1. Financial Statement Analysis Financial and Managerial Accounting
Chapter 15
Financial Statement Analysis
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.
Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.
PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

2. Some of the action has been automated, so click the mouse when you see this lightning bolt in the lower right-hand corner of the screen. You can point and click anywhere on the screen.

3. After studying this chapter, you should be able to:
Objectives
1. List the basic financial statement analytical procedures.
2. Apply financial statement analysis to assess the solvency of a business.
3. Apply financial statement analysis to assess the profitability of a business.
4. Summarize the uses and limitations of analytical measures.
5. Describe the contents of corporate annual reports.
After studying this chapter, you should be able to:

4. What is horizontal analysis?

5. Horizontal Analysis
It’s an analysis of the percentage increases and decreases of related items in comparative financial statements.

6. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
Total stockholders’ equity $ 829,500 $ 787,500 $42, %
Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)

7. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
Total stockholders’ equity $ 829,500 $ 787,500 $42, %
Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
Horizontal Analysis:
Difference $17,000
Base year (2005) $533,000
= 3.2%

8. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
Total stockholders’ equity $ 829,500 $ 787,500 $42, %
Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
Horizontal Analysis:
Difference $(82,500)
Base year (2005) $177,500
= (46.5%)

9. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005
Okay, go to the next slide and calculate the percentage change for fixed assets.
Amount Percent
Increase (Decrease)
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
Total stockholders’ equity $ 829,500 $ 787,500 $42, %
Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
Horizontal Analysis:
Difference ?
Base year (2005) ?
= ?

10. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
Total stockholders’ equity $ 829,500 $ 787,500 $42, %
Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)

11. Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Assets
Current assets $ 550,000 $ 533,000 $ 17, %
Long-term investments 95, ,500 (82,500) (46.5%)
Fixed assets (net) 444, ,000 (25,500) (5.4%)
Intangible assets 50,000 50,000 —
Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%)
Liabilities
Current liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)
Long-term liabilities 100, ,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%)
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150,000 $ 150,000 —
Common stock, $10 par 500, ,000 —
Retained earnings 179, ,500 $42, %
Total stockholders’ equity $ 829,500 $ 787,500 $42, %
Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
(5.4%)

12. Lincoln Company Comparative Income Statement December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Sales $1,530,500 $1,234,000 $296, %
Sales returns 32,500 34,000 (1,500) (4.4%)
Net sales $1,498,000 $1,200,000 $298, %
Cost of goods sold 1,043, , , %
Gross profit $ 455,000 $ 380,000 $ 75, %
Selling expenses $ 191,000 $ 147,000 $ 44, %
Administrative expenses 104,000 97,400 6, %
Total operating expenses $ 295,000 $ 244,400 $ 50, %
Operating income $ 160,000 $ 135,600 $ 24, %
Other income 8,500 11,000 (2,500) (22.7%)
$ 168,500 $ 146,600 $ 21, %
Other expense 6,000 12,000 (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600 $ 27, %
Income tax 71,500 58,100 13, %
Net income $ 91,000 $ 76,500 $ 14, %

13. Lincoln Company Comparative Income Statement
December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Sales $1,530,500 $1,234,000 $296, %
Sales returns 32,500 34,000 (1,500) (4.4%)
Net sales $1,498,000 $1,200,000 $298, %
Cost of goods sold 1,043, , , %
Gross profit $ 455,000 $ 380,000 $ 75, %
Selling expenses $ 191,000 $ 147,000 $ 44, %
Administrative expenses 104,000 97,400 6, % Total operating expenses $ 295,000 $ 244,400 $ 50, %
Operating income $ 160,000 $ 135,600 $ 24, %
Other income 8,500 11,000 (2,500) (22.7%)
$ 168,500 $ 146,600 $ 21, %
Other expense 6,000 12,000 (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600 $ 27, %
Income tax 71,500 58,100 13, %
Net income $ 91,000 $ 76,500 $ 14, %
24.0%
Horizontal Analysis:
Increase amount $296,500
Base year (2005) $1,234,000
= 24.0%

