Chapter 13
Measuring and Evaluating
Financial Performance
PowerPoint Authors:
Brandy Mackintosh
Lindsay Heiser
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 13-1
Describe the purpose and
uses of horizontal, vertical,
and ratio analyses.
13-2
Horizontal, Vertical, and Ratio
Analyses
Horizontal (trend) analyses are conducted to help financial statement
users recognize important financial changes that unfold over time.
12/31/12
Gross Profit in 2012
Trend Analysis
12/31/13
Gross Profit in 2013
Δ in Gross Profit $
and/or % from 2012
Vertical analyses focus on important relationships between items on the
same financial statement.
2013
Amount
Sales
Cost of Goods Sold
Gross Profit
13-3
$200,000
150,000
$ 50,000
Percent
100%
75%
25%
Horizontal, Vertical, and Ratio
Analyses
Ratio analyses are conducted to understand relationships among various
items reported in one or more of the financial statements.
Receivable
Turnover
Ratio
=
Net Sales Revenue
Average Net Receivables
It is essential to understand that no analysis is complete unless it leads
to an interpretation that helps financial statement users understand and
evaluate a company’s financial results
13-4
Learning Objective 13-2
Use horizontal (trend) analysis
to recognize financial changes
that unfold over time.
13-5
Horizontal (Trend) Computations
Trend analyses are usually calculated in terms of
year-to-year dollar and percentage changes.
Let’s look at an example
13-6
Horizontal (Trend) Computations
$48,815 – $47,220
× 100
$47,220
Now let’s calculate the percentage
Calculate
Now
Can
let’s
youlook
the
calculate
change
at the remainder
the
in dollars
dollar and
for
of the
Net
change in Net Sales Revenue between
Sales
trend
percentage
analysis
Revenue
change
ofbetween
the Income
for Cost
2010
Statement.
ofand
Sales?
2009.
2009 and 2008.
13-7
Learning Objective 13-3
Use vertical (common size)
analysis to understand
important relationships within
financial statements.
13-8
Vertical (Common Size) Computations
Vertical, or common size, analysis focuses on
important relationships within financial statements.
Income Statement
Sales = 100%
Balance Sheet
Total Assets = 100%
Cost of Sales
× 100
Net Sales Revenue
13-9
Learning Objective 13-4
Calculate financial ratios to
assess profitability, liquidity,
and solvency.
13-10
Ratio Computations
Ratio analysis compares the amounts for one or more line
items to the amounts for other line items in the same year.
Ratios are classified into three categories . . .
Solvency ratios
examine a company’s
ability to pay
interest and repay
debt when due.
Profitability ratios
examine a company’s
ability to generate
income.
Liquidity ratios
help us determine if a
company has sufficient
current assets to repay
liabilities when due.
13-11
Common Profitability Ratios
13-12
Common Liquidity Ratios
13-13
Common Solvency Ratios
13-14
Learning Objective 13-5
Interpret the results of
financial analyses.
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Interpreting Horizontal and Vertical
Analyses
Lowe’s began relying more on debt and
less equity financing. Long-term
liabilities increased 28.7 percent and
stockholders’ equity decreased by 5%.
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Lowe’s assets
grew only by
2.1% in fiscal
2010.
Interpreting Horizontal and Vertical
Cost of sales and operating expenses
Analyses are the most important determinants of
the company’s profitability.
The increase in Net
Income in fiscal 2010
is explained by the
increase in Net Sales
Revenue and the
decreases in Cost of
Sales and Operating
Expenses as a
percentage of sales.
13-17
Interpreting Horizontal and Vertical
Analyses
Lowe’s has experienced a small
Lowe’s did a better job of
controlling its Operating
Expenses between 2009
and 2010.
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decrease in its percentage of Cost of
Sales in relation to Sales Revenue from
fiscal 2009 to 2010. Decreasing cost of
sales means higher Gross Profit.
Ratio
Calculations
13-19
Ratio Calculations
13-20
Profitability Ratios
Net Profit Margin – The slowly improving economy helped boost
Lowe’s profits in 2010 as shown by the increase in Net Profit
Margin.
Gross Profit Percentage – Lowe’s gross profit percentage indicates
how much profit was made on each dollar of sales after deducting
the Cost of Goods Sold.
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Profitability Ratios
Asset Turnover Ratio – indicates the amount of sales revenue
generated for each dollar invested in assets during the period.
Fixed Asset Turnover – indicates how much revenue the company
generates in sales for each dollar invested in fixed assets,
Home Depot 2010 fixed asset turnover ratio was 2.69
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Profitability Ratios
Return on Equity (ROE) – Compares the amount of net income to
average stockholders’ equity. ROE reports the net amount earned
during the period as a percentage of each dollar contributed by
stockholders and retained in the business.
Earnings Per Share (EPS) – Shows the amount of earnings
generated for each share of outstanding common stock.
