Chapter 15
Financial Statement
Analysis
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
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Objectives
1. List the basic financial statement
After studying this
analytical procedures.
chapter, you should
2. Apply financial statement analysis to
be able to:
assess the solvency of a business.
3. Apply financial statement analysis to
assess the profitability of a business.
4. Summarize the uses and limitations of
analytical measures.
5. Describe the contents of corporate
annual reports.
Horizontal Analysis
What is horizontal
analysis?
Horizontal Analysis
It’s an analysis of the percentage
increases and decreases of related
items in comparative financial
statements.
Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred 6% stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders’ equity
Total liab. & SE
Balance Sheet
2006
$ 550,000
95,000
444,500
50,000
$1,139,500
2005
$ 533,000
177,500
470,000
50,000
$1,230,500
Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)
—
$ (91,000)
(7.4%)
$ 210,000
100,000
$ 310,000
$ 243,000
200,000
$ 443,000
$ (33,000)
(100,000)
$(133,000)
(13.6%)
(50.0%)
(30.0%)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500
$ 787,500
$1230,500
—
—
$42,000
$42,000
$(91,000)
30.5%
5.3%
(7.4%)
Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred 6% stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders’ equity
Total liab. & SE
Increase (Decrease)
2006
2005
Amount
Percent
$ 550,000 $ 533,000 $ 17,000
3.2%
95,000
177,500
(82,500) (46.5%)
444,500 Analysis:
470,000
(25,500)
(5.4%)
Horizontal
50,000
50,000
—
Difference
$1,139,500
$1,230,500$17,000
$ (91,000)
(7.4%)
Base year (2005) $533,000
= 3.2%
$ 210,000
100,000
$ 310,000
$ 243,000
200,000
$ 443,000
$ (33,000)
(100,000)
$(133,000)
(13.6%)
(50.0%)
(30.0%)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500
$ 787,500
$1230,500
—
—
$42,000
$42,000
$(91,000)
30.5%
5.3%
(7.4%)
Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders’ equity
Total liab. & SE
2006
$ 550,000
95,000
444,500
50,000
$1,139,500
2005
$ 533,000
177,500
470,000
50,000
$1,230,500
Horizontal Analysis:
Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)
—
$ (91,000)
(7.4%)
$ 210,000
$ (33,000) (13.6%)
Difference $ 243,000
$(82,500)
100,000
200,000
(100,000)
(50.0%)
= (46.5%)
Base
year (2005)
$177,500
$ 310,000
$ 443,000
$(133,000) (30.0%)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500
$ 787,500
$1230,500
—
—
$42,000
$42,000
$(91,000)
30.5%
5.3%
(7.4%)
Lincoln Company
Comparative Balance Sheet
December
31, go
2006to
andthe
2005next
Okay,
slideIncrease (Decrease)
2006
2005
Amount
Percent
and calculate
the
Assets
Current assets
$ 550,000
$ 533,000
$ 17,000
3.2%
percentage
change
for
fixed
Long-term investments
95,000
177,500
(82,500) (46.5%)
Fixed assets (net)
444,500
assets. 470,000 (25,500) (5.4%)
Intangible assets
50,000
50,000
—
Total assets
$1,139,500 $1,230,500 $ (91,000)
(7.4%)
Liabilities
Horizontal
Current liabilities
$ 210,000 Analysis:
$ 243,000 $ (33,000) (13.6%)
Long-term liabilities
100,000
200,000
(100,000) (50.0%)
Total liabilities
$Difference
310,000
$ 443,000 ? $(133,000) (30.0%)
= ?
Stockholders’ Equity
Base year (2005)
?
Preferred 6% stock, $100 par $ 150,000
$ 150,000
—
Common stock, $10 par
500,000
500,000
—
Retained earnings
179,500
137,500
$42,000
30.5%
Total stockholders’ equity
$ 829,500
$ 787,500
$42,000
5.3%
Total liab. & SE
$1,139,500 $1230,500
$(91,000)
(7.4%)
Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred 6% stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders’ equity
Total liab. & SE
Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)
—
$ (91,000)
(7.4%)
2006
$ 550,000
95,000
444,500
50,000
$1,139,500
2005
$ 533,000
177,500
470,000
50,000
$1,230,500
$ 210,000
100,000
$ 310,000
$ 243,000
200,000
$ 443,000
$ (33,000)
(100,000)
$(133,000)
(13.6%)
(50.0%)
(30.0%)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500
$ 787,500
$1230,500
—
—
$42,000
$42,000
$(91,000)
30.5%
5.3%
(7.4%)
Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred 6% stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders’ equity
Total liab. & SE
Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)
—
$ (91,000)
(7.4%)
2006
$ 550,000
95,000
444,500
50,000
$1,139,500
2005
$ 533,000
177,500
470,000
50,000
$1,230,500
$ 210,000
100,000
$ 310,000
$ 243,000
200,000
$ 443,000
$ (33,000)
(100,000)
$(133,000)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500
$ 787,500
$1230,500
—
—
$42,000
$42,000
$(91,000)
(5.4%)
(13.6%)
(50.0%)
(30.0%)
30.5%
5.3%
(7.4%)
Lincoln Company
Comparative Income Statement
December 31, 2006 and 2005
Sales
Sales returns
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Operating income
Other income
Other expense
Income before income tax
Income tax
Net income
2006
$1,530,500
32,500
$1,498,000
1,043,000
$ 455,000
$ 191,000
104,000
$ 295,000
$ 160,000
8,500
$ 168,500
6,000
$ 162,500
71,500
$ 91,000
Income Statement
2005
$1,234,000
34,000
$1,200,000
820,000
$ 380,000
$ 147,000
97,400
$ 244,400
$ 135,600
11,000
$ 146,600
12,000
$ 134,600
58,100
$ 76,500
Increase (Decrease)
Amount
Percent
$296,500
24.0%
(1,500)
(4.4%)
$298,000
24.8%
223,000
27.2%
$ 75,000
19.7%
$ 44,000
29.9%
6,600
6.8%
$ 50,600
20.7%
$ 24,400
18.0%
(2,500) (22.7%)
$ 21,900
14.9%
(6,000) (50.0%)
$ 27,900
20.7%
13,400
23.1%
$ 14,500
19.0%
Lincoln Company
Comparative Income Statement
December 31, 2006 and 2005
Increase (Decrease)
2006
2005
Amount
Percent
Sales
$1,530,500 $1,234,000
$296,500
24.0%
24.0%
Sales returns
32,500
34,000
(1,500)
(4.4%)
Net sales
$1,498,000 $1,200,000
$298,000
24.8%
Cost of goods sold
1,043,000
820,000
223,000
27.2%
Gross profit
$ 455,000
$ 380,000
$ 75,000
19.7%
Horizontal Analysis:
Selling expenses
$ 191,000
$ 147,000
$ 44,000
29.9%
Administrative expenses
104,000
Increase
amount 97,400
$296,500 6,600 6.8% Total
operating expenses
$ 295,000
$ 244,400
$ 50,600
= 24.0%20.7%
Base
year (2005)
$1,234,000
Operating income
$ 160,000
$ 135,600
$ 24,400
18.0%
Other income
8,500
11,000
(2,500) (22.7%)
$ 168,500
$ 146,600
$ 21,900
14.9%
Other expense
6,000
12,000
(6,000) (50.0%)
Income before income tax
$ 162,500
$ 134,600
$ 27,900
20.7%
Income tax
71,500
58,100
13,400
23.1%
Net income
$ 91,000
$ 76,500
$ 14,500
19.0%
Lincoln Company
Comparative Income Statement
December 31, 2006 and 2005
Increase (Decrease)
2006
2005
Amount
Percent
Sales
$1,530,500 $1,234,000
$296,500
24.0%
Sales returns
32,500
34,000
(1,500)
(4.4%)
24.8%
Net sales
$1,498,000 $1,200,000
$298,000
Cost of goods sold
1,043,000
820,000
223,000
27.2%
Gross profit
$ 455,000
$ 380,000
$ 75,000
19.7%
Selling expenses
$ 191,000
$ 147,000
$ 44,000
29.9%
Administrative expenses
104,000
97,400
6,600 6.8% Total
operating expenses
$ 295,000
$ 244,400
$ 50,600
20.7%
Horizontal
Analysis:
Operating income
$ 160,000
$ 135,600
$ 24,400
18.0%
Other income
8,500
Increase
amount 11,000
$298,000 (2,500) (22.7%)
= 24.8%14.9%
$ 168,500
$ 146,600
$ 21,900
Base year
(2005) $1,200,000
Other expense
6,000
12,000
(6,000) (50.0%)
Income before income tax
$ 162,500
$ 134,600
$ 27,900
20.7%
Income tax
71,500
58,100
13,400
23.1%
Net income
$ 91,000
$ 76,500
$ 14,500
19.0%
Vertical Analysis
A percentage analysis can be
used to show the relationship of
each component to a total
within a single statement.
Vertical Analysis
The total, or 100% item,
on the balance sheet is
“total assets.”
Lincoln Company
Comparative Balance Sheet
December 31, 2006
Amount Percent
Assets
Current assets
$ 550,000
Long-term investments
95,000
Property, plant, & equip. (net)
444,500
Intangible assets
50,000
Total assets
$1,139,500
Liabilities
Current liabilities
$ 210,000
Long-term liabilities
100,000
Vertical
Analysis:
Total
liabilities
$ 310,000
Stockholders’ Equity
Current assets
$550,000
Preferred stock, 6%, $100 par $ 150,000 =
Totalstock,
assets
Common
$10 par $1,139,500
500,000
Retained earnings
179,500
Total stockholders’ equity
$ 829,500
Total liab. & SE
$1,139,500
Balance
Sheet
December
31, 2005
Amount
Percent
48.3%
8.3
39.0
4.4
100.0%
$ 533,000
177,500
470,000
50,000
$1,230,500
43.3%
14.4
38.2
4.1
100.0%
18.4%
8.8
27.2%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
13.2%
48.3%
$ 150,000
500,000
137,500
$ 787,500
$1,230,500
12.2%
40.6
11.2
64.0%
100.0%
43.9
15.7
72.8%
100.0%
Lincoln Company
Comparative Balance Sheet
December 31, 2006
Amount Percent
December 31, 2005
Amount Percent
Assets
Current assets
$ 550,000
48.3%
$ 533,000 43.3%
43.3%
Long-term investments
95,000
8.3
177,500
14.4
Property, plant, & equip. (net)
444,500
39.0
470,000
38.2
Intangible assets
50,000
4.4
50,000
4.1
Total assets
$1,139,500 100.0%
$1,230,500 100.0%
Liabilities
Current liabilities
$ 210,000
18.4%
$ 243,000
19.7%
Long-term liabilities
100,000
8.8
200,000
16.3
Vertical
Analysis:27.2%
Total liabilities
$ 310,000
$ 443,000
36.0%
Stockholders’ Equity
Current assets
$533,000
Preferred 6% stock, $100 par $ 150,000
13.2%
$ 150,000
12.2%
= 43.3%
$1,230,500500,000
Common stock, $10 par Total assets
500,000
43.9
40.6
Retained earnings
179,500
15.7
137,500
11.2
Total stockholders’ equity
$ 829,500
72.8%
$ 787,500
64.0%
Total liab. & SE
$1,139,500 100.0%
$1,230,500 100.0%
Lincoln Company
Comparative Balance Sheet
December 31, 2006
Amount Percent
Assets
Current assets
Long-term investments
Property, plant, & equip. (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred 6% stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders’ equity
Total liab. & SE
December 31, 2005
Amount Percent
$ 550,000
95,000
444,500
50,000
$1,139,500
48.3%
8.3
39.0
4.4
100.0%
$ 533,000
177,500
470,000
50,000
$1,230,500
43.3%
14.4
38.2
4.1
100.0%
$ 210,000
100,000
$ 310,000
18.4%
8.8
27.2%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
13.2%
43.9
15.7
72.8%
100.0%
$ 150,000
500,000
137,500
$ 787,500
$1,230,500
12.2%
40.6
11.2
64.0%
100.0%
Lincoln Company
Income
Comparative Income Statement
Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount Percent
Amount Percent
Sales
$1,530,500
102.2% $1,234,000 102.8%
Sales returns
32,500
2.2
34,000
2.8
Net sales
$1,498,000
100.0% $1,200,000 100.0%
Cost of goods sold
1,043,000
69.6
820,000 68.3
Gross profit
$ 455,000
30.4% $ 380,000 31.7%
Selling expenses
$ 191,000 Net12.8%
sales $ 147,000 12.3%
Administrative expenses
104,000
6.9
97,400
8.1
Total operating expenses
$ 295,000 is 100.0%
19.7% $ 244,400 20.4%
Income from operations
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3% $ 146,600 12.2%
Other expense
6,000
0.4
12,000
1.0
Income before income tax
$ 162,500
10.9% $ 134,600
11.2%
Income tax expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1% $ 76,500
6.4%
Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount Percent
Amount Percent
Sales
$1,530,500
102.2% $1,234,000 102.8%
Sales returns
32,500
2.2
34,000
2.8
Net sales
$1,498,000
100.0% $1,200,000 100.0%
Cost of goods sold
1,043,000
69.6
820,000 68.3
Gross profit
$ 455,000
30.4% $ 380,000 31.7%
Selling expenses
$ 191,000
12.8% $ 147,000 12.3%
Administrative expenses
104,000
6.9
97,400
8.1
Total operating expenses
$ 295,000
19.7% $ 244,400 20.4%
Income from operations
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
Vertical Analysis:
$ 168,500
11.3% $ 146,600 12.2%
Other expense
0.4
12,000
1.0
Selling expenses $191,0006,000
Income before income tax
$ 162,500= 12.8%
10.9% $ 134,600
11.2%
Nettax
sales
$1,498,000
Income
expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1% $ 76,500
6.4%
Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount Percent
Amount Percent
Sales
$1,530,500
102.2% $1,234,000 102.8%
Sales returns
32,500
2.2
34,000
2.8
Net sales
$1,498,000
100.0% $1,200,000 100.0%
Cost of goods sold
1,043,000
69.6
820,000 68.3
Gross profit
$ 455,000
30.4% $ 380,000 31.7%
Selling expenses
$ 191,000
12.8% $ 147,000 12.3%
Administrative expenses
104,000
6.9
97,400
8.1
Total operating expenses
$ 295,000
19.7% $ 244,400 20.4%
Income from operations
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3% $ 146,600 12.2%
Other expense
6,000
0.4
12,000
1.0
Income before income tax
$ 162,500
10.9% $ 134,600
11.2%
Income tax expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1% $ 76,500
6.4%
Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount Percent
Amount Percent
Sales
$1,530,500
102.2% $1,234,000 102.8%
Sales returns
32,500
2.2
34,000
2.8
Net sales
$1,498,000
100.0% $1,200,000 100.0%
Cost of goods sold
1,043,000
69.6
820,000 68.3
Gross profit
$ 455,000
30.4% $ 380,000 31.7%
Selling expenses
$ 191,000
12.8% $ 147,000 12.3%
Administrative expenses
104,000
6.9
97,400
8.1
Total operating expenses
$ 295,000
19.7% $ 244,400 20.4%
Income from operations
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3% $ 146,600 12.2%
Other expense
6,000
0.4
12,000
1.0
Income before income tax
$ 162,500
10.9% $ 134,600
11.2%
Income tax expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1% $ 76,500
6.4%
Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount Percent
Amount Percent
Sales
$1,530,500
102.2% $1,234,000 102.8%
Sales returns
32,500
2.2
34,000
2.8
Net sales
$1,498,000
100.0% $1,200,000 100.0%
Cost of goods sold
1,043,000
69.6
820,000 68.3
Gross profit
$ 455,000
30.4% $ 380,000 31.7%
Selling expenses
$ 191,000
12.8% $ 147,000 12.3%
Administrative expenses
104,000
6.9
97,400
8.1
Total operating expenses
$ 295,000
19.7% $ 244,400 20.4%
Income from operations
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3% $ 146,600 12.2%
Other expense
6,000
0.4
12,000
1.0
Income before income tax
$ 162,500
10.9% $ 134,600
11.2%
Income tax expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1% $ 76,500
6.4%
Common Size Statements
Vertical analysis with both dollar and
percentage amounts is also useful in
comparing one company with another or
with industry averages. Such
comparisons are easier to make with the
use of common-size statements in
which all items are expressed in
percentages.
Common-Size Income Statement
Solvency Analysis
 Solvency is the ability of a business to meet
its financial obligations (debts) as they are
due.
 Solvency analysis focuses on the ability of
a business to pay or otherwise satisfy its
current and noncurrent liabilities.
 This ability is normally assessed by
examining balance sheet relationships.
Current Position Analysis
Working Capital and Current Ratio
Current assets
Current liabilities
Working capital
Current ratio
2006
$550,000
210,000
$340,000
2.6
2005
$533,000
243,000
$290,000
2.2
Use: To indicate the ability to
meet
Divide
currently maturing obligations.
current
assets by
current
liabilities
Current Position Analysis
Quick Ratio
Quick assets:
Cash
Marketable securities
Accounts receivable (net)
Total
Current liabilities
Quick ratio
2006
2005
$ 90,500
75,000
115,000
$280,500
$210,000
1.3
$ 64,700
60,000
120,000
$244,700
$243,000
1.0
Use: To indicate instant debt-paying ability.
