13-1
(3) Analyzing and Interpreting
Financial Statements
1
Basics of Analysis
Application
of analytical
tools
Reduces
uncertainty
Involves
transforming
data
Purpose of Analysis
Financial statement analysis helps users
make better decisions.
Internal Users
External Users
Managers
Officers
Internal Auditors
Shareholders
Lenders
Customers
Building Blocks of Analysis
Ability to meet
short-term
obligations and
to efficiently
generate
revenues
Ability to provide
financial rewards
sufficient to
attract and retain
financing
Liquidity
and
Efficiency
Solvency
Market
Profitability
Prospects
Ability to
generate future
revenues and
meet long-term
obligations
Ability to
generate
positive
market
expectations
Information for Analysis
Income Statement
Balance Sheet
Statement of
Changes in
Stockholders’ Equity
Statement of Cash
Flows
Notes
Standards for Comparison
 Intracompany
 Competitor
 Industry
 Guidelines
Financial Statement Analysis
Horizontal Analysis
Comparing a company’s financial condition and performance across time
Vertical Analysis
Comparing a company’s financial condition and performance to a base amount
Tools of Analysis
Using key relations
among financial
statement items
Horizontal Analysis
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
Assets
Current assets:
Cash and equivalents
Accounts receivable, net
Inventory
Prepaid expenses
Total current assets
Property and equipment:
Land
Buildings and equipment, net
Total property and equipment
Total assets
2003
$
12,000
60,000
80,000
3,000
$ 155,000
$
23,500
40,000
100,000
1,200
$ 164,700
40,000
120,000
$ 160,000
$ 315,000
40,000
85,000
$ 125,000
$ 289,700
Dollar
Change
Percent
Change
Comparative Statements
Calculate Change in Dollar Amount
Dollar
Change
=
Analysis Period
Amount
–
Base Period
Amount
Since we are measuring the amount of
the change between 2003 and 2004, the
dollar amounts for 2003 become the
“base” period amounts.
Comparative Statements
Calculate Change as a Percent
Percent
Change
=
Dollar Change
Base Period Amount
×
100%
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
2003
Dollar
Change
Percent
Change*
Assets
Current assets:
Cash and equivalents
$ 12,000 $ 23,500 $ (11,500)
(48.9)
Accounts receivable, net
60,000
40,000
Inventory
80,000
100,000
Prepaid expenses
3,000
1,200
1,800
$12,000 – $23,500 = $(11,500)
Total current assets
$ 155,000 $ 164,700
Property and equipment:
($11,500
÷ $23,500)
× 100%- = 48.9% 0.0
Land
40,000
40,000
Buildings and equipment, net
120,000
85,000
Total property and equipment $ 160,000 $ 125,000
Total assets
$ 315,000 $ 289,700
* Percent rounded to first decimal point.
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
Assets
Current assets:
Cash and equivalents
$ 12,000
Accounts receivable, net
60,000
Inventory
80,000
Prepaid expenses
3,000
Total current assets
$ 155,000
Property and equipment:
Land
40,000
Buildings and equipment, net
120,000
Total property and equipment $ 160,000
Total assets
$ 315,000
* Percent rounded to first decimal point.
2003
Dollar
Change
Percent
Change*
$ 23,500 $ (11,500)
40,000 20,000
100,000 (20,000)
1,200
1,800
$ 164,700 $ (9,700)
(48.9)
50.0
(20.0)
150.0
(5.9)
40,000
85,000 35,000
$ 125,000 $ 35,000
$ 289,700 $ 25,300
0.0
41.2
28.0
8.7
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable
Notes payable
Total current liabilities
Long-term liabilities:
Bonds payable, 8%
Total liabilities
Shareholders' equity:
Preferred stock
Common stock
Additional paid-in capital
Total paid-in capital
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity
* Percent rounded to first decimal point.
2003
Dollar
Change
$ 67,000 $ 44,000 $ 23,000
3,000
6,000
(3,000)
$ 70,000 $ 50,000 $ 20,000
75,000
$ 145,000
80,000
(5,000)
$ 130,000 $ 15,000
20,000
20,000
60,000
60,000
10,000
10,000
$ 90,000 $ 90,000
80,000
69,700
10,300
$ 170,000 $ 159,700 $ 10,300
$ 315,000 $ 289,700 $ 25,300
Percent
Change*
52.3
(50.0)
40.0
(6.3)
11.5
0.0
0.0
0.0
0.0
14.8
6.4
8.7
Trend Analysis
Trend analysis is used to reveal patterns in data
covering successive periods.
