1. Financial Statements and Ratios
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a publicly accessible website, in whole or in part.

2. PERFORMANCE OBJECTIVES
Section I The Balance Sheet 15-1: Preparing a balance sheet 15-2: Preparing a vertical analysis of a balance sheet 15-3: Preparing a horizontal analysis of a balance sheet Section II The Income Statement 15-4: Preparing an income statement 15-5: Preparing a vertical analysis of an income statement 15-6: Preparing a horizontal analysis of an income statement Section III Financial Ratios and Trend Analysis 15-7: Calculating financial ratios 15-8: Preparing a tend analysis of financial data
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a publicly accessible website, in whole or in part.

3. Balance Sheet financial statements financial analysis
A series of accounting reports summarizing a company’s financial data compiled from business activity over a period of time. The four most common are the balance sheet, the income statement, the owner’s equity statement, and the cash flow statement.
financial analysis
The assessment of a company’s past, present, and anticipated future financial condition based on the information found on the financial statements.
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a publicly accessible website, in whole or in part.

4. Balance Sheet balance sheet financial position creditor
continued
balance sheet
A financial statement illustrating the financial position of a company in terms of assets, liabilities, and owner’s equity as of a certain date.
financial position
The economic resources owned by a company and the claims against those resources at a specific point in time.
creditor
One to whom money is owed.
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a publicly accessible website, in whole or in part.

5. Balance Sheet liabilities owner’s equity assets
continued
liabilities
Debts or obligations of a business resulting from past transactions that require the company to pay money, provide goods, or perform services in the future.
owner’s equity
The resources claimed by the owner against the assets of a business:
Owner’s equity = Assets - Liabilities
Also called proprietorship, capital, or net worth.
assets
Economic resources, such as cash, inventories, and land, buildings, and equipment owned by a business.
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a publicly accessible website, in whole or in part.

6. Assets = Liabilities + Owner’s equity.
Balance Sheet
continued
accounting equation
Algebraic expression of a company’s financial position:
Assets = Liabilities + Owner’s equity.
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a publicly accessible website, in whole or in part.

7. Preparing a Balance Sheet
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a publicly accessible website, in whole or in part.

8. Preparing a Balance Sheet
continued
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a publicly accessible website, in whole or in part.

9. Balance Sheet Components
Assets
Current Assets: convertible to cash within 1 year
Cash, marketable securities, accounts receivable, notes receivable, prepaid expenses, supplies, inventory
Property, Plant, and Equipment
Fixed or long term assets
Land, buildings, machinery, and equipment
Investments and Other Assets
Investments, other assets, intangibles
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a publicly accessible website, in whole or in part.

10. Balance Sheet Components
continued
Liabilities
Current liabilities: due within 1 year
Accounts payable, notes payable, salaries payable, taxes payable
Long-Term Liabilities: due in 1 year or more
Mortgage payable, debenture bonds
Equity: net worth
Owner’s equity
Stockholder’s equity:
Capital stock
Retained earnings
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a publicly accessible website, in whole or in part.

11. To prepare a balance sheet
Step 1 Centered at the top of the page, write the company name, type of statement, and date.
Step 2 In the section labeled ASSETS, list and total all of the Current Assets; Property, Plant, and Equipment; and Investments and Other Assets.
Step 3 Add the three components of the Assets section to get Total Assets.
Step 4 Double-underline Total Assets.
Step 5 In a section labeled LIABILITIES AND OWNER’S EQUITY, list and total all Current Liabilities and Long-Term Liabilities.
Step 6 Add the two components of the Liabilities section to get Total Liabilities.
Step 7 List and total the Owner’s or Stockholders’ Equity.
Step 8 Add the Total Liabilities and Owner’s Equity.
Step 9 Double-underline Total Liabilities and Owner’s Equity.
Note: In accordance with the accounting equation, check to be sure that
Assets = Liabilities + Owner’s Equity
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a publicly accessible website, in whole or in part.

12. Balance Sheet Preparation Example
Prepare a balance sheet as of December 31, 2014, for The Music Note, a sole proprietorship of Anthony Sullivan, using the following information:
Current assets, $132,500
Property, plant, and equipment, $88,760
Investments and other assets, $32,400
Current liabilities, $51,150
Long term liabilities, $87,760
Capital, $114,750
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a publicly accessible website, in whole or in part.

13. Balance Sheet Preparation Example
continued
Assets:
Current Assets $132,500
Total Current Assets 132,500
Property, Plant, and Equipment 88,760
Total Property, Plant and Equipment 88,760
Investments and Other Assets 32,400
Total Investments and Other Assets 32,400
Total Assets $253,660
Liabilities and Owner’s Equity
Current liabilities 51,150
Total current liabilities $ 51,150
Long-term liabilities 87,760
Total long-term liabilities 87, Total liabilities 138,910
Owner’s Equity
Capital (Anthony Sullivan) 114,750
Total Owner’s Equity 114,750
Total Liabilities and Owner’s Equity $253,660
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a publicly accessible website, in whole or in part.

14. Vertical Analysis of a Balance Sheet
A percentage method of analyzing financial statements whereby each item on the statement is expressed as a percent of a base amount. On balance sheet analysis, the base is total assets; on income statement analysis, the base is net sales.
common-size balance sheet
A special form of balance sheet that lists only the vertical analysis percentages, not the dollar figures. All items are expressed as a percent of total assets.
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a publicly accessible website, in whole or in part.

15. To Prepare a vertical analysis of a balance sheet
Step 1 Use the percentage formula, Rate = Portion ÷ Base, to find the percentage of each item on the balance sheet. Use each item as the portion and total assets as the base.
Step 2 Round each answer to the nearest tenth of a percent.
Note: A 0.1% differential may sometimes occur due to rounding.
Step 3 List the percent of each balance sheet item in a column to the right of the monetary amount.
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a publicly accessible website, in whole or in part.

16. Vertical Analysis Example
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a publicly accessible website, in whole or in part.

17. Vertical Analysis Example
continued
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a publicly accessible website, in whole or in part.

18. Horizontal Analysis of a Balance Sheet
comparative balance sheet
Balance sheet prepared with the data from the current year or operating period side-by-side with the figures from one or more previous periods.
horizontal analysis
Method of analyzing financial statements whereby each item of the current period is compared in dollars and percent with the corresponding item from a previous period.
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a publicly accessible website, in whole or in part.

19. To prepare a horizontal analysis of a balance sheet
Step 1 Set up a comparative balance sheet format with the current period listed first and the previous period listed next.
Step 2 Label the next two columns:
Increase (Decrease)
Amount Percent
Step 3 For each item on the balance sheet, calculate the dollar difference between the current and previous period and enter this figure in the Amount column. Enter all decreases in parentheses.
Step 4 Calculate the percent change (increase or decrease) using the percentage formula:
Percent change (rate) =
Step 5 Enter the percent change, rounded to the nearest tenth percent, in the Percent column. Once again, enter all decreases in parentheses.
Amount of change, Step 3 (portion)
Previous period amount (base)
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a publicly accessible website, in whole or in part.

20. Horizontal Analysis Example
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a publicly accessible website, in whole or in part.

21. Horizontal Analysis Example
continued
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a publicly accessible website, in whole or in part.

22. The Income Statement income, operating, or profit and loss statement
Financial statement summarizing the operations of a business over a period of time.
Illustrates the amount of revenue earned, expenses incurred, and the resulting profit or loss:
Revenue – Expenses = Profit (or loss)
revenue
The primary source of money, both cash and credit, flowing into the business from its customers for goods sold or services rendered over a period of time.
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a publicly accessible website, in whole or in part.

23. The Income Statement expenses profit or loss
continued
expenses
Costs incurred by a business in the process of earning revenue.
profit or loss
The difference between revenue earned and expenses incurred during an operating period.
Profit when revenue is greater than expenses; loss when expenses are greater than revenue.
Profit is also known as earnings or income.
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a publicly accessible website, in whole or in part.

24. Preparing an Income Statement
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a publicly accessible website, in whole or in part.

25. Income Statement Components
Revenue:
Gross sales
- Sales returns and allowances
- Sales discounts
Net Sales
Cost of Goods Sold:
Merchandise inventory (beginning)
+ Net purchases
+ Freight in
Goods available for sale
- Merchandise inventory (ending)
Cost of goods sold
Gross Margin:
Net sales
-Cost of goods sold
Gross margin or Gross profit
Total Operating Expenses:
Gross margin
-Total operating expenses
Income before taxes
Net Income:
Income before taxes
-Income tax
Net income (loss)
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a publicly accessible website, in whole or in part.

26. To prepare an income statement
Step 1 Centered at the top of the page, write the company name, type of statement, and period of time covered by the statement (for example, “Year ended Dec. 31, 2011” or “April 2011”).
Step 2 In a two-column format, calculate:
a. Net Sales: Gross sales
– Sales returns and allowances
– Sales discounts
Net Sales
b. Cost of Goods Sold: Merchandise inventory (beginning)
+ Net purchases
+ Freight in
Goods available for sale
– Merchandise inventory (ending)
Cost of goods sold
c. Gross Margin: Net sales
– Cost of goods sold
Gross margin
d. Total Operating Expenses: Sum of all operating expenses
e. Income before Taxes: Gross margin
– Total operating expenses
Income before taxes
f. Net Income: Income before taxes
– Income tax
Net income (loss)
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a publicly accessible website, in whole or in part.

27. Preparing an Income Statement Example
Use the following financial information to construct an income statement for the first quarter of 2014 from the following information:
Gross sales: $240,000
Sales discounts: $43,500
Beginning inventory, Jan. 1: $86,400
Ending inventory, March 31: $103,200
Net purchases: $76,900
Total operating expenses: $108,000
Income tax: $14,550
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a publicly accessible website, in whole or in part.

