Chapter
Nine
Financial
Statement
Analysis
© 2015 McGraw-Hill Education.
Factors in Communicating Useful
Information
The primary objective of accounting is to provide
information useful for decision making. To provide
information that supports this objective, accountants must
consider the following:
Users
Types of
Decisions
Information
Analysis
9-2
LO 1
LO 1
Differentiate
between horizontal
and vertical analysis.
9-3
Methods of Analysis
Horizontal Analysis
Percentage Analysis
Vertical Analysis
Ratio Analysis
9-4
Milavec Company Financial
Statements
9-5
Milavec Company
Financial Statements
2015
2014
9-6
Horizontal and Percentage
Analysis
Horizontal analysis (or trend analysis)
refers to studying the behavior of
individual financial statement items over
several accounting periods.
Absolute Amounts
Percentage Analysis
9-7
Milavec Company Horizontal
Analysis
2015
2014
9-8
Vertical Analysis
Vertical analysis uses
percentages to compare
individual components of
financial statements to a key
statement figure. A commonsize financial statement is a
vertical analysis in which
each financial statement item
is expressed as a
percentage.
9-9
Vertical Analysis of Income
Statement
In income
statements, all
items are
usually
expressed as a
percentage of
sales.
9-10
Milavec Company Vertical Analysis
2012
2011
9-11
Vertical Analysis of Balance Sheet
In balance
sheets, all items
are usually
expressed as a
percentage of
total assets.
9-12
2012
2011
9-13
Ratio Analysis
Ratio analysis
involves studying
various
relationships
between different
items reported in a
set of financial
statements.
9-14
LO 1
LO 1
Calculate ratios for
assessing a
company’s liquidity.
9-15
Liquidity Ratios
Liquidity ratios indicate a
company’s ability to pay shortterm debts. They focus on
current assets and current
liabilities.
1. Working Capital
2. Current Ratio
3. Quick Ratio
4. Accounts Receivable Ratios
5. Inventory Ratios
9-16
Working Capital
The excess of current assets
over current liabilities is
known as working capital.
2012
2011
9-17
Current Ratio
Current
Ratio
=
Current Assets
Current Liabilities
The current ratio measures a
company’s short-term debt
paying ability.
A declining ratio may be a
sign of deteriorating
financial condition, or it
might result from eliminating
obsolete inventories.
9-18
Current Ratio
9-19
Quick (Acid-Test) Ratio
AcidTest
=
Ratio
Quick Assets
Current Liabilities
Quick assets include Cash,
Current Marketable Securities, and
Accounts Receivable.
This ratio measures a company’s ability
to meet obligations without having to
liquidate inventory.
9-20
Quick (Acid-Test) Ratio
9-21
Accounts Receivable Turnover
Accounts
Receivable
Turnover
=
Net Credit Sales
Average Accounts
Receivable
This ratio measures how many
times a company converts its
receivables into cash each year.
9-22
Accounts Receivable Turnover
9-23
Average Days to Collect
Receivables
Average
Collection
Period
Average
Collection
Period
=
=
365 Days
Accounts Receivable Turnover
365 Days
16.98 Times
= 21 days
This ratio measures, on average,
how many days it takes to collect
an accounts receivable.
9-24
Inventory Turnover
Inventory
Turnover
=
Cost of Goods Sold
Average Inventory
This ratio measures how many times a
company’s inventory has been sold
and replaced during the year.
9-25
Inventory Turnover
9-26
Average Days to Sell Inventory
Average
Sale Period
Average
=
Sale Period
365 Days
= Inventory Turnover
365 Days
10.80 Times
=
34 days
This ratio measures how many
days, on average, it takes to sell
the inventory.
9-27
LO 3
LO 1
Calculate ratios for
assessing a
company’s solvency.
9-28
Solvency Ratios
Solvency ratios are used to analyze
a company’s long-term debtpaying ability and its financing
structure.
1. Debt to Assets Ratio
2. Debt to Equity Ratio
3. Number of Times Interest Earned
4. Plant Assets to Long-Term Liabilities
9-29
Debt to Assets Ratio
Debt to
Assets
Ratio
=
Total Liabilities
Total Assets
This ratio measures the
percentage of a company’s
assets that are financed by
debt.