Accounts Receivable Analysis
Accounts Receivable Turnover
Net sales on account
Accounts receivable (net):
Beginning of year
End of year
Total
Average (Total ÷ 2)
2006
$1,498,000
2005
$1,200,000
$ 120,000
115,500
$ 235,000
$ 117,500
$ 140,000
120,000
$ 260,000
$ 130,000
Net sales on account
Average accounts
receivable
Accounts Receivable Analysis
Accounts Receivable Turnover
Net sales on account
Accounts receivable (net):
Beginning of year
End of year
Total
Average
Accounts receivable turnover
2006
$1,498,000
2005
$1,200,000
$ 120,000
115,500
$ 235,000
$ 117,500
12.7
$ 140,000
120,000
$ 260,000
$ 130,000
9.2
Use: To assess the efficiency in collecting
receivables and in the management of credit.
Accounts Receivable Analysis
Number of Days’ Sales in Receivables
2006
Accounts receivable (net),
end of year
Net sales on account
Average daily sales on
account (sales ÷ 365)
2005
$ 115,000
$1,498,000
$ 120,000
$1,200,000
$
$
4,104
Accounts receivable, end of year
Average daily sales on account
3,288
Accounts Receivable Analysis
Number of Days’ Sales in Receivables
2006
Accounts receivable (net),
end of year
Net sales on account
Average daily sales on
account (sales ÷ 365)
Number of days’ sales in
receivables
2005
$ 115,000
$1,498,000
$ 120,000
$1,200,000
$
$
4,104
28.0
3,288
36.5
Use: To assess the efficiency in collecting
receivables and in the management of credit.
Inventory Analysis
Inventory Turnover
Cost of goods sold
Inventories:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Inventory turnover =
2006
$1,043,000
2005
$ 820,000
$ 283,000
264,000
$ 547,000
$ 273,500
$ 311,000
283,000
$ 594,000
$ 297,000
Cost of goods sold
Average inventory
Inventory Analysis
Inventory Turnover
Cost of goods sold
Inventories:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Inventory turnover
2006
$1,043,000
2005
$ 820,000
$ 283,000
264,000
$ 547,000
$ 273,500
3.8
$ 311,000
283,000
$ 594,000
$ 297,000
2.8
Use: To assess the efficiency in the
management of inventory.
Inventory Analysis
Number of Days’ Sales in Inventory
Inventories, end of year
Cost of goods sold
Average daily cost of
goods sold
(COGS ÷ 365)
Number of
Days’ Sales =
in Inventory
2006
$ 264,000
$1,043,000
2005
$283,000
$820,000
$
$
2,858
2,247
Inventories, end of year
Average daily cost of goods sold
Inventory Analysis
Number of Days’ Sales in Inventory
Inventories, end of year
Cost of goods sold
Average daily cost of
goods sold
(COGS ÷ 365)
Number of days’ sales
in inventory
2006
$ 264,000
$1,043,000
2005
$283,000
$820,000
$
$
2,858
92.4
Use: To assess the efficiency in the
management of inventory.
2,247
125.9
Long-Term Creditors
Ratio of Fixed Assets to Long-Term Liabilities
Fixed assets (net)
Long-term liabilities
Ratio of fixed assets to
long-term liabilities
2006
$444,500
$100,000
2005
$470,000
$200,000
4.4
2.4
Use: To indicate the margin of safety
to long-term creditors.
Long-Term Creditors
Ratio of Liabilities to Stockholders’ Equity
Total liabilities
Total stockholders’ equity
Ratio of liabilities to
stockholders’ equity
2006
$310,000
$829,500
2005
$443,000
$787,500
0.37
0.56
Use: To indicate the margin of safety to
creditors.
Long-Term Creditors
Number of Times Interest Charges Earned
Income before income tax
Add interest expense
Amount available for interest
Number of
Times Interest =
Charges Earned
2006
2005
$ 900,000 $ 800,000
300,000
250,000
$1,200,000 $1,050,000
Income before
income tax + interest expense
Interest expense
Long-Term Creditors
Number of Times Interest Charges Earned
Income before income tax
Add interest expense
Amount available for interest
Number of times earned
2006
2005
$ 900,000 $ 800,000
300,000
250,000
$1,200,000 $1,050,000
4.0
Use: To assess the risk to debtholders in
terms of number of times interest
charges were earned.
4.2
Profitability Analysis
 Profitability is the ability of an entity to
earn profits.
 This ability to earn profits depends on the
effectiveness and efficiency of operations
as well as resources available.