Trend
Analysis Period Amount
=
Percent
Base Period Amount
× 100%
Trend Analysis
Berry Products
Income Information
For the Years Ended December 31,
Item
Revenues
Cost of sales
Gross profit
2004
$ 400,000
285,000
115,000
2003
$ 355,000
250,000
105,000
2002
$ 320,000
225,000
95,000
2001
$ 290,000
198,000
92,000
2000 is the base period so its
amounts will equal 100%.
2000
$ 275,000
190,000
85,000
Trend Analysis
Berry Products
Income Information
For the Years Ended December 31,
Item
Revenues
Cost of sales
Gross profit
2004
$ 400,000
285,000
115,000
2003
$ 355,000
250,000
105,000
2002
$ 320,000
225,000
95,000
Item
Revenues
Cost of sales
Gross profit
2004
2003
2002
(290,000 ¸ 275,000) ´
(198,000 ¸ 190,000) ´
(92,000 ¸ 85,000) ´
100% = 105%
100% = 104%
100% = 108%
2001
$ 290,000
198,000
92,000
2001
105%
104%
108%
2000
$ 275,000
190,000
85,000
2000
100%
100%
100%
Trend Analysis
Berry Products
Income Information
For the Years Ended December 31,
Item
Revenues
Cost of sales
Gross profit
Item
Revenues
Cost of sales
Gross profit
2004
$ 400,000
285,000
115,000
2004
145%
150%
135%
2003
$ 355,000
250,000
105,000
2003
129%
132%
124%
2002
$ 320,000
225,000
95,000
2002
116%
118%
112%
2001
$ 290,000
198,000
92,000
2001
105%
104%
108%
2000
$ 275,000
190,000
85,000
2000
100%
100%
100%
Common-Size Statements
Calculate Common-size Percent
Common-size
Percent
=
Analysis Amount
Base Amount
×
100%
Financial Statement
Base Amount
Balance Sheet
Total Assets
Income Statement
Revenues
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
2003
Common-size
Percents*
2004
2003
Assets
Current assets:
Cash and equivalents
$ 12,000 $ 23,500
3.8%
8.1%
Accounts receivable, net
60,000
40,000
Inventory
80,000
100,000
Prepaid expenses
3,000
1,200
($12,000 ÷ $315,000)
100%
= 3.8%
Total current assets
$ 155,000× $
164,700
Property and equipment:
Land
40,000
12.7%
($23,50040,000
÷ $289,700)
× 100%
= 8.1%
Buildings and equipment, net
120,000
85,000
Total property and equipment $ 160,000 $ 125,000
Total assets
$ 315,000 $ 289,700
* Percent rounded to first decimal point.
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable
Notes payable
Total current liabilities
Long-term liabilities:
Bonds payable, 8%
Total liabilities
Shareholders' equity:
Preferred stock
Common stock
Additional paid-in capital
Total paid-in capital
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity
* Percent rounded to first decimal point.
2003
$ 67,000 $
3,000
$ 70,000 $
Common-size
Percents*
2004
2003
44,000
6,000
50,000
21.3%
1.0%
22.2%
15.2%
2.1%
17.3%
80,000
$ 130,000
23.8%
46.0%
27.6%
44.9%
20,000
20,000
60,000
60,000
10,000
10,000
$ 90,000 $ 90,000
80,000
69,700
$ 170,000 $ 159,700
$ 315,000 $ 289,700
6.3%
19.0%
3.2%
28.6%
25.4%
54.0%
100.0%
6.9%
20.7%
3.5%
31.1%
24.1%
55.1%
100.0%
75,000
$ 145,000
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2004
Assets
Current assets:
Cash and equivalents
$ 12,000
Accounts receivable, net
60,000
Inventory
80,000
Prepaid expenses
3,000
Total current assets
$ 155,000
Property and equipment:
Land
40,000
Buildings and equipment, net
120,000
Total property and equipment $ 160,000
Total assets
$ 315,000
* Percent rounded to first decimal point.
2003
Common-size
Percents*
2004
2003
$ 23,500
40,000
100,000
1,200
$ 164,700
3.8%
19.0%
25.4%
1.0%
49.2%
8.1%
13.8%
34.5%
0.4%
56.9%
40,000
85,000
$ 125,000
$ 289,700
12.7%
38.1%
50.8%
100.0%
13.8%
29.3%
43.1%
100.0%
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31,
2004
2003
$ 520,000 $ 480,000
Revenues
Costs and expenses:
Cost of sales
360,000
315,000
Selling and admin.
