HOW HEALTHY IS C&C?
C&C’s cash balance has fallen dramatically, and
George Douglas wonders why.
Cedric Renn, a potential employee, wonders if
C&C will be around for the long term.
Meredith Lincoln wonders if she should increase
C&C’s credit limit.
Each can use C&C’s financial statements to help
answer their question.
WHAT IS FINANCIAL STATEMENT ANALYSIS?
Analyzing a firm’s past financial performance
Finding out how a firm measures up against other
firms in the industry
Forecasting future performance
WHY DO FINANCIAL STATEMENT ANALYSIS?
Managers
Stockholders (current AND potential)
Creditors
Customers
Bankers
Employees
Analysts
HORIZONTAL ANALYSIS
Shows the percentage increase or decrease in a
particular line item on the financial statements;
may also be expressed in dollars
Requires two years’ of information to calculate
The earliest year is considered the “base year”
HORIZONTAL ANALYSIS
Current Year Amount – Base Year Amount
Base Year Amount
HORIZONTAL ANALYSIS: SALES REVENUE
12/31/10
Sales revenue
Cost of goods sold
Gross margin
Selling and administrative expenses
Operating income
Interest expense
Income before taxes
Income tax expense
Net income
12/31/09
$ Change
% Change
$5,237,000
$4,654,000
$583,000
12.5%
3,876,432
3,464,440
411,992
11.9%
1,360,568
171,008
14.4%
$5,237,000
-1,178,560
$4,654,000
1,160,566
1,067,721
92,845= 12.5%
8.7%
$4,654,000
200,002
121,839
78,163
64.2%
41,715
43,210
(1,492)
(3.5%)
158,287
78,629
79,658
101.3%
47,486
23,589
23,897
101.3%
55,040
$ 55,761
101.3%
$ 110,801
$
C&C INCOME STATEMENT
12/31/10
Sales revenue
12/31/09
$ Change
% Change
$5,237,000
$4,654,000
$583,000
12.5%
3,876,432
3,464,440
411,992
11.9%
1,360,568
1,178,560
171,008
14.4%
1,160,566
1,067,721
92,845
8.7%
Operating income
200,002
121,839
78,163
64.2%
Interest expense
41,715
43,210
(1,492)
(3.5%)
158,287
78,629
79,658
101.3%
47,486
23,589
23,897
101.3%
55,040
$ 55,761
101.3%
Cost of goods sold
Gross margin
Selling and administrative expenses
Income before taxes
Income tax expense
Net income
$ 110,801
$
Why don’t we add the % change column?
HORIZONTAL ANALYSIS ALLOWS US TO…
Identify trends and changes in
account balances over time
Predict account balances based
on the identified trend
TREND ANALYSIS
Shows account balances as a percentage of the
base year
Can see how account balances are changing over
time
TREND ANALYSIS CALCULATION FOR REVENUE
12/31/10
Sales revenue
Cost of goods sold
Gross margin
Selling and administrative expenses
$583,000
112.5%
3,876,432
3,464,440
411,992
111.9%
1,360,568
1,178,560
1,160,566
Interest expense
Net income
% Change
$4,654,000
200,002
Income tax expense
$ Change
$5,237,000
Operating income
Income before taxes
12/31/09
$5,237,000
171,008
114.4%
= 112.5%
1,067,721
92,845
18.7%
$4,654,000
121,839
78,163
164.2%
41,715
43,210
(1,492)
(13.5%)
158,287
78,629
79,658
201.3%
47,486
23,589
23,897
201.3%
55,040
$ 55,761
201.3%
$ 110,801
$
COMMON-SIZE STATEMENTS
Every line item on the financial statement is
presented as a percentage of a major statement
component
• Total assets for the balance sheet
• Net sales for the income statement
• Also known as vertical analysis
COMMON-SIZE BALANCE SHEET
Account Balance
Total Assets
COMMON SIZE BALANCE SHEET
12/31/10
$
Cash
Accounts receivable, net
Total inventory
Prepaid expenses
Total current assets
Property, plant & equipment
Other assets
Total assets
$
12/31/09
%
7,752
0.42%
623,713
33.34%
$7,752640,372
34.23%
= 0.42%
24,388
1.30%
$1,870,787
$
$
%
22,114
1.23%
583,429
32.46%
547,109
30.44%
8,164
0.46%
1,296,225
69.29%
1,160,816
64.59%
532,858
28.48%
600,647
33.42%
41,704
2.23%
35,812
1.99%
$1,870,787
100.00%
$1,797,275
100.00%
COMMON-SIZE BALANCE SHEET
12/31/10
Cash
0.42%
12/31/10
Accounts payable
Accounts receivable,Notice
net
4.64%
Total inventory
6.68%
Prepaid expenses
33.34%
Other
accrued expenses
that
the Total
Assets
and
34.23% & Stockholders’
Short-term debt
Total Liabilities
1.30%
of LTD
Equity lines
must Current
total maturities
to 100%
23.60%
1.07%
Total current assets
69.29%
Total current liabilities
35.99%
Property, plant & equipment
28.48%
Long-term debt
14.97%
2.23%
Total liabilities
50.96%
100.00%
Common stock
11.23%
Retained earnings
37.81%
Total stockholders’ equity
49.04%
Other assets
Total assets
Total liabilities & equity
100.00%
WHAT DOES THIS MEAN?