 Profitability analysis focuses primarily on
the relationship between operating results
reported in the income statement and
resources reported in the balance sheet.
The Common Stockholder
Ratio of Net Sales to Assets
Net sales
Total assets:
Beginning of year
End of year
Total
Average (Total ÷ 2)
2006
$1,498,000
2005
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
Excludes long-term investments
The Common Stockholder
Ratio of Net Sales to Assets
Net sales
Total assets:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Ratio of net sales to assets
2006
$1,498,000
2005
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
1.4
Use: To assess the effectiveness of
the use of assets.
1.2
The Common Stockholder
Rate Earned on Total Assets
Net income
Plus interest expense
Total
Total assets:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Rate earned on total assets
2006
$ 91,000
6,000
$ 97,000
2005
$ 76,500
12,000
$ 88,500
$1,230,500
1,139,500
$2,370,000
$1,185,000
8.2%
$1,187,500
1,230,500
$2,418,000
$1,209,000
7.3%
Use: To assess the profitability of the assets.
The Common Stockholder
Rate Earned on Stockholders’ Equity
Net income
Stockholders’ equity:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Rate earned on stockholders’
equity
2006
$ 91,000
2005
$ 76,500
$ 787,500
829,500
$1,617,000
$ 808,500
$ 750,000
787,500
$1,537,500
$ 768,750
11.3%
10.0%
Use: To assess the profitability of the
investment by stockholders.
Leverage
11.3%
10.0%
Leverage
3.1%
10%
8.2%
7.3%
Leverage
2.7%
5%
0%
2006
Rate earned
on total
assets
2005
Rate earned on
stockholders’
equity
The Common Stockholder
Rate Earned on Common Stockholders’ Equity
Net income
Less preferred dividends
Remainder—common stock
Common stockholders’ equity:
Beginning of year
End of year
Total
Average (Total ÷ 2)
$
$
2006
91,000
9,000
82,000
$ 637,500
679,500
$1,317,000
$ 658,500
$
$
2005
76,500
9,000
67,500
$ 600,000
637,500
$1,237,500
$ 618,750
The Common Stockholder
Rate Earned on Common Stockholders’ Equity
Net income
Less preferred dividends
Remainder—common stock
Common stockholders’ equity:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Rate earned on common
stockholders’ equity
$
$
2006
91,000
9,000
82,000
$
$
2005
76,500
9,000
67,500
$ 637,500
679,500
$1,317,000
$ 658,500
$ 600,000
637,500
$1,237,500
$ 618,750
12.5%
10.9%
Use: To assess the profitability of the
investment by common stockholders.
The Common Stockholder
Earnings Per Share on Common Stock
Net income
Less preferred dividends
Remainder—common stock
Shares of common stock
Earnings per share on common stock
2006
$ 91,000
9,000
$ 82,000
50,000
$1.64
2005
$ 76,500
9,000
$ 67,500
50,000
$1.35
Use: To assess the profitability of the
investment by common stockholders.
The Common Stockholder
Price-Earnings Ratio
2006
Market price per share of common
$41.00
Earnings per share on common
÷ 1.64
Price-earnings ratio on common stock
25
2005
$27.00
÷ 1.35
20
Use: To indicate future earnings
prospects, based on the relationship
between market value of common
stock and earnings.
Dividends and Earnings Per Share
$2.00
$1.64
Per
share
$1.50
$1.00
$1.35
$0.80
$0.60
$0.50
$0.00
2006
Dividends
2005
Earnings
The Common Stockholder
Dividend Yield on Common Stock
Dividends per share of common
Market price per share of common
Dividend yield on common stock
2006
$ 0.80
÷ 41.00
1.95%
2005
$ 0.60
÷ 27.00
2.22%
Use: To indicate the rate of return to common
stockholders in terms of dividends.
Corporate Annual Reports
In addition to financial statements, the annual
report includes a management discussion analysis
(MDA) and an independent auditors’ report.
The MDA includes an analysis of the results of
operations and discusses management’s
opinion about future performance. It
compares the prior year’s income statement
with the current year’s. It also contains an
analysis of the firm’s financial condition.
Corporate Annual Reports
In addition to financial statements, the annual
report includes a management discussion analysis
(MDA) and an independent auditors’ report.
Before issuing annual statements, all
publicly held corporations are required
to have an independent audit of their
financial statements. The CPAs who
conduct the audit render an opinion as
to the fairness of the statements.
Chapter 15
The End