FINANCIAL STATEMENTS
ANALYSIS
Financial Statement Analysis
Who analyzes financial statements?
– Internal users
i.e., Management, Shareholders, Internal
auditors, Budget Analyst,
– External users
• Examples?
•
Investors, creditors, regulatory agencies & …
•
stock market analysts, Business analysts, Financial
Analyst, Investment Analyst and
•
auditors
Financial Statement Analysis
• What do internal users use it for?
Planning, evaluating and controlling company
operations
• What do external users use it for?
Assessing past performance and current financial
position and making predictions about the future
profitability and solvency of the company as well
as evaluating the effectiveness of management
Financial Statement Analysis
Information is available from
– Published annual reports
•
•
•
•
•
(1)
(2)
(3)
(4)
(5)
Financial statements
Notes to financial statements
Letters to stockholders
Auditor’s report (Independent accountants)
Management’s discussion and analysis
– Reports filed with the government
Taxation Department, SECP.
Financial Statement Analysis
Information is available from
– Other sources
•
•
•
•
(1)
(2)
(3)
(4)
Newspapers (e.g., The News)
Periodicals (e.g. The Economist, Fortune)
Financial information organizations
Other business publications
Methods of
Financial Statement Analysis
• Horizontal Analysis
• Vertical Analysis
• Common-Size Statements
• Trend Percentages
• Ratio Analysis
Horizontal Analysis
Vertical Analysis
Common-Size Statements
Trend Percentages
Ratio Analysis
Horizontal Analysis Example
The management of ABC Company provides you with
comparative balance sheets of the years ended
December 31, 2009 and 2010. Management asks
you to prepare a horizontal analysis on the
information.
ABC CORPORATION
Comparative Balance Sheets
December 31, 2009 and 2010
2010
2009
Assets
Current assets:
Cash
$
12,000
$
23,500
Accounts receivable, net
60,000
40,000
Inventory
80,000
100,000
3,000
1,200
155,000
164,700
40,000
40,000
120,000
85,000
160,000
125,000
Prepaid expenses
Total current assets
Property and equipment:
Land
Buildings and equipment, net
Total property and equipment
Total assets
$
315,000
$
289,700
In
A
Horizontal Analysis Example
Calculating Change in Dollar Amounts
Dollar
Change
=
Current Year
Figure
–
Base Year
Figure
Since we are measuring the amount of the
change between 2010 and 2009, the dollar
amounts for 2009 become the “base” year
figures.
Horizontal Analysis Example
Calculating Change as a Percentage
Percentage
Change
=
Dollar Change
Base Year Figure
×
100%
Horizontal Analysis Example
ABC CORPORATION
Comparative Balance Sheets
December 31, 2010 and 2009
2010
2009
Increase (Decrease)
Amount
%
Assets
Current assets:
Cash
$
12,000 $
23,500 $ (11,500)
Accounts receivable, net
60,000
40,000
Inventory
80,000
100,000
Prepaid expenses
3,000
1,200
Total current assets
155,000
164,700
$12,000
–
$23,500
= $(11,500)
Property and equipment:
Land
40,000
40,000
Buildings and equipment, net
120,000
85,000
Total property and equipment
160,000
125,000
Total assets
$ 315,000 $ 289,700
Horizontal Analysis Example
ABC CORPORATION
Comparative Balance Sheets
December 31, 2010 and 2009
2010
2009
Increase (Decrease)
Amount
%
Assets
Current assets:
Cash
$
12,000 $
23,500 $ (11,500)
(48.9)
Accounts receivable, net
60,000
40,000
Inventory
80,000
100,000
Prepaid expenses
3,000
1,200
Total current assets
155,000
164,700
($11,500
÷
$23,500)
× 100% = 48.9%
Property and equipment:
Land
40,000
40,000
Buildings and equipment, net
120,000
85,000
Total property and equipment
160,000
125,000
Total assets
$ 315,000 $ 289,700
Horizontal Analysis Example
ABC CORPORATION
Comparative Balance Sheets
December 31, 2010 and 2009
Increase (Decrease)
Amount
%
2010
2009
12,000 $
60,000
80,000
3,000
155,000
23,500 $ (11,500)
40,000
20,000
100,000
(20,000)
1,200
1,800
164,700
(9,700)
40,000
120,000
160,000
315,000 $
40,000
85,000
125,000
289,700 $
Assets
Current assets:
Cash
Accounts receivable, net
Inventory
Prepaid expenses
Total current assets
Property and equipment:
Land
Buildings and equipment, net
Total property and equipment
Total assets
$
$
35,000
35,000
25,300
(48.9)
50.0
(20.0)
150.0
(5.9)
0.0
41.2
28.0
8.7
Horizontal Analysis Example
Let’s apply the same
procedures to the
liability and stockholders’
equity sections of the
balance sheet.