12/31/10
Cash
0.42%
12/31/10
Accounts payable
23.60%
Accounts receivable, net
33.34%
Other accrued expenses
4.64%
Total inventory
34.23%
Short-term debt
6.68%
Current maturities of LTD
1.07%
Total current liabilities
35.99%
Retained earnings
37.81%
Total stockholders’ equity
49.04%
Prepaid expenses
1.30%
Total current assets
69.29%
Property, plant & equipment
28.48%
Other assets
Total assets
2.23%
100.00%
33.34% of C&C’s assets
are in the form of
accounts receivable.
23.60%
Long-term
debt
of C&C’s14.97%
capitalization
is provided
Total
liabilities
50.96%
by short-term
creditors.
Common
stock
11.23%
Total liabilities & equity
100.00%
COMMON SIZE INCOME STATEMENT
Account Balance
Net Sales
COMMON SIZE INCOME STATEMENT
12/31/10
Sales revenue
12/31/09
$5,237,000
100.00%
$4,654,000
100.00%
3,876,432
74.02%
3,464,440
74.44%
1,360,568
25.98%
$3,876,432
= 74.02%
Selling and administrative expenses
1,160,566
22.16%
$5,237,000
1,178,560
25.56%
1,067,721
22.94%
Cost of goods sold
Gross margin
Operating income
200,002
3.82%
121,839
2.62%
Interest expense
41,715
0.80%
43,210
0.93%
158,287
3.02%
78,629
1.69%
47,486
0.91%
23,589
0.51%
$ 110,801
2.11%
55,040
1.18%
Income before taxes
Income tax expense
Net income
$
COMMON SIZE INCOME STATEMENT
12/31/10
Sales revenue
12/31/09
100.00%
100.00%
74.02%
74.44%
25.98%
25.56%
22.16%
22.94%
Operating income
3.82%
2.62%
Interest expense
0.80%
0.93%
3.02%
1.69%
0.91%
0.51%
2.11%
1.18%
Cost of goods sold
Gross margin
Selling and administrative expenses
Income before taxes
Income tax expense
Net income
Notice that we start with Net Sales at 100%. If
there had been Gross Sales and then Sales
Returns, Gross Sales would be greater than 100.
WHAT DOES THIS MEAN?
12/31/10
Sales revenue
12/31/09
100.00%
100.00%
74.02%
74.44%
25.98%
25.56%
22.16%
22.94%
Operating income
3.82%
2.62%
Interest expense
0.80%
0.93%
3.02%
1.69%
0.91%
0.51%
2.11%
1.18%
Cost of goods sold
Gross margin
Selling and administrative expenses
Income before taxes
Income tax expense
Net income
This means that for every $1.00
collected in sales revenue, 74.44¢
goes to make C&C’s goods for sale.
COMMON SIZE STATEMENTS ALLOW US TO…
Look at changes in the makeup of the base
component
• Has COGS as a percentage of net sales increased
this year?
Compare companies of different absolute sizes
• Qualcomm vs. Ericsson
Compare a firm to industry averages
RATIO ANALYSIS
A comparison of the relationship between two or
more financial statement items
Reveals symptoms of underlying strengths and
weaknesses
Four major categories
•
•
•
•
Liquidity ratios
Leverage ratios
Profitability ratios
Market measure ratios
RATIO ANALYSIS ALLOWS US TO…
Compare a company with industry averages or
norms (cross-sectional analysis)
Examine changes in a company’s ratios over time
(longitudinal analysis)
Focus further investigations into a company’s
performance (reveals symptoms, not answers)
LIQUIDITY RATIOS
What is liquidity?
• Ability to convert assets into cash within a year or the
length of the business cycle
Why is it important?