14. Lincoln Company Comparative Income Statement
December 31, 2006 and 2005
Amount Percent
Increase (Decrease)
Sales $1,530,500 $1,234,000 $296, %
Sales returns 32,500 34,000 (1,500) (4.4%)
Net sales $1,498,000 $1,200,000 $298, %
Cost of goods sold 1,043, , , %
Gross profit $ 455,000 $ 380,000 $ 75, %
Selling expenses $ 191,000 $ 147,000 $ 44, %
Administrative expenses 104,000 97,400 6, % Total operating expenses $ 295,000 $ 244,400 $ 50, %
Operating income $ 160,000 $ 135,600 $ 24, %
Other income 8,500 11,000 (2,500) (22.7%)
$ 168,500 $ 146,600 $ 21, %
Other expense 6,000 12,000 (6,000) (50.0%)
Income before income tax $ 162,500 $ 134,600 $ 27, %
Income tax 71,500 58,100 13, %
Net income $ 91,000 $ 76,500 $ 14, %
24.8%
Horizontal Analysis:
Increase amount $298,000
Base year (2005) $1,200,000
= 24.8%

15. Vertical Analysis
A percentage analysis can be used to show the relationship of each component to a total within a single statement.

16. The total, or 100% item, on the balance sheet is “total assets.”
Vertical Analysis
The total, or 100% item, on the balance sheet is “total assets.”

17. Lincoln Company Comparative Balance Sheet
December 31, December 31, 2005
Amount Percent Amount Percent
Assets
Current assets $ 550, % $ 533, %
Long-term investments 95, ,
Property, plant, & equip. (net) 444, ,
Intangible assets 50, , Total assets $1,139, % $1,230, %
Liabilities
Current liabilities $ 210, % $ 243, %
Long-term liabilities 100, ,
Total liabilities $ 310, % $ 443, %
Stockholders’ Equity
Preferred stock, 6%, $100 par $ 150, % $ 150, % Common stock, $10 par 500, ,
Retained earnings 179, ,
Total stockholders’ equity $ 829, % $ 787, %
Total liab. & SE $1,139, % $1,230, %
48.3%
Vertical Analysis:
Current assets $550,000
Total assets $1,139,500
= 48.3%

18. Lincoln Company Comparative Balance Sheet
December 31, December 31, 2005
Amount Percent Amount Percent
Assets
Current assets $ 550, % $ 533, %
Long-term investments 95, ,
Property, plant, & equip. (net) 444, ,
Intangible assets 50, , Total assets $1,139, % $1,230, %
Liabilities
Current liabilities $ 210, % $ 243, %
Long-term liabilities 100, ,
Total liabilities $ 310, % $ 443, %
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150, % $ 150, % Common stock, $10 par 500, ,
Retained earnings 179, ,
Total stockholders’ equity $ 829, % $ 787, %
Total liab. & SE $1,139, % $1,230, %
43.3%
Vertical Analysis:
Current assets $533,000
Total assets $1,230,500
= 43.3%

19. Lincoln Company Comparative Balance Sheet
December 31, December 31, 2005
Amount Percent Amount Percent
Assets
Current assets $ 550, % $ 533, %
Long-term investments 95, ,
Property, plant, & equip. (net) 444, ,
Intangible assets 50, , Total assets $1,139, % $1,230, %
Liabilities
Current liabilities $ 210, % $ 243, %
Long-term liabilities 100, ,
Total liabilities $ 310, % $ 443, %
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150, % $ 150, % Common stock, $10 par 500, ,
Retained earnings 179, ,
Total stockholders’ equity $ 829, % $ 787, %
Total liab. & SE $1,139, % $1,230, %