13-23
Profitability Ratios
Price /Earnings (P/E) Ratio – Shows the relationship between EPS
and the market price of one share of the company’s stock.
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Liquidity Ratios
Let’s change our attention to an examination of liquidity
ratios. The analyses in this section focus on the
company’s ability to survive in the short term, by
converting assets to cash that can be used to pay current
liabilities as they come due.
Receivable Turnover Ratio – Most retail home improvement
companies have low levels of accounts receivable relative to sales
revenue because they collect the majority of their sales
immediately in cash.
Receivable
Turnover
Ratio
13-25
=
Net Sales Revenue
Average Net Receivables
Liquidity Ratios
Inventory Turnover Ratio – The inventory turnover ratio indicates how
frequently inventory is bought and sold. The “days to sell” indicates the
average number of days needed to sell each purchase of inventory.
Home Depot sells its inventory in an average of 85 days in 2010.
Current Ratio – The current ratio measures the company’s ability to
pay its current liabilities
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Liquidity Ratios
Quick Ratio – The quick ratio is a much more stringent test of
short-term liquidity than is the current ratio. Lowe’s quick ratio
increased slightly in 2010, just as its current ratio did.
Referred to as “quick assets.”
Let’s examine some Solvency Ratios
Solvency ratios focus on a company’s ability to survive over the long
term, that is, its ability to repay debt at maturity and pay interest prior to
that time.
13-27
Solvency Ratios
Debt to Assets Ratio – indicates the proportion of total assets that
creditors finance.
In 2010, The Home Depot had a debt-to-assets ratio of 53 percent.
Times Interest Earned – indicates how many times the company’s
interest expense was covered by its operating results.
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Learning Objective 13-6
Describe how analyses
depend on key accounting
decisions and concepts.
13-29
Underlying Accounting Decisions
and Concepts
Accounting Decisions
Difference in Strategies,
e.g. type of financing.
Difference in Operations,
e.g. quality of items sold.
Difference in Accounting
Methods, e.g. FIFO vs. LIFO.
13-30
Accounting Concepts
Companies may elect to use any acceptable generally
accepted accounting principle (GAAP) as long as they
apply the principle consistently.
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Conceptual Framework for Financial
Accounting and Reporting
13-32
Factors Contributing to Going-Concern
Problems
Factors that commonly contribute to
going-concern problems are listed below.
13-33
Chapter 13
Supplement 13A
Nonrecurring and Other Special
Items
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Nonrecurring Items




13-35
Extraordinary Items
Very few events qualify as
extraordinary items.
Cumulative Effect of Changes in
Accounting Methods
Direct adjustment to Retained Earnings rather
than income reporting.
Discontinued Operations
For discontinued component two items are reported:
1. Operating income prior to the date of disposal.
2. Gain or loss on sale or disposal of net assets.
Nonrecurring Items
NONRECURING ITEM
Discontinued Operations.
13-36
Other Special Items
Comprehensive Income includes:
1. Gains or losses from certain foreign currency
exchange rate changes.
2. Gains or losses resulting from the change in value
of certain types of investments.
Excluded from net income
because they are likely to
disappear before they are
ever realized.
13-37
Chapter 13
Supplement 13B
Reviewing and
Contrasting IFRS and
GAAP
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview
At a basic level both IFRS and GAAP are concerned with
accounting rules that describe
1) when an item should be recognized in the accounting
system,
2) how that item should be classified (asset , liability, equity,
expense, or revenue), and
3) the amount at which each item should be measured.
IFRS
13-39
Yes
Report fixed assets at
fair value.
No
GAAP
Chapter 13
Solved Exercises
M13-1, M13-2, M13-6, E13-1, E13-3,
E13-4, E13-10, E13-13
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
M13-1 Calculations for Horizontal Analyses
Using the following income statements, perform the calculations
needed for horizontal analyses. Round percentages to one decimal
place.
13-41
M13-1 Calculations for Horizontal Analyses
($100,000 – $75,000)
× 100 = 33.3%
$75,000
13-42
M13-2 Calculations for Vertical Analyses
Refer to M13-1 . Perform the calculations needed for vertical analyses.
Round percentages to one decimal place.
$21,000
$100,000
13-43
× 100 = 21.0%
M13-6 Inferring Financial Information Using Gross Profit
Percentage and Year-over-Year Comparisons
A consumer products company reported a 25 percent increase in sales
from 2012 to 2013. Sales in 2012 were $200,000. In 2013, the company
reported Cost of Goods Sold in the amount of $150,000. What was the
gross profit percentage in 2013? Round to one decimal place.
Sales ($200,000 x 1.25)
Cost of Goods Sold (given)
Gross Profit
$250,000
(150,000)
$100,000
100.0%
-60.0%
40.0%
$100,000
× 100 = 40.0%
$250,000
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End of Chapter 13
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