.27  Cup-A-Jo’s assets are about 1.27 times the amount of shareholders’ equity invested =

15. Statement Analysis - 15 Return on Equity for Cup-A-Jo @Cambridge Business Publishers, 2009 Total assets Shareholders’ equity × $472,450 $371,700 1.27 = ROE = Return on Sales × Assets Turnover × Financial Leverage Sales revenue Total assets $305,000 $472,450 0.646 Net income Sales revenue = $39,700 $305,000 = 13.0% ×× × × × = 10.7%

16. Statement Analysis - 16 Long-term Debt-to-Equity  Reveals the relative investment of long- term lenders versus that of shareholders  Indicates whether the financing strategy of the company is heavier on debt or equity @Cambridge Business Publishers, 2009 Debt-to- Equity Long-term debt Shareholders’ equity $67,500 $371,700 = 0.182== Cup-A-Jo’s long-term debt is about 18% of the amount of shareholders’ equity.

17. Statement Analysis - 17 Times-Interest-Earned Ratio  Reveals the extent to which operating earnings is able to ‘cover’ current debt service charges (interest) @Cambridge Business Publishers, 2009 Interest Coverage Operating income Interest expense $70,000 $6,300 = 11.1 = = Cup-A-Jo’s operating income is able to cover interest about 11 times per year.