Accounting 2
Lecture no 2
Prepared by:
Jan Hájek
COMMONLY USED
ABBREVIATION
EAT – Earnings after taxes
EBT – Earnings before taxes
EBIT – Earnings before interest
EBITD – Earnings before interest, taxes, depreciation
EBITDA – Earnings before interest, taxes, depreciation,
amortization
PURPOSE OF FINANCIAL
ANALYSIS
Financial measures are often used
to rank corporate performance.
Example measures include:
Growth
in sales
Return to
stockholders
Profit
margins
Determined by
analyzing the
financial
statements.
Return on
equity
FINANCIAL STATEMENTS CAN BE
USED FOR:
Classified
Financial
Statements
Comparative
Financial
Statements
Consolidated
Financial
Statements
Items with certain
characteristics are
grouped together.
Amounts from
several years
appear side by side.
Information for the
parent and subsidiary
are presented.
Results
in standardized,
meaningful
subtotals.
Helps identify
significant
changes and
trends.
Presented as if
the two companies
are a single
business unit.
BASICS OF FINANCIAL
STATEMENT ANALYSIS

Analysing financial statements involves
evaluating three characteristics of a
company:
1. its liquidity
2. its profitability
3. its solvency
COMPARATIVE ANALYSIS

Three types of
comparisons:
 Intracompany basis
 Intercompany basis
 Industry averages
http://biz.yahoo.com/p/sum_conameu.html
COMPARATIVE ANALYSIS

Three tools:
 Horizontal analysis
 Vertical analysis
 Ratio analysis
HORIZONTAL ANALYSIS
Dollar Change:
Dollar
Change
=
Analysis Period
Amount
–
Base Period
Amount
Percentage Change:
Percent
Change
=
Dollar Change
÷
Base Period
Amount
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2003
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 one decimal point.
2002
Dollar
Change
Percent
Change*
$ 23,500 $
40,000
100,000
1,200
$ 164,700
(11,500)
20,000
(20,000)
1,800
(9,700)
-48.9%
50.0%
-20.0%
150.0%
-5.9%
40,000
85,000
$ 125,000
$ 289,700 $
35,000
35,000
25,300
0.0%
41.2%
28.0%
8.7%
TREND ANALYSIS
Trend
Analysis
Amount
Trend analysis
is usedPeriod
to reveal
patterns in data
=
100%
×
periods.
Percent covering
Basesuccessive
Period Amount
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
2003
$ 400,000
285,000
115,000
2002
$ 355,000
250,000
105,000
2001
$ 320,000
225,000
95,000
2000
$ 290,000
198,000
92,000
2003
2002
2001
2000
145% is the
129%
116%
105%
1999
base period
so
150%
132%
118%
104%
its135%
amounts
will equal
124%
112% 100%.
108%
(290,000  275,000) 
(198,000  190,000) 
(92,000  85,000)

100% = 105%
100% = 104%
100% = 108%
1999
$ 275,000
190,000
85,000
1999
100%
100%
100%
VERTICAL ANALYSIS
 Expresses
each item in a financial
statement as a percent of a base amount
(total assets or net sales)
Component
Percent
=
Analysis Amount
Base Amount
×
100%
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2003
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.
2002
13-13
Common-size
Percents*
2003
2002
$ 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 Balance Sheets
December 31,
Complete the common-size analysis for the liabilities and equity
accounts.
2003
2002
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable
$ 67,000 $ 44,000
Notes payable
3,000
6,000
Total current liabilities
$ 70,000 $ 50,000
Long-term liabilities:
Bonds payable, 8%
75,000
80,000
Total liabilities
$ 145,000 $ 130,000
Shareholders' equity:
Preferred stock
20,000
20,000
Common stock
60,000
60,000
Additional paid-in capital
10,000
10,000
Total paid-in capital
$ 90,000 $ 90,000
Retained earnings
80,000
69,700
Total shareholders' equity
$ 170,000 $ 159,700
Total liabilities and shareholders' equity
$ 315,000 $ 289,700
* Percent rounded to first decimal point.
13-14
Common-size
Percents*
2003
2002
21.3%
1.0%
22.2%
15.2%
2.1%
17.3%
23.8%
46.0%
27.6%
44.9%
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%
RATIO ANALYSIS
Liquidity Ratios
Measure short-term ability
of the enterprise to pay its
maturing obligations and to
meet unexpected needs for
cash.
Profitability Ratios
Revenues
-
Expenses
Since 1892
=
Net
Income
Measure the income or
operating success of an
enterprise for a given period
of time.
Solvency Ratios
XYZ
Co.
Measure the ability of the
enterprise to survive over a
long period of time.
LIQUIDITY RATIOS
 Current
ratio
 Acid test ratio
 Cash current debt coverage ratio
 Receivables turnover
 Collection period
 Inventory turnover
 Days sales in inventory
CURRENT RATIO