9-30
Debt to Equity Ratio
Debt to
Equity
Ratio
=
Total Liabilities
Total Stockholders’ Equity
This ratio indicates the relative
proportions of debt to equity on a
company’s balance sheet.
Stockholders like a lot of
debt if the company can
take advantage of
positive financial
leverage.
Creditors prefer less
debt and more equity
because equity
represents a buffer of
protection.
9-31
Debt to Assets and Debt to
Equity Ratios
9-32
Number of Times
Interest is Earned Ratio
Times
Interest
Earned
=
Earnings before Interest Expense
and Income Taxes
Interest Expense
This is the most common
measure of a company’s ability
to provide protection for its longterm creditors.
9-33
Number of Times Interest Earned
Ratio
9-34
Plant Assets to Long-Term
Liabilities
Plant Assets
to Long-Term
Liabilities
=
Net Plant Assets
Long-Term Liabilities
This ratio suggests how well
long-term debt is managed to
finance long-term assets.
9-35
Plant Assets to Long-Term
Liabilities
9-36
LO 4
LO 1
Calculate ratios for
assessing company
management’s
effectiveness.
9-37
Profitability Ratios
Profitability ratios measure a
company’s ability to generate
earnings.
1. Net Margin (or Return on Sales)
2. Asset Turnover Ratio
3. Return on Investment
4. Return on Equity
9-38
Net Margin
Net =
Margin
Net Income
Net Sales
This measure describes the percent
remaining of each sales dollar after
subtracting other expenses as well as
cost of goods sold.
9-39
Net Margin
9-40
Asset Turnover Ratio
Asset
Turnover
=
Net Sales
Average Total Assets
This ratio measures how many
sales dollars were generated for
each dollar of assets invested.
9-41
Asset Turnover Ratio
9-42
Return on Investment (ROI)
Return on
Investment
Net Income
=
Average Total Assets
This is the ratio of wealth generated
(net income) to the amount invested
(average total assets).
9-43
Return on Investment (ROI)
For Milavec, ROI was as follows.
2012
$25,000 ÷ $481,500* = 5.19%
2011
$22,000 ÷ $437,500* = 5.03%
* The computation of average assets is calculated as
beginning assets plus ending assets divided by 2.
9-44
Return on Equity
Return on
Equity
=
Net Income
Average Total Stockholders’
Equity
This measure is often used to measure
the profitability of the stockholders’
investment.
9-45
Return on Equity
9-46
LO 5
LO 1
Calculate ratios for
assessing a
company’s position
in the stock market.
9-47
Stock Market Ratios
Stock market ratios analyze the
earnings and dividends of a
company.
1. Earnings Per Share
2. Book Value
3. Price-Earnings (PE) Ratio
4. Dividend Yield
9-48
Earnings Per Share
Earnings
per
Share
=
Net Earnings Available for Common Stock
Average Number of Outstanding Common
Shares
This measure indicates how much
income was earned for each share of
common stock outstanding.
9-49
Earnings Per Share
$25,000 (net income) - $3,000 (preferred dividend)
= $1.60 per share
(15,000 + 12,500)/2 (average outstanding common shares)
9-50
Book Value Per Share
Book Value
per Share
Stockholders’ Equity - Preferred Dividends
Outstanding Common Shares
=
This ratio measures the amount that would be
distributed to holders of each share of common
stock if all assets were sold at their balance sheet
carrying amounts and if all creditors were paid off.
9-51
Book Value Per Share
$362,000 - $50,000
15,000
= $20.80 per share
9-52
Price-Earnings Ratio
Price-Earnings =
Ratio
Market Price Per Share
Earnings Per Share
This ratio compares the earnings of a
company to the market price for a share
of the company’s stock.
9-53
Dividend Yield
Dividend
Yield
=
Dividends Per Share
Market Price Per Share
This ratio identifies the return, in terms
of cash dividends, on the current
market price of the stock.
9-54
Limitations of Financial
Statement Analysis
Different
Industries
Changing
Economic
Environment
Accounting
Principles
9-55
End of Chapter Nine
9-56