Accounting 2
ACCT 1110
Financial Statement Analysis
Chapter 14
Careful Analysis of Financial Information can aid Decision Makers
Objectives of Financial Statement of Analysis
Financial statement analysis should provide information that will provide information about:
1.
2.
3.
5.
6.
Liquidity: Ability to pay bills when due and to meet unexpected needs for cash
Profitability: Ability to earn a satisfactory Net Income
Long-Term Solvency: Ability to pay long term debts. Ability to survive for many years.
Market Strength: Ability to maintain a position in the market that will increase the
wealth of the owners.
Risk: Ability to handle unexpected changes in the business environment. Financial risk,
technology risk, market risk
Sources of Financial Information:
1.
Reports Published by the Company
a.
The Financial Statements (Balance Sheet, Income Statement, Cash Flow
Statement, and Statement of Owners Equity.
b.
Narrative information from Management and the Auditors
c.
Comparative Information for a series of years
2.
Industry Comparisons
3.
SEC Reports
4.
Business Periodicals and Investment Services
Tools and Techniques of Financial Analysis
1.
2.
Trend Analysis - In what direction are the numbers headed?
A.
Horizontal Analysis - measuring year to year changes
B.
Vertical Analysis - measuring changes within the components of the
Financial Statements. Analysts frequently use vertical anlaysis to compare
one compnay
Creation and Interpretation of Financial Ratios and Statistics
-2Trend Analysis
Horizontal Analysis: Compute Percentage Changes from year to year.
Percentage Change = Dollar change divided by base year.
Vertical Analysis: - State all items on a financial statement as a percent.
On the Balance sheet each item is a percent of total assets.
On the Income statement each item is a percent of total sales
Income statement: Divide Each Number on the Income Statement by Sales.
Balance Sheet: Divide Each Number on the Balance sheet by Total Assets.
Trend Analysis - An Example
Horizontal Analysis
2011
251,680
127,098
124,582
2010
228,800
116,68
112,112
Dollar
Change
22,880
10,410
12,470
16,359
45,302
10,000
71,661
55,921
16,016
34,320
10,000
60,336
51,776
343
10,982
_____
11,325
1,145
Sales
Cost of Goods Sold
Gross Profit
2011
100.0%
50.5%
50.5%
2010
100.0%
51.0%
49.0%
Operating Expenses
Salaries Expense
Utilities Expense
Depreciation Expense
Total Expenses
Net Income
6.5%
18.0%
4.0%
28.5%
21.0%
7.0%
15.0%
4.4%
26.4%
22.6%
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Salaries Expense
Utilities Expense
Depreciation Expense
Total Expenses
Net Income
Percentage
Change
10.0%
8.9%
11.1%
2.1%
32.0%
_____
18.8%
2.2%
Vertical Analysis
This process could be repeated on the Balance Sheet Divide each component on the Balance
Sheet by Total Assets. Look at the Trends
-3-
Calculating and Using Ratios
Ability to Pay Current Liabilities (Liquidity Ratios)
1.
Current Ratio
Current Assets
Current Liabilities
Measures ability to pay
current liabilities
2.
Quick Ratio
(Acid Test Ratio)
Cash + short term
investments + Receivables
Current Liabilities
Measures ability to pay
to pay current liabilities
with the most liquid assets
Ability to Sell Inventory & Collect Receivables
3.
Inventory
Turnover
Cost of Goods Sold
Average Inventory
Measures how efficiently
inventory is being used
4.
Accounts
Receivable
Turnover
______Net Sales
Average Net Accounts
Receivables
Measures Collectibility of
Receivables
5.
Days Sales
In Receivables
Average Net Receivables
One Day’s Sales*
Measures Collectability of
Receivables
*Note: One days sales = Net sales divided by 365
(if net sales is not available use sales)
Measuring Ability to Pay Long Term Debt
(Debt Ratios also called Risk Ratios)
6.
Debt
Ratio
Total Liabilities
Total Assets
7.
Times-interest
Earned ratio
Ebit
Interest Expense
Measure amount of assets financed
with debt compared to equity. Also
a measure of Financial risk
Measures interest coverage.
Measures risk & safety
Note: Ebit = Earnings before Interest and Taxes.
Note: This formula is slightly different from the text.
This formula replaces what is in the text.
-4Measuring Profitability (Profitability Ratios)
8.
Rate of return
On net sales
Net Income____
Net Sales
9.
Return on total
Net Income + Interest Expense
Assets (ROA)
Average Total Assets
(Often called profit margin)
Measures Profitability.
10.
Return on common Net Income – Preferred Dividends
Stockholder’s equity Average Common Stockholder’s
Equity
Measures Profitability
11.
Earning per
Common Share
Profitability Measure
Net Income - Pfd Dividends
Average Shares of Stock
Outstanding
Measures amount of profit
from each dