1. 13-1 Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright ©2015 Pearson Education Inc. All rights reserved.

2. 13-2 1.Perform horizontal analysis Learning Objective Copyright ©2015 Pearson Education Inc. All rights reserved.

3. 13-3 LO 1 PERFORM HORIZONTAL ANALYSIS  Study of percentage changes from year-to-year  Two steps: 1.Compute dollar amount of change from one period to the next 2.Divide dollar amount of change by base-period amount Copyright ©2015 Pearson Education Inc. All rights reserved.

4. 13-4 LO 1 Illustration: Amazon.com, Inc. Step 1 Compute the dollar amount of change from 2011 to 2012 Step 2 Percentage change for the period Amazon.com’s net sales (in millions) increased by 27.1% during 2012, computed as follows: Copyright ©2015 Pearson Education Inc. All rights reserved.

5. 13-5 LO 1 Illustration: Amazon.com, Inc. Exhibit 13-2 | Comparative Consolidated Statements of Operations—Horizontal Analysis (partial exhibit) Copyright ©2015 Pearson Education Inc. All rights reserved.

6. 13-6 LO 1 Illustration: Amazon.com, Inc. Exhibit 13-3 | Consolidated Balance Sheets—Horizontal Analysis (partial exhibit) Copyright ©2015 Pearson Education Inc. All rights reserved.

7. 13-7 Illustration Prepare a horizontal analysis of the comparative income statements of Ama Music Co. Advance slide in presentation mode to reveal $ Change and % Change LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

8. 13-8 LO 1 Trend Percentages  Form of horizontal analysis  Base year selected and set equal to 100%  Amount of each following year stated as a percent of base Copyright ©2015 Pearson Education Inc. All rights reserved.

9. 13-9 LO 1 Trend Percentages Amazon.com, Inc., showed income from operations as follows: Trend percentages are computed by dividing each successive year’s amount by the 2008 amount Copyright ©2015 Pearson Education Inc. All rights reserved.

10. 13-10 2.Perform vertical analysis Learning Objective Copyright ©2015 Pearson Education Inc. All rights reserved.

11. 13-11 LO 2 PERFORM VERTICAL ANALYSIS  Shows relationship of a financial-statement item to its base  Income statement, base is total revenue  Balance sheet, base is total assets Copyright ©2015 Pearson Education Inc. All rights reserved.

12. 13-12 LO 2 Illustration: Amazon.com, Inc. Exhibit 13-4 | Comparative Consolidated Statements of Operations—Vertical Analysis (partial exhibit) Copyright ©2015 Pearson Education Inc. All rights reserved.

13. 13-13 LO 2 Illustration: Amazon.com, Inc. Exhibit 13-5 | Consolidated Balance Sheets—Vertical Analysis (partial exhibit) Copyright ©2015 Pearson Education Inc. All rights reserved.

14. 13-14 3.Prepare common-size financial statements Learning Objective Copyright ©2015 Pearson Education Inc. All rights reserved.

15. 13-15 LO 3 PERPARE COMMON-SIZE FINANCIAL STATEMENTS  Report only percentages (no dollar amounts)  Assists in the comparison of different companies  Expresses financial results in terms of a common denominator Copyright ©2015 Pearson Education Inc. All rights reserved.

16. Calculate the common-size percentages for the following income statement: Advance slide in presentation mode to reveal answer Copyright ©2015 Pearson Education Inc. All rights reserved. 13-16

17. 13-17 Benchmarking  Compares company to a standard set by others  Facilitated by common-size statements  Has goal of improvement Exhibit 13-6 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

18. 13-18 4.Analyze the statement of cash flows Learning Objective Copyright ©2015 Pearson Education Inc. All rights reserved.

19. 13-19 ANALYZE STATEMENT OF CASH FLOWS Cash flow signs of a healthy company:  Net cash flow provided by operating activities exceeds net income  Operations are the major source of cash  Investing activities include more purchases than sales of long-term assets  Financing activities are not dominated by borrowing LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

20. 13-20 ANALYZE STATEMENT OF CASH FLOWS LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

21. 13-21 5.Use ratios to make business decisions Learning Objective Copyright ©2015 Pearson Education Inc. All rights reserved.

22. 13-22 LO 5 USE RATIOS TO MAKE BUSINESS DECISIONS Measuring ability to pay current liabilities Measuring turnover and cash conversion cycle Measuring leverage Measuring profitability Analyzing stock as an investment Copyright ©2015 Pearson Education Inc. All rights reserved.

23. 13-23 Ability to Pay Current Liabilities LO 5 Working Capital CurrentRatio Quick (Acid-test) Ratio Copyright ©2015 Pearson Education Inc. All rights reserved.

24. 13-24 Ability to Pay Current Liabilities LO 5 Working Capital:  Measures ability to pay current liabilities with current assets  Generally, the larger the working capital, the better the ability to pay debts  Capital is total assets minus total liabilities  Like a “current” version of total capital Copyright ©2015 Pearson Education Inc. All rights reserved.