ABC CORPORATION
Comparative Balance Sheets
December 31, 2010 and 2009
2010
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable
Notes payable
Total current liabilities
Long-term liabilities:
Bonds payable, 8%
Total liabilities
Stockholders' equity:
Preferred stock
Common stock
Additional paid-in capital
Total paid-in capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
67,000 $
3,000
70,000
2009
Increase (Decrease)
Amount
%
44,000 $
6,000
50,000
23,000
(3,000)
20,000
52.3
(50.0)
40.0
75,000
145,000
80,000
130,000
(5,000)
15,000
(6.3)
11.5
20,000
60,000
10,000
90,000
80,000
170,000
315,000 $
20,000
60,000
10,000
90,000
69,700
159,700
289,700 $
10,300
10,300
25,300
0.0
0.0
0.0
0.0
14.8
6.4
8.7
Horizontal Analysis Example
Now, let’s apply the
procedures to the
income statement.
ABC CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2010 and 2009
Increase (Decrease)
2010
2009
Amount
%
Net sales
$ 520,000 $ 480,000 $ 40,000
8.3
Cost of goods sold
360,000
315,000
45,000
14.3
Gross margin
160,000
165,000
(5,000)
(3.0)
Operating expenses
128,600
126,000
2,600
2.1
Net operating income
31,400
39,000
(7,600)
(19.5)
Interest expense
6,400
7,000
(600)
(8.6)
Net income before taxes
25,000
32,000
(7,000)
(21.9)
Less income taxes (30%)
7,500
9,600
(2,100)
(21.9)
Net income
$ 17,500 $ 22,400 $
(4,900)
(21.9)
ABC CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2010 and 2009
Increase (Decrease)
2010
2009
Amount
%
Net sales
$ 520,000 $ 480,000 $ 40,000
8.3
Cost of goods sold
360,000
315,000
45,000
14.3
Gross margin
160,000
165,000
(5,000)
(3.0)
Operating expenses
128,600
126,000
2,600
2.1
Net operating income
31,400
39,000
(7,600)
(19.5)
Interest expense
6,400
7,000
(600)
(8.6)
Sales increased by
8.3% while
net
Net income before taxes
25,000
32,000
(7,000)
(21.9)
income
decreased
by
21.9%.
Less income taxes (30%)
7,500
9,600
(2,100)
(21.9)
Net income
$ 17,500 $ 22,400 $
(4,900)
(21.9)
There were increases in both cost of goods
sold (14.3%) and operating expenses (2.1%).
These increased costs
than offset the
ABCmore
CORPORATION
Income
increase inComparative
sales, yielding
anStatements
overall
Fordecrease
the Years Ended
in netDecember
income. 31, 2010 and 2009
Net sales
Cost of goods sold
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before taxes
Less income taxes (30%)
Net income
2010
$ 520,000
360,000
160,000
128,600
31,400
6,400
25,000
7,500
$ 17,500
2009
$ 480,000
315,000
165,000
126,000
39,000
7,000
32,000
9,600
$ 22,400
Increase (Decrease)
Amount
%
$ 40,000
8.3
45,000
14.3
(5,000)
(3.0)
2,600
2.1
(7,600)
(19.5)
(600)
(8.6)
(7,000)
(21.9)
(2,100)
(21.9)
$
(4,900)
(21.9)
Vertical Analysis Example
The management of Sample Company asks you to
prepare a vertical analysis for the comparative
balance sheets of the company.