28. Income Statement Example
Revenue
Gross sales $240,000
Sales discounts 43,500
Net sales $196,500
Cost of Goods Sold
Merchandise Inv. Jan 86,400
Net purchases 76,900
Goods available for sale 163,300
Less: Merchandise Inv. Mar ,200
Cost of Goods Sold . 60,100
Gross Margin 136,400
Operating Expenses
Total Operating Expenses 108,000
Income before Taxes 28,400
Income Tax 14,550
Net Income $13,850
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a publicly accessible website, in whole or in part.

29. To Prepare a vertical analysis of an income statement
Step 1 Use the percentage formula, Rate = Portion ÷ Base, to find the rate of each item on the income statement. Use each item as the portion and net sales as the base.
Step 2 Round each answer to the nearest tenth of a percent.
Note: A 0.1% differential may sometimes occur due to rounding.
Step 3 List the percentage of each statement item in a column to the right of the monetary amount.
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a publicly accessible website, in whole or in part.

30. Vertical Analysis of an Income Statement
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a publicly accessible website, in whole or in part.

31. Vertical Analysis of an Income Statement
continued
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a publicly accessible website, in whole or in part.

32. To prepare a horizontal analysis of an income statement
Step 1 Set up a comparative income statement format with the current period listed first and the previous period listed next.
Step 2 Label the next two columns:
Increase (Decrease)
Amount Percent
Step 3 For each item on the income statement, calculate the dollar difference between the current and previous period and enter this figure in the Amount column. Enter all decreases in parentheses.
Step 4 Calculate the percent change (increase or decrease) using the percentage formula:
Percent change (rate) =
Step 5 Enter the percent change, rounded to the nearest tenth percent, in the Percent column. Once again, enter all decreases in parentheses.
Amount of change, Step 3 (portion)
Previous period amount (base)
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a publicly accessible website, in whole or in part.

33. Horizontal Analysis of an Income Statement
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a publicly accessible website, in whole or in part.

34. Horizontal Analysis of an Income Statement
continued
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a publicly accessible website, in whole or in part.

35. Financial Ratios liquidity ratios efficiency ratios leverage ratios
Tell how well a company can pay off its short-term debts and meet unexpected needs for cash.
efficiency ratios
Indicate how effectively a company uses its resources to generate sales.
leverage ratios
Show how and to what degree a company has financed its assets.
profitability ratios
Tell how much of each dollar of sales, assets, and owner’s investment resulted in net profit.
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a publicly accessible website, in whole or in part.

36. Liquidity Ratios working capital
Is the difference between current assets and current liabilities at a point in time. Theoretically, the amount of money left over if all the current liabilities were paid off by current assets.
current ratio, or working capital ratio
Is the comparison of a firm’s current assets to current liabilities.
acid test, or quick ratio
Indicates a firm’s ability to quickly liquidate assets to pay off current debt.
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a publicly accessible website, in whole or in part.

37. Efficiency Ratios average collection period inventory turnover
Indicates how quickly a firm’s credit accounts are being collected. Expressed in days.
inventory turnover
Tells the number of times during an operating period that the average inventory was sold.
asset turnover ratio
Tells the number of dollars in sales a firm generates from each dollar it has invested in assets.
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a publicly accessible website, in whole or in part.

38. Leverage Ratios debt-to-assets ratio debt-to-equity ratio
Measures to what degree the assets of the firm have been financed with borrowed funds, or leveraged.
debt-to-equity ratio
Compares the total debt of a firm to the owner’s equity.
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a publicly accessible website, in whole or in part.

39. Profitability Ratios gross profit margin net profit margin
An assessment of how well the cost of goods sold category of expenses was controlled. Expressed as a percent of net sales.
net profit margin
An assessment of management’s overall ability to control the cost of goods sold and the operating expenses of a firm.
Expressed as a percent of net sales.
return on investment
The amount of profit generated by a firm in relation to the amount invested by the owners. Expressed as a percent of owner’s equity.
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a publicly accessible website, in whole or in part.

40. Trend Analysis of Financial Data
The use of index numbers to calculate percentage changes of a company’s financial data for several successive operating periods.
index numbers
Are used in trend analysis indicating changes in magnitude of financial data over a period of time. Calculated by setting a base period equal to 100% and calculating other periods in relation to the base period.
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a publicly accessible website, in whole or in part.

41. For preparing a trend analysis
Step 1 Choose a base year and let it equal 100%.
Step 2 Calculate the index number for each succeeding year.
Index number =
Step 3 Round each index number to the nearest tenth of a percent.
Yearly amount
Base year amount
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a publicly accessible website, in whole or in part.

42. Trend Analysis Example
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a publicly accessible website, in whole or in part.