20. Income Statement Net sales is 100.0%
Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005
Income
Statement
Amount Percent Amount Percent
Sales $1,530, % $1,234, %
Sales returns 32, ,
Net sales $1,498, % $1,200, %
Cost of goods sold 1,043, ,
Gross profit $ 455, % $ 380, %
Selling expenses $ 191, % $ 147, %
Administrative expenses 104, ,
Total operating expenses $ 295, % $ 244, %
Income from operations $ 160, $ 135, %
Other income 8, ,
$ 168, % $ 146, %
Other expense 6, ,
Income before income tax $ 162, % $ 134, %
Income tax expense 71, ,
Net income $ 91, % $ 76, %
Net sales is 100.0%

21. Vertical Analysis: Selling expenses $191,000 Net sales $1,498,000
Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005
Amount Percent Amount Percent
Sales $1,530, % $1,234, %
Sales returns 32, ,
Net sales $1,498, % $1,200, %
Cost of goods sold 1,043, ,
Gross profit $ 455, % $ 380, %
Selling expenses $ 191, % $ 147, %
Administrative expenses 104, ,
Total operating expenses $ 295, % $ 244, %
Income from operations $ 160, $ 135, %
Other income 8, ,
$ 168, % $ 146, %
Other expense 6, ,
Income before income tax $ 162, % $ 134, %
Income tax expense 71, ,
Net income $ 91, % $ 76, %
12.8%
Vertical Analysis:
Selling expenses $191,000
Net sales $1,498,000
= 12.8%

22. Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005
Amount Percent Amount Percent
Sales $1,530, % $1,234, %
Sales returns 32, ,
Net sales $1,498, % $1,200, %
Cost of goods sold 1,043, ,
Gross profit $ 455, % $ 380, %
Selling expenses $ 191, % $ 147, %
Administrative expenses 104, ,
Total operating expenses $ 295, % $ 244, %
Income from operations $ 160, $ 135, %
Other income 8, ,
$ 168, % $ 146, %
Other expense 6, ,
Income before income tax $ 162, % $ 134, %
Income tax expense 71, ,
Net income $ 91, % $ 76, %

23. Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005
Amount Percent Amount Percent
Sales $1,530, % $1,234, %
Sales returns 32, ,
Net sales $1,498, % $1,200, %
Cost of goods sold 1,043, ,
Gross profit $ 455, % $ 380, %
Selling expenses $ 191, % $ 147, %
Administrative expenses 104, ,
Total operating expenses $ 295, % $ 244, %
Income from operations $ 160, $ 135, %
Other income 8, ,
$ 168, % $ 146, %
Other expense 6, ,
Income before income tax $ 162, % $ 134, %
Income tax expense 71, ,
Net income $ 91, % $ 76, %

24. Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005
Amount Percent Amount Percent
Sales $1,530, % $1,234, %
Sales returns 32, ,
Net sales $1,498, % $1,200, %
Cost of goods sold 1,043, ,
Gross profit $ 455, % $ 380, %
Selling expenses $ 191, % $ 147, %
Administrative expenses 104, ,
Total operating expenses $ 295, % $ 244, %
Income from operations $ 160, $ 135, %
Other income 8, ,
$ 168, % $ 146, %
Other expense 6, ,
Income before income tax $ 162, % $ 134, %
Income tax expense 71, ,
Net income $ 91, % $ 76, %

25. Common Size Statements
Vertical analysis with both dollar and percentage amounts is also useful in comparing one company with another or with industry averages. Such comparisons are easier to make with the use of common-size statements in which all items are expressed in percentages.

26. Common-Size Income Statement

27. Solvency Analysis
Solvency is the ability of a business to meet its financial obligations (debts) as they are due.
Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities.
This ability is normally assessed by examining balance sheet relationships.

28. Current Position Analysis
Working Capital and Current Ratio
Current assets $550,000 $533,000
Current liabilities , ,000
Working capital $340,000 $290,000
Current ratio
Divide current assets by current liabilities
Use: To indicate the ability to meet currently maturing obligations.

29. Current Position Analysis
Quick Ratio
Quick assets:
Cash $ 90,500 $ 64,700
Marketable securities 75,000 60,000
Accounts receivable (net) 115, ,000
Total $280,500 $244,700
Current liabilities $210,000 $243,000
Quick ratio
Use: To indicate instant debt-paying ability.