25. 13-25 Ability to Pay Current Liabilities LO 5 Current Ratio:  Measures ability to pay current liabilities with current assets  In general, a higher current ratio indicates a stronger financial position Copyright ©2015 Pearson Education Inc. All rights reserved.

26. 13-26 Ability to Pay Current Liabilities LO 5 Quick (Acid-test) Ratio:  Shows ability to pay all current liabilities if they come due immediately (quickly)  Narrower base to measure liquidity than current ratio  Ratio of 0.90 to 1.00 is acceptable in most industries Copyright ©2015 Pearson Education Inc. All rights reserved.

27. 13-27 LO 5 Inventory Turnover Accounts Receivable Turnover Accounts Payable Turnover Turnover and Cash Conversion Cycle Days’ Sales Outstanding Cash Conversion Cycle Copyright ©2015 Pearson Education Inc. All rights reserved.

28. 13-28 Turnover and Cash Conversion Cycle LO 5 Inventory Turnover:  Measures number of times a company sells its average level of inventory during a year  Varies widely with nature of business  Compare ratio over time as well as with industry averages or competitors Copyright ©2015 Pearson Education Inc. All rights reserved.

29. 13-29 Turnover and Cash Conversion Cycle LO 5 Days Inventory Outstanding:  Converts inventory turnover ratio into days Copyright ©2015 Pearson Education Inc. All rights reserved.

30. 13-30 Turnover and Cash Conversion Cycle LO 5 Accounts Receivable Turnover:  Measures ability to collect cash from credit customers  In general, higher the ratio, the better  Tells how many times during the year average receivables were turned into cash Copyright ©2015 Pearson Education Inc. All rights reserved.

31. 13-31 Turnover and Cash Conversion Cycle LO 5 Days’ Sales Outstanding:  How many days’ sales remain in accounts receivable  How may days it takes to collect the average level of receivables Copyright ©2015 Pearson Education Inc. All rights reserved.

32. 13-32 Turnover and Cash Conversion Cycle LO 5 Accounts Payable Turnover:  Measures number of times per year that entity pays off its accounts payable Copyright ©2015 Pearson Education Inc. All rights reserved.

33. 13-33 Turnover and Cash Conversion Cycle LO 5 Days’ Payable Outstanding:  How many days it takes a company to pay off accounts payable Copyright ©2015 Pearson Education Inc. All rights reserved.

34. 13-34 Turnover and Cash Conversion Cycle LO 5 Cash Conversion Cycle:  Shows overall liquidity by computing the total days it takes to convert inventory to receivables and back to cash, less the days to pay off its suppliers Copyright ©2015 Pearson Education Inc. All rights reserved.

35. 13-35 LO 5 Debt Ratio Times- Interest- Earned Ratio Leverage: Overall Ability to Pay Debts Copyright ©2015 Pearson Education Inc. All rights reserved.

36. 13-36 LO 5 Debt Ratio:  Indicates percentage of assets financed with debt  Ratio of 1 reveals that debt has financed all the assets  Ratio of 0.50 means that debt finances half the assets  Higher the ratio, greater the pressure to pay interest and principal Leverage: Overall Ability to Pay Debts Copyright ©2015 Pearson Education Inc. All rights reserved.

37. 13-37 Times-Interest-Earned Ratio:  Measures number of times operating income can cover interest expense  Also called interest-coverage ratio  High ratio indicates ease in paying interest; a low value suggests difficulty LO 5 Leverage: Overall Ability to Pay Debts Copyright ©2015 Pearson Education Inc. All rights reserved.

38. 13-38 LO 5 Illustration Using the data on the next slide, calculate the following ratios for 2014: (Round answers to two decimal places) a.Working capital b.Current ratio c.Quick (acid-test) ratio d.Debt ratio e.Times-interest-earned ratio Copyright ©2015 Pearson Education Inc. All rights reserved.

39. 13-39 LO 5 Illustration Summary data: Copyright ©2015 Pearson Education Inc. All rights reserved.

40. 13-40 LO 5 Illustration a. Working capital $455,000$207,000-$248,000= Copyright ©2015 Pearson Education Inc. All rights reserved.

41. 13-41 LO 5 Illustration b. Current Ratio $455,000 $207,000 2.20 = Copyright ©2015 Pearson Education Inc. All rights reserved.

42. 13-42 LO 5 Illustration c. Quick Ratio $193,000 $207,000.93 = Copyright ©2015 Pearson Education Inc. All rights reserved.

43. 13-43 LO 5 Illustration d. Debt Ratio $304,000 $510,000.60 = Copyright ©2015 Pearson Education Inc. All rights reserved.

44. 13-44 LO 5 Illustration e. Times- Interest- Earned Ratio $301,000 $41,000 7.34 = Copyright ©2015 Pearson Education Inc. All rights reserved.