128,600
126,000
Interest expense
6,400
7,000
Income before taxes
$ 25,000 $ 32,000
Income taxes (30%)
7,500
9,600
Net income
$ 17,500 $ 22,400
Net income per share
$
0.79 $
1.01
Avg. # common shares
22,200
22,200
* Rounded to first decimal point.
Common-size
Percents*
2004
2003
100.0% 100.0%
69.2%
24.7%
1.2%
4.8%
1.4%
3.4%
65.6%
26.3%
1.5%
6.7%
2.0%
4.7%
Common-Size Graphics
This is a graphical analysis of Clover
Corporation’s common-size income
statement for 2004.
Interest
expense
1.2%
Selling and
administrative
24.7%
Income taxes
1.4%
Net income
3.4%
Cost of sales
69.2%
Liquidity
and
Efficiency
Solvency
Market
Profitability
Prospects
Let’s use the following financial
statements for Norton Corporation for
our ratio analysis.
General Rule of Financial
ratios
• Balance sheet : One point of time
• Income Statement & Cash Flows St. : A period
of time
If the ratio mixes a Balance Sheet account with
an I/S or CF St. account then use the average
of the Balance sheet account
AVG= (Beginning Balance + Ending Balance) ÷ 2
NORTON CORPORATION
Balance Sheet
December 31,
Assets
Current assets:
Cash
Accounts receivable, net
Inventory
Prepaid expenses
Total current assets
Property and equipment:
Land
Buildings and equipment, net
Total property and equipment
Total assets
2004
2003
$ 30,000
20,000
12,000
3,000
$ 65,000
$ 20,000
17,000
10,000
2,000
$ 49,000
165,000
116,390
$ 281,390
$ 346,390
123,000
128,000
$ 251,000
$ 300,000
NORTON CORPORATION
Balance Sheet
December 31,
2004
2003
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable
Notes payable, short-term
Total current liabilities
Long-term liabilities:
Notes payable, long-term
Total liabilities
Shareholders' equity:
Common stock, $1 par value
Additional paid-in capital
Total paid-in capital
Retained earnings
Total shareholders' equity
70,000
$ 112,000
78,000
$ 120,000
27,400
158,100
$ 185,500
48,890
$ 234,390
17,000
113,000
$ 130,000
50,000
$ 180,000
Total liabilities and shareholders' equity
$ 346,390
$ 300,000
$
$
39,000
3,000
42,000
$
$
40,000
2,000
42,000
NORTON CORPORATION
Income Statement
For the Years Ended December 31,
Revenues
Cost of sales
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before taxes
Less income taxes (30%)
Net income
$
$
$
$
$
2004
494,000
140,000
354,000
270,000
84,000
7,300
76,700
23,010
53,690
$
$
$
$
$
2003
450,000
127,000
323,000
249,000
74,000
8,000
66,000
19,800
46,200
Liquidity and Efficiency
Current
Ratio
Inventory
Turnover
Days’ Sales
Uncollected
Acid-test
Ratio
Accounts
Receivable
Turnover
Days’ Sales
in Inventory
Total Asset
Turnover
Liquidity
and Efficiency
NORTON CORPORATION
2004
Cash
$
30,000
Accounts receivable, net
Use this information
to calculate the
liquidity and
efficiency ratios for
Norton
Corporation.
Beginning of year
17,000
End of year
20,000
Inventory
Beginning of year
10,000
End of year
12,000
Total current assets
65,000
Total current liabilities
42,000
Total assets
Beginning of year
300,000
End of year
346,390
Revenues
494,000
Cost of sales
140,000
Working Capital
Working capital represents current assets
financed from long-term capital sources
that do not require near-term repayment.
Dec. 31, 2004
Current assets
$
Current liabilities
Working capital
65,000
(42,000)
$
23,000
Current Ratio
Current
Current Assets
=
Ratio
Current Liabilities
Current
=
Ratio
$65,000
= 1.55 : 1
$42,000
This ratio measures the
short-term debt-paying
ability of the company.
Acid-Test Ratio
Quick Assets
Acid-Test =
Current Liabilities
Ratio
Quick assets are Cash, Short-Term Investments,
and Current Receivables.
Acid-Test = $50,000 = 1.19 : 1
$42,000
Ratio
This ratio is like the current
ratio but excludes current assets
such as inventories and prepaid
expenses that may be difficult to
quickly convert into cash.
Accounts Receivable
Turnover
Accounts
Sales on Account
Receivable = Average Accounts Receivable
Turnover
Accounts
$494,000
Receivable = ($17,000 + $20,000) ÷ 2 = 26.7 times
Turnover
This ratio measures how many
times a company converts its
receivables into cash each year.