30. Accounts Receivable Analysis
Accounts Receivable Turnover
Net sales on account $1,498,000 $1,200,000
Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000
End of year 115, ,000
Total $ 235,000 $ 260,000
Average (Total ÷ 2) $ 117,500 $ 130,000
Net sales on account
Average accounts receivable

31. Accounts Receivable Analysis
Accounts Receivable Turnover
Net sales on account $1,498,000 $1,200,000
Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000
End of year 115, ,000
Total $ 235,000 $ 260,000
Average $ 117,500 $ 130,000
Accounts receivable turnover
Use: To assess the efficiency in collecting receivables and in the management of credit.

32. Accounts Receivable Analysis
Number of Days’ Sales in Receivables
Accounts receivable (net),
end of year $ 115,000 $ 120,000
Net sales on account $1,498,000 $1,200,000
Average daily sales on
account (sales ÷ 365) $ ,104 $ ,288
Accounts receivable, end of year
Average daily sales on account

33. Accounts Receivable Analysis
Number of Days’ Sales in Receivables
Accounts receivable (net),
end of year $ 115,000 $ 120,000
Net sales on account $1,498,000 $1,200,000
Average daily sales on
account (sales ÷ 365) $ ,104 $ ,288
Number of days’ sales in
receivables
Use: To assess the efficiency in collecting receivables and in the management of credit.

34. Inventory Analysis Inventory Turnover Cost of goods sold
Cost of goods sold $1,043,000 $ 820,000
Inventories:
Beginning of year $ 283,000 $ 311,000
End of year 264, ,000
Total $ 547,000 $ 594,000
Average (Total ÷ 2) $ 273,500 $ 297,000
Cost of goods sold
Average inventory
Inventory turnover =

35. Inventory Analysis
Inventory Turnover
Cost of goods sold $1,043,000 $ 820,000
Inventories:
Beginning of year $ 283,000 $ 311,000
End of year 264, ,000
Total $ 547,000 $ 594,000
Average (Total ÷ 2) $ 273,500 $ 297,000
Inventory turnover
Use: To assess the efficiency in the management of inventory.

36. Inventory Analysis Number of Days’ Sales in Inventory
Inventories, end of year $ 264,000 $283,000
Cost of goods sold $1,043,000 $820,000
Average daily cost of
goods sold
(COGS ÷ 365) $ ,858 $ 2,247
Inventories, end of year
Average daily cost of goods sold
Number of Days’ Sales in Inventory =

37. Inventory Analysis
Number of Days’ Sales in Inventory
Inventories, end of year $ 264,000 $283,000
Cost of goods sold $1,043,000 $820,000
Average daily cost of
goods sold
(COGS ÷ 365) $ ,858 $ 2,247
Number of days’ sales
in inventory
Use: To assess the efficiency in the management of inventory.

38. Long-Term Creditors
Ratio of Fixed Assets to Long-Term Liabilities
Fixed assets (net) $444,500 $470,000
Long-term liabilities $100,000 $200,000
Ratio of fixed assets to
long-term liabilities
Use: To indicate the margin of safety to long-term creditors.

39. Long-Term Creditors
Ratio of Liabilities to Stockholders’ Equity
Total liabilities $310,000 $443,000
Total stockholders’ equity $829,500 $787,500
Ratio of liabilities to
stockholders’ equity
Use: To indicate the margin of safety to creditors.

40. Long-Term Creditors Number of Times Interest Charges Earned
Income before income tax $ 900,000 $ 800,000
Add interest expense , ,000
Amount available for interest $1,200,000 $1,050,000
Income before
income tax + interest expense
Interest expense
Number of Times Interest Charges Earned =

41. Long-Term Creditors
Number of Times Interest Charges Earned
Income before income tax $ 900,000 $ 800,000
Add interest expense , ,000
Amount available for interest $1,200,000 $1,050,000
Number of times earned
Use: To assess the risk to debtholders in terms of number of times interest charges were earned.