Measures short-term debt-paying
ability
Current
ratio
=
Current assets
Current liabilities
ACID TEST RATIO

Measures immediate short-term
debt-paying ability
Acid test Cash + temporary investments + net recievables
=
Current liabilities
ratio
CASH CURRENT DEBT
COVERAGE RATIO

Measures immediate short-term
debt-paying ability
Debt
coverage
ratio
=
Cash provided by operating activities
Average current liabilities
RECEIVABLES TURNOVER

Measures liquidity of receivables
Recievables
turnover
=
Net credit sales
Average net
recievables
COLLECTION PERIOD

Measures number of days
receivables are outstanding
Collection
period
=
365 days
Recievables
turnover
INVENTORY TURNOVER

Measures liquidity of inventory
Inventory
turnover
=
Cost of goods sold
Average inventory
DAYS SALES IN INVENTORY

Measures number of days inventory
is on hand
Days in
inventory
=
365 days
Inventory turnover
PROFITABILITY RATIOS
 Profit
margin
 Gross profit margin
 Cash return on sales
 Asset turnover
 Return on assets
 Return on common
shareholders’ equity
 Book
value per share
 Cash flow per share
 Earnings per share
(EPS)
 Price-earnings (PE)
ratio
 Payout ratio
 Dividend yield
PROFIT MARGIN

Measures net income generated by
each dollar of sales
Profit
margin
=
Net income
Net sales
GROSS PROFIT MARGIN

Measures margin between selling
price and cost of goods sold
generated by each dollar of sales
Gross profit
margin
=
Gross profit
Net sales
CASH RETURN ON SALES

Measures net cash flow generated by
each dollar of sales
Cash return
on sales
=
Net cash provided by
operating activities
Net sales
ASSET TURNOVER

Measures how efficiently assets are
used to generate sales
Asset
turnover
=
Net sales
Average total
assets
RETURN ON ASSETS

Measures overall profitability of
assets
Return on
assets
=
Net income
Average total
assets
RETURN ON COMMON
SHAREHOLDERS’ EQUITY

Measures profitability of common
shareholders’ investment
Return on common
shareholders‘ =
equity
Net income
Average common
Shareholders‘ equity
BOOK VALUE PER SHARE

Measures the equity (net assets) per
common share
Book value
per share
=
Common shareholders‘
equity
Number of common shares
CASH FLOW PER SHARE

Measures the net cash flow per
common share
Cash flow
per share
=
Net cash provided by
all activities
Average common
Shareholders‘ equity
EARNINGS PER SHARE (EPS)

Measures net income earned on
each common share
Earnings
per share
Net income
=
Number of common
shares
PRICE-EARNINGS (PE) RATIO

Measures relationship between
market price per share and earnings
per share
Price-earnings
ratio
Share price
=
Earnings per share
PAYOUT RATIO

Measures % of earnings distributed
in the form of cash dividends
Payout
ratio
Cash dividends
=
Net income
DIVIDEND YIELD

Measures rate of return earned from
dividends
Dividend
yield
=
Cash dividends per
share
Share price
SOLVENCY RATIOS
Debt to total assets
 Interest coverage
 Cash interest coverage
 Cash total debt coverage

DEBT TO TOTAL ASSETS/
FINANCIAL LEVERAGE

Measures % of total assets provided
by creditors
Debt total
assets
Financial
leverage
Total liabilities
=
Total assets
Total assets
=
Shareholders‘ equity
INTEREST COVERAGE

Measures ability to meet interest
payments as they come due
Interest
coverage
EBIT
=
Interest Expense
CASH INTEREST COVERAGE

Measures cash available to meet
interest payments as they come due
(cash basis)
Cash interest
coverage
EBITDA
=
Interest expense
CASH TOTAL DEBT COVERAGE

Measures long-term debt-paying
ability (cash basis)
Cash total
debt coverage
ratio
=
Net cash provided by
operating activity
Average total liabilities
LIMITATIONS OF FINANCIAL
ANALYSIS
Estimates
 Historical cost
 Alternative
accounting
methods
 Atypical data
 Diversification