Inventory Turnover
Inventory
Turnover
Inventory
Turnover
Cost of Goods Sold
=
Average Inventory
$140,000
=
= 12.73 times
($10,000 + $12,000) ÷ 2
This ratio measures the number
of times merchandise
is sold and replaced during the year.
Days’ Sales Uncollected
Days’ Sales
Accounts Receivable
=
´ 365
Uncollected
Net Sales
Days’ Sales
$20,000
=
´ 365 = 14.8 days
Uncollected
$494,000
This ratio measures the liquidity
of receivables.
Days’ Sales in Inventory
Days’ Sales
=
in Inventory
Ending Inventory
Cost of Goods Sold
´ 365
Days’ Sales
$12,000
=
´ 365 = 31.29 days
in Inventory
$140,000
This ratio measures the liquidity
of inventory.
Total Asset Turnover
Total Asset
Net Sales
=
Turnover
Average Total Assets
Total Asset
$494,000
=
= 1.53 times
Turnover
($300,000 + $346,390) ÷ 2
This ratio measures the
efficiency of assets in producing
sales.
Solvency
Debt
Ratio
Equity
Ratio
Solvency
Use this information to calculate the
solvency ratios for Norton Corporation.
NORTON CORPORATION
2004
Net income before interest
expense and income taxes
Interest expense
$
84,000
7,300
Total shareholders' equity
234,390
Total liabilities
112,000
Total assets
346,390
Debt Ratio
Total Liabilities
Debt
=
Ratio
Total Assets
Debt
=
Ratio
$112,000
= 32.3%
$346,390
This ratio measures what portion of a
company’s assets are contributed by
creditors.
Equity Ratio
Total Equity
Equity
=
Ratio
Total Assets
Equity
=
Ratio
$234,390
= 67.7%
$346,390
This ratio measures what portion of a
company’s assets are contributed by
owners.
Profitability
Profit
Margin
Return on
Total Assets
Gross
Margin
Return on
Common
Stockholders’
Equity
Profitability
Use this
information
to calculate
the
profitability
ratios for
Norton
Corporation.
NORTON CORPORATION
2004
Number of common shares
outstanding all year
Net income
27,400
$
53,690
Shareholders' equity
Beginning of year
180,000
End of year
234,390
Revenues
494,000
Cost of sales
140,000
Total assets
Beginning of year
300,000
End of year
346,390
Profit Margin
Profit
=
Margin
Net Income
Net Sales
$53,690
Profit
= 10.87%
=
Margin $494,000
This ratio describes a
company’s ability to earn a net
income from sales.
Gross Margin
Gross Net Sales - Cost of Sales
=
Margin
Net Sales
Gross $494,000 - $140,000
= 71.66%
=
Margin
$494,000
This ratio measures the amount
remaining from $1 in sales that is left
to cover operating expenses and a
profit after considering cost of sales.
Return on Total Assets
Return on =
Net Income
Total Assets
Average Total Assets
Return on
$53,690
=
= 16.61%
Total Assets ($300,000 + $346,390) ÷ 2
This ratio is generally considered
the best overall measure of a
company’s profitability.
DuPont Analysis
Return on =
Net Income
Total Assets
Average Total Assets
=
=
Net Income
Net Sales
Profit Margin
X
X
Net Sales
Average Total Assets
Total Asset Turnover
Return on Common
Stockholders’ Equity
Return on
Common
Net Income - Preferred Dividends
=
Stockholders’
Average Common Stockholders’
Equity
Equity
Return on
$53,690 - 0
Common =
= 25.9%
Stockholders’ ($180,000 + $234,390) ÷ 2
Equity
This measure indicates how well the
company employed the owners’
investments to earn income.
Market Prospects
PriceEarnings
Ratio
Dividend
Yield
Market Prospects
Use this
information
to calculate
the market
ratios for
Norton
Corporation.
NORTON CORPORATION
December 31, 2004
Earnings per Share
Market Price
Annual Dividend per Share
$
1.96
15.00
2.00
Price-Earnings Ratio
Price-Earnings
Market Price Per Share
=
Ratio
Earnings Per Share
Price-Earnings
$15.00
=
= 7.65 times
Ratio
$1.96
This measure is often used by investors as a general
guideline in gauging stock values. Generally, the
higher the price-earnings ratio, the more opportunity
a company has for growth.
Dividend Yield
Dividend
Annual Dividends Per Share
=
Yield
Market Price Per Share
Dividend
$2.00
=
= 13.3%
Yield
$15.00
This ratio identifies the return, in terms of
cash dividends, on the current market
price of the stock.