42. Profitability Analysis
Profitability is the ability of an entity to earn profits.
This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available.
Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet.

43. The Common Stockholder
Ratio of Net Sales to Assets
Net sales $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044,500 1,053,000
Total $2,097,500 $2,063,000
Average (Total ÷ 2) $1,048,750 $1,031,500
Excludes long-term investments

44. The Common Stockholder
Ratio of Net Sales to Assets
Net sales $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044,500 1,053,000
Total $2,097,500 $2,063,000
Average (Total ÷ 2) $1,048,750 $1,031,500
Ratio of net sales to assets
Use: To assess the effectiveness of the use of assets.

45. The Common Stockholder
Rate Earned on Total Assets
Net income $ 91,000 $ 76,500
Plus interest expense 6,000 12,000
Total $ 97,000 $ 88,500
Total assets:
Beginning of year $1,230,500 $1,187,500
End of year 1,139,500 1,230,500
Total $2,370,000 $2,418,000
Average (Total ÷ 2) $1,185,000 $1,209,000
Rate earned on total assets % %
Use: To assess the profitability of the assets.

46. The Common Stockholder
Rate Earned on Stockholders’ Equity
Net income $ 91,000 $ 76,500
Stockholders’ equity:
Beginning of year $ 787,500 $ 750,000
End of year 829, ,500
Total $1,617,000 $1,537,500
Average (Total ÷ 2) $ 808,500 $ 768,750
Rate earned on stockholders’
equity % %
Use: To assess the profitability of the investment by stockholders.

47. Leverage 11.3% 10.0% Leverage 3.1% Leverage 2.7% 8.2% 7.3%
10%
Leverage 2.7%
8.2%
7.3% 5% 0%
2006
2005
Rate earned on total assets
Rate earned on stockholders’ equity

48. The Common Stockholder
Rate Earned on Common Stockholders’ Equity
Net income $ ,000 $ ,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ ,000 $ ,500
Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000
End of year 679, ,500
Total $1,317,000 $1,237,500
Average (Total ÷ 2) $ 658,500 $ 618,750

49. The Common Stockholder
Rate Earned on Common Stockholders’ Equity
Net income $ ,000 $ ,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ ,000 $ ,500
Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000
End of year 679, ,500
Total $1,317,000 $1,237,500
Average (Total ÷ 2) $ 658,500 $ 618,750
Rate earned on common
stockholders’ equity % %
Use: To assess the profitability of the investment by common stockholders.

50. The Common Stockholder
Earnings Per Share on Common Stock
Net income $ 91,000 $ 76,500
Less preferred dividends 9,000 9,000
Remainder—common stock $ 82,000 $ 67,500
Shares of common stock 50,000 50,000
Earnings per share on common stock $ $1.35
Use: To assess the profitability of the investment by common stockholders.

51. The Common Stockholder
Price-Earnings Ratio
Market price per share of common $41.00 $27.00
Earnings per share on common ÷ 1.64 ÷ 1.35
Price-earnings ratio on common stock
Use: To indicate future earnings prospects, based on the relationship between market value of common stock and earnings.

52. Dividends and Earnings Per Share
$2.00
$1.64
$1.50
Per share
$1.35
$1.00
$0.80
$0.60
$0.50
$0.00
2006
2005
Dividends
Earnings

53. The Common Stockholder
Dividend Yield on Common Stock
Dividends per share of common $ $
Market price per share of common ÷ ÷ 27.00
Dividend yield on common stock % %
Use: To indicate the rate of return to common stockholders in terms of dividends.

54. Corporate Annual Reports
In addition to financial statements, the annual report includes a management discussion analysis (MDA) and an independent auditors’ report.
The MDA includes an analysis of the results of operations and discusses management’s opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition.

55. Corporate Annual Reports
In addition to financial statements, the annual report includes a management discussion analysis (MDA) and an independent auditors’ report.
Before issuing annual statements, all publicly held corporations are required to have an independent audit of their financial statements. The CPAs who conduct the audit render an opinion as to the fairness of the statements.

56. Chapter 15
The End