Hhtfa9e Ch13 Inst

1Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Financial Statement AnalysisChapter 13


Perform a horizontal analysis


Horizontal Analysis•Study of percentage changes from year-to-year

•Two steps:1. Compute dollar amount of change2. Divide dollar amount of change by base-period amount


Exercise 13-16AMcMahon Music Company

Comparative Income StatementsYears Ended December 31, 2012 and 2011

2012 2011 $ Change

% Change

Total revenue $1,007,000

$917,000 $90,000

9.8%

Expenses: Cost of goods sold $477,000 $408,75

0$68,250 14.3%

Selling & gen’l expense

287,000 265,000 22,000 7.7%

Interest expense 23,500 13,500 10,000 74.1% Income tax expense

105,500 84,650 20,850 24.6%

Total expenses 893,000 771,900 121,100 15.7% Net income $184,000 $145,10

0$38,900 26.8%


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


Trend %Any year

Base year

Perform a vertical analysis


Vertical Analysis•Shows relationship of a financial-

statement item to its base▫For Income Statement, total revenue is the

base

▫For Balance Sheet, total assets is the base


Vertical analysis %

Total revenue

Each income statement item

Prepare common-size financial statements


Common-Size Statements•Report only vertical analysis percents▫No dollar amounts

•Help in the comparison of different companies▫Financial results in terms of a common

denominator


Benchmarking•Compares company to a standard set by others▫Often a key competitor

•Facilitated by common-size statements

•Has goal of improvement


Analyze the statement of cash flows


Cash-Flow Signs of Healthy Company


Use ratios to make business decisions


Ratio Categories

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 15

Ability to Pay Current Liabilities


Working Capital & Current Ratio

17

Working capital

Current assets

Current liabilities

Current ratio

Current assets

Current liabilities

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Quick (Acid-Test) Ratio

18

Cash + Short-term investments + Net current receivables

Current liabilities


Measuring Turnover and the Cash Conversion Cycle


Inventory Turnover


Cost of goods sold

Average inventory

(Beginning inventory + Ending inventory)/2)

Days’ inventory outstandi

ng

365Inventory turnover

Accounts Receivable Turnover


Net sales

Average net accounts receivable

(Beginning net receivables + Ending net receivables)/2)

Days’-Sales-In-Receivables


One day’s sales

Net sales

365 days

Days’ sales in average accounts

receivable

Average net accounts receivable

One day’s sales

Accounts Payables Turnover


Cost of goods sold

Average accounts payable

365Days’ payable

outstanding Payables turnover

Cash Conversion Cycle


DIO DPODSO

DIO = Days’ Inventory OutstandingDSO = Days’ Sales OutstandingDPO = Days’ Payable Outstanding

Measuring Leverage: Overall Ability to Pay Debts


Debt ratio


Total liabilities

Total assets

Times-Interest-Earned


Income from operations

Interest expense

Exercise 13-22A


2012 2011 Cash $50,000 $49,000 Short-term investments 28,000 27,000 Net receivables 115,000 128,000 Inventory 240,000 268,000 Prepaid expenses 22,000 8,000 Total assets 510,000 540,000 Total current liabilities 207,000 262,000 Long-term debt 97,000 174,000 Income from operations 301,000 150,000 Interest expense 41,000 42,000

Exercise 13-22A


Working capital

Current assets

Current liabilities

Current assets

Cash + Short-term investments + Net receivables + Inventory +

Prepaid expenses

$50,000 + 28,000 + 115,000 + 240,000 + 22,000

2012

$455,000

$455,000

$262,000

$193,000

Exercise 13-22A


Working capital

Current assets

Current liabilities

Current assets

Cash + Short-term investments + Net receivables + Inventory +

Prepaid expenses

$49,000 + 27,000 + 128,000 + 268,000 + 8,000

2011

$480,000

$480,000

$207,000

$248,000

Exercise 13-22A

31

Current ratio

Current assets

Current liabilities

$455,000 $262,0001.74


2012

2011

$480,000

$207,0002.32

Exercise 13-22A

32


Current liabilities

Quick ratio 2012 =

$50,000 +28,000 + 115,000

$207,000

.93


Exercise 13-22A

33


Current liabilities

Quick ratio 2011 =

$49,000 + 27,000 + 128,000

$262,000

.78


Exercise 13-22A


Debt ratioTotal liabilities

Total assets

Current liabilities +

Long-term debt

$207,000 +97,000$304,000

$510,000

2012

.60

2011 $262,000 + 174,000$436,000

$540,000.81

Exercise 13-22A


Income from operations

Interest expense

Times Interest Earned

2012$301,000

$41,000

$150,000

$42,000

7.34

3.572011

Measuring Profitability


Gross margin & Operating profit Percentages


Operating profit %

Net sales

Gross margin Gross

margin %

Operating income

Net sales

DuPont Analysis


Return on assets

Net profit

marginAsset

turnover

Leverage ratio

Return on equity

Leverage ratio

Return on

equity

Net incom

eNet

sales

Net sales

Average total

assets

Average total

assetsAverage common equity

Net incom

eAverage common equity

Rate of Return (Net Profit Margin) on Sales


Net income

Net sales

Asset Turnover


Net sales

Average total assets

Rate of Return on Total Assets


Rate of Return on

SalesAsset

turnover

Leverage (Equity Multiplier) Ratio


Average total assets

Average common stockholders’ equity

Rate of Return on Common Equity


Net income – Preferred dividends

Average common stockholders’ equity

Earnings per Share


Net income –Preferred dividends

Average number of common shares outstanding

Use other measures to make investment decisions


Analyzing Stock Investments


Price/Earnings Ratio


Market price per share of common stock

Earnings per share

Dividend Yield


Dividend per share of common stock

Market price per share of common stock

Book Value


Total stockholders’

equityPreferred equity

Weighted-average number of common shares outstanding

Measure the economic value added by operations


Economic Value Added (EVA ®)•Combines accounting and finance data •Measures if operations have increased

stockholder wealth▫Positive EVA® suggests increase in wealth


Net income

Interest expense

Capital charge

Cost of Capital


Notes payable

Current maturities

of long-term debt

Long-term debt

Stockholders’ equity

Capital charge =

Cost of

capital

Red Flags in Financial Statement Analysis•Earnings problems•Decreased cash flow•Too much debt•Inability to collect receivables•Buildup of inventories•Trends of sales, inventory and receivables


Efficient Markets•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




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Hhtfa9e Ch13 Inst