45. 13-45 LO 5 Measuring Profitability Gross Margin Percentage Operating Income Percentage DuPont Analysis Rate of Return on Sales Asset Turnover Rate of Return on Total Assets Leverage Ratio Rate of Return on Equity Earnings Per Share Copyright ©2015 Pearson Education Inc. All rights reserved.

46. 13-46 LO 5 Gross (Profit) Margin Percentage:  Amount of profit that the entity makes from merely selling a product before other operating costs are subtracted Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

47. 13-47 LO 5 Operating Income (Profit) Percentage:  Measures percentage of profit earned from each sales dollar in a company’s core business operations  Persistently high operating income compared to net sales is an important determinant of earnings quality Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

48. 13-48 DuPont Analysis: Measuring Profitability Return on assets Rate of return on sales Asset turnover Leverage ratio Return on equity Leverage ratio Return on equity Net sales x= xx= Net income Net sales Average total assets x Average common equity x Net income Average common equity = Detailed analysis of return on assets (ROA) and return on common stockholders’ equity (ROE) Copyright ©2015 Pearson Education Inc. All rights reserved.

49. 13-49 LO 5 Rate of Return (Net Profit Margin Ratio) on Sales:  Shows percentage of each sales dollar earned as net income  Higher the percentage, the more profit is being generated by sales dollars Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

50. 13-50 LO 5 Asset Turnover:  Measures amount of net sales generated for each dollar invested in assets  Measure of how efficiently management is operating the company  Companies with high asset turnover tend to be more productive Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

51. 13-51 LO 5 Rate of Return on Total Assets (ROA):  Measures how profitably a company uses its assets Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

52. 13-52 LO 5 Leverage (Equity Multiplier) Ratio:  Measures  Impact of debt financing on profitability  Proportion of each dollar of assets financed with stockholders’ equity Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

53. 13-53 Rate of Return on Common Stockholders’ Equity:  Shows relationship between net income and common stockholders’ investment in the company—how much income is earned for every $1 invested LO 5 Measuring Profitability Copyright ©2015 Pearson Education Inc. All rights reserved.

54. 13-54 LO 5 Earnings per Share (EPS) of Common Stock:  Amount of net income earned for each share of outstanding common stock  Most widely quoted of all financial statistics  Only ratio that appears on the income statement Measuring Profitability EPS = Net income – Preferred Dividends Average number of shares of common stock outstanding Copyright ©2015 Pearson Education Inc. All rights reserved.

55. 13-55 LO 5 Price/Earnings Ratio Dividend Yield Book Value per Share of Common Stock Analyzing Stock Investments Copyright ©2015 Pearson Education Inc. All rights reserved.

56. 13-56 LO 5 Price-Earnings Ratio (Multiple):  Shows market price of $1 of earnings  Ratio, abbreviated P/E, appears in the Wall Street Journal stock listings and online Analyzing Stock Investments Copyright ©2015 Pearson Education Inc. All rights reserved.

57. 13-57 LO 5 Dividend Yield:  Measures percentage of a stock’s market value returned annually to stockholders as dividends Analyzing Stock Investments Copyright ©2015 Pearson Education Inc. All rights reserved.

58. 13-58 LO 5 Book Value per Share of Common Stock:  Indicates recorded accounting amount for each share of common stock outstanding Analyzing Stock Investments Copyright ©2015 Pearson Education Inc. All rights reserved.

59. 13-59 LO 5  To be useful, ratios should be analyzed over a period of years to consider all relevant factors  Any one year, or even any two years, may not represent the company’s performance over the long term Limitations of Ratio Analysis Copyright ©2015 Pearson Education Inc. All rights reserved.

60. 13-60 6.Use other measures to make investment decisions Learning Objective Copyright ©2015 Pearson Education Inc. All rights reserved.

61. 13-61 LO 6  Combines accounting and finance data  Measures if operations have increased stockholder wealth  Positive EVA ® suggests increase in wealth EVA = Net income before taxes + Interest expense – Capital charge Economic Value Added (EVA ® ) Copyright ©2015 Pearson Education Inc. All rights reserved.

62. 13-62 LO 6 Capital charge = Economic Value Added (EVA ® ) Copyright ©2015 Pearson Education Inc. All rights reserved.

63. 13-63 LO 6  Earnings problems  Decreased cash flow  Too much debt  Inability to collect receivables  Buildup of inventories  Trends of sales, inventory and receivables Red Flags in Financial Statement Analysis Copyright ©2015 Pearson Education Inc. All rights reserved.

64. 13-64 LO 6  Market prices fully reflect all information  Managers cannot fool market with accounting manipulations  Market sets fair price for stock  Appropriate investment strategy:  Manage risk  Diversify investments  Minimize transaction costs Efficient Markets Copyright ©2015 Pearson Education Inc. All rights reserved.

65. This work is protected by United States copyright law and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. Copyright Copyright ©2015 Pearson Education Inc. All rights reserved.