Vertical Analysis Example
Sample Company
Balance Sheet (Assets)
At December 31, 1999 and 1998
% of Total Assets
1999
1998
1999
1998
Cash
$ 82,000
$ 30,000
17%
8%
Accts. Rec.
120,000
100,000
25%
26%
Inventory
87,000
82,000
18%
21%
Land
101,000
90,000
21%
23%
Equipment
110,000
100,000
23%
26%
Accum. Depr.
(17,000)
(15,000)
-4%
-4%
Total
$ 483,000
$ 387,000
100%
100%
Vertical Analysis Example
Sample Company
Balance Sheet (Assets)
At December 31, 1999 and 1998
% of Total Assets
1999
1998
1999
1998
Cash
$ 82,000
$ 30,000
17%
8%
Accts. Rec.
120,000
100,000
25%
26%
Inventory
87,000
82,000
18%
21%
$82,000 ÷ $483,000 = 17% rounded
Land
101,000
90,000
21%
23%
$30,000110,000
÷ $387,000 100,000
= 8% rounded
Equipment
23%
26%
Accum. Depr.
(17,000)
(15,000)
-4%
-4%
Total
$ 483,000
$ 387,000
100%
100%
Vertical Analysis Example
Sample Company
Balance Sheet (Liabilities & Stockholders' Equity)
At December 31, 1999 and 1998
% of Total Assets
1999
1998
1999
1998
Acts. Payable
$ 76,000
$ 60,000
16%
16%
Wages Payable
33,000
17,000
7%
4%
Notes Payable
50,000
10%
13%
$76,000 ÷ $483,000
= 50,000
16% rounded
Common Stock
170,000
160,000
35%
41%
Retained Earnings
154,000
100,000
32%
26%
Total
$ 483,000
$ 387,000
100%
100%
Trend Percentages Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a trend
analysis.
1999
Revenues $ 2,405
Expenses
2,033
Net income $
372
Wheeler, Inc.
Operating Data
1998
1997
$ 2,244
$ 2,112
1,966
1,870
$
278
$
242
1996
$ 1,991
1,803
$
188
1995
$ 1,820
1,701
$
119
Trend Percentages Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a trend
analysis.
1999
Revenues $ 2,405
Expenses
2,033
Net income $
372
Wheeler, Inc.
Operating Data
1998
1997
$ 2,244
$ 2,112
1,966
1,870
$
278
$
242
1996
$ 1,991
1,803
$
188
1995
$ 1,820
1,701
$
119
$1,991 - $1,820 = $171
Trend Percentages Example
Using 1995 as the base year, we develop the
following percentage relationships.
Revenues
Expenses
Net income
1999
132%
120%
313%
Wheeler, Inc.
Operating Data
1998
1997
123%
116%
116%
110%
234%
203%
1996
109%
106%
158%
1995
100%
100%
100%
$1,991 - $1,820 = $171
$171 ÷ $1,820 = 9% rounded
140
Trend line
for Sales
% of 100 Base
130
120
110
100
90
Sales
Expenses
1995
1996
1997
Years
1998
1999
Ratios
Ratios can be expressed in three different ways:
1. Ratio (e.g., current ratio of 2:1)
2. % (e.g., profit margin of 2%)
3. $ (e.g., EPS of $2.25)
“Using ratios and percentages without considering
the underlying leads to incorrect conclusions.”
Categories of Ratios
• Liquidity Ratios
Indicate a company’s short-term
debt-paying ability
• Equity (Long-Term Solvency) Ratios
Show relationship between debt and equity
financing in a company
• Profitability Tests
Relate income to other variables
• Market Tests
Help assess relative merits of stocks in the
marketplace
Important Considerations
• Need for comparable data
– Data is provided by different companies.
– Must compare by industry

Influence of external factors
General business conditions
 Seasonal nature of business operations


Impact of inflation