• Need to pay bills on time
• Need to take advantage of opportunities
WORKING CAPITAL CALCULATION
Total Current Assets – Total Current Liabilities
Current Assets
12/31/10
Current Liabilities
12/31/10
Cash
$
Accounts payable
$441,602
7,752
Accounts receivable, net
623,713
Other accrued expenses
Total inventory
640,372
Short-term debt
Prepaid expenses
24,388
Total current assets
$1,296,225
Current maturities of LTD
Total current liabilities
$1,296,225 – $673,351 = $622,874
86,749
125,000
20,000
$673,351
CURRENT RATIO CALCULATION
Total Current Assets
Total Current Liabilities
Current Assets
12/31/10
Current Liabilities
12/31/10
Cash
$
Accounts payable
$441,602
7,752
Accounts receivable, net
623,713
Other accrued expenses
Total inventory
640,372
Short-term debt
Prepaid expenses
Total current assets
24,388
$1,296,225
Current maturities of LTD
Total current liabilities
$1,296,225
= 1.93
$673,351
86,749
125,000
20,000
$673,351
CURRENT RATIO – WHAT DOES IT MEAN?
Literally, that C&C has 1.93 times more current
assets than current liabilities
Measures the buffer to cover shrinkage in asset
value in the event of forced liquidation
Measures ability to absorb random business
shocks and uncertain cash flows
Rule of thumb 2:1, but don’t let it get too high; very
industry-sensitive
ACID-TEST RATIO CALCULATION
Cash + Cash Equivalents + A/R
Total Current Liabilities
Current Assets
12/31/10
Current Liabilities
12/31/10
Cash
$
Accounts payable
$441,602
7,752
Accounts receivable, net
623,713
Other accrued expenses
Total inventory
640,372
Short-term debt
Prepaid expenses
Total current assets
24,388
$1,296,225
Current maturities of LTD
Total current liabilities
$7,752 + $623,713
= 0.94
$673,351
86,749
125,000
20,000
$673,351
ACID-TEST RATIO – WHAT DOES IT MEAN?
Literally, C&C has 0.94 times “highly liquid” current
assets as current liabilities
More stringent test than current ratio since it uses
only the most liquid current assets
Rule of thumb is 1:1
CURRENT AND ACID-TEST RATIO LIMITATIONS
Static measures of liquidity
Not useful for predictions of cash flows
No insight into quality of the assets
No insight into timing of cash conversion
ACTIVITY RATIOS
What are they used for?
• To measure how well a company is managing (using)
its assets
• Provides some insight into the quality of the assets
underlying the liquidity ratios
Two areas we’ll study
• Accounts Receivable
• Inventory
A/R TURNOVER CALCULATION
Net Credit Sales
Average A/R
Current Assets
12/31/10
Cash
$
12/31/09
Income Statement
7,752
$22,114
Sales revenue
Accounts receivable, net
623,713
583,429
Cost of goods sold
Total inventory
640,372
547,109
24,388
8,164
$1,296,225
$1,797,275
Prepaid expenses
Total current assets
Gross margin
12/31/10
$5,237,000
3,876,432
1,360,568
$5,237,000
= 8.68 times
($623,713 + $583,429) / 2
WHAT DOES IT MEAN?
A/R Turnover
• Measures how many times receivables are generated
and collected within a year
• Higher turnover means faster collection of cash
AVERAGE COLLECTION PERIOD
365 Days
A/R Turnover
365 days
8.68 times
= 42 days
INVENTORY TURNOVER CALCULATION
Cost of Goods Sold
Average Inventory
Current Assets
12/31/10
Cash
$
12/31/09
Income Statement
7,752
$22,114
Sales revenue
Accounts receivable, net
623,713
583,429
Cost of goods sold
Total inventory
640,372
547,109
24,388
8,164
$1,296,225
$1,160,816
Prepaid expenses
Total current assets
Gross margin
12/31/10
$5,237,000
3,876,432
1,360,568
$3,876,432
= 6.53 times
($640,372 + $547,109) / 2
WHAT DOES IT MEAN?
Inventory Turnover
• Measures how many times inventory is sold within a
year
• Higher turnover means faster sale of inventory and
less likely to have obsolete items, but too high may
indicate stock-out problems
AVERAGE DAYS TO SELL INVENTORY CALCULATION
365 Days
Inventory Turnover
365 days
6.53 times
= 55.9 days
DO YOU UNDERSTAND INVENTORY TURNOVER?
©Thomas Perkins/iStockphoto
Who would you expect to have the highest
inventory turnover? Why?
Ice cream
manufacturer
Airplane
manufacturer
LEVERAGE RATIOS
Longer time-frame of concern than short-term
creditors
Interested in short-term position for payment of
interest
Interested in long-term position for repayment of
loan balance
DEBT RATIO CALCULATION
Total Liabilities
Total Assets
Assets
12/31/10
Total current assets
$1,296,225
Property, plant & equipment, net
Other assets
Total assets
Liabilities
12/31/10
Total current liabilities
$673,351
532,858
Long-term debt
280,000
41,704
Total liabilities
$953,351
$1,870,787
$953,351
= 50.9%
$1,870,787
DEBT-TO-EQUITY RATIO CALCULATION
Total Liabilities
Total Stockholders’ Equity
Liabilities
12/31/10
Total current liabilities
$673,351
Long-term debt
280,000
Total liabilities
953,351
Common stock
210,000
Retained earnings
707,436
Total stockholders’ equity
917,436
Total liabilities & stockholders’ equity
$1,807,787
$953,351
= 1.04
$917,436
WHAT DOES IT MEAN?
Debt-to-Equity Ratio
• At C&C there is $1.04 in debt for every $1 of
stockholder’s equity. Put another way, about 50% of
the asset base is financed through debt, or borrowed
money, while 50% is financed by stockholders’ capital
• The higher the ratio, the greater the risk assumed by
the creditors
THE TIMES-INTEREST-EARNED CALCULATION
Earnings before Interest and Taxes
Interest Expense
Income Statement
Sales revenue
Cost of goods sold
Gross margin
Selling and administrative expenses
12/31/10
$5,237,000
3,876,432
1,360,568
1,160,566
Operating income
200,002
Interest expense
41,715
Income before taxes
Income tax expense
Net income
$200,002
$41,715
158,287
47,486
$ 110,801
= 4.79 times
PROFITABILITY RATIOS
Focuses on returns to the stockholder
GROSS MARGIN CALCULATION
Gross Margin
Net Sales
Income Statement
Sales revenue
Cost of goods sold
Gross margin
Selling and administrative expenses
12/31/10
$5,237,000
3,876,432
1,360,568
1,160,566
Operating income
200,002
Interest expense
41,715
Income before taxes
Income tax expense
Net income
$1,360,568
$5,237,000
158,287
47,486
$ 110,801
= 25.98%
RETURN ON ASSETS CALCULATION
NI + [ Interest Expense × (1 – tax rate) ]
Average Total Assets
Balance Sheet
Total assets
12/31/10
12/31/09
$1,870,787
$1,797,275
Income Statement
12/31/10
Operating income
200,002
Interest expense
41,715
Income before taxes
Income tax expense
Net income
$41,715
$158,287
158,287
47,486
$ 110,801
$110,801 + [ 41,715× (1 –
)]
=7.63%
($1,870,787 + $1,797,275) / 2
RETURN ON COMMON STOCKHOLDER’S EQUITY CALCULATION
NI – Preferred Dividends
Average Common Stockholders’ Equity
Balance Sheet
12/31/10
12/31/09
Common stock
210,000
210,000
Operating income
200,002
Retained earnings
707,436
596,635
Interest expense
41,715
$917,436
$806,635
Total common equity
Income Statement
Income before taxes
12/31/10
158,287
Income tax expense
Net income
47,486
$ 110,801
$110,801 - $0
= 12.85%
($917,436 + $806,635) / 2
MARKET MEASURE RATIOS
Only calculated for publicly traded stocks
EARNINGS PER SHARE CALCULATION
NI – Preferred Dividends
Average Number of Shares Outstanding
$1,486.7 - $0
= $3.07
484.9
PRICE/EARNINGS RATIO CALCULATION
Market Price per Share
Earnings per Share
$66.07
$3.07
= 21.52 times
(Closing market price, 12/31/09)
DIVIDEND PAYOUT RATIO CALCULATION
Dividends per Share
Earnings per Share
$0.98
$3.07
= 32%
SOME THINGS TO REMEMBER…
Ratios are a snapshot
The firm’s choice of accounting principles
influences reported income
Read the footnotes to find unusual items
Contingent liabilities could influence future
earnings
Discontinued operations or extraordinary items
may influence future performance
INDUSTRY CLASSIFICATION
Standard Industrial Classification (SIC) code
• 2329 for C&C
North American Industrial Classification System
(NAICS) code
• 315299 for C&C
SOURCES OF INDUSTRY DATA
Published Industry Analyses
Government Statistics
Industry trade groups
GOVERNMENT DATA EXAMPLE
Value of U.S. Men’s and Boys’ Team Sports Uniform Shipments
Sources: U.S. Census Bureau, Annual Survey of Manufactures
Value of Product Shipments: 2001, 2004, 2006
TRADE ASSOCIATION DATA EXAMPLE
U.S. Participants in Team Baseball, 6 Years of Age or Older,
at Least Once per Year
Sources: SMGA, Sports Participation Topline Report: 2006 Edition; 2007 Sports
and Fitness Participation Report; 2008 Sports and Fitness Participation Report;
2009 Sports and Fitness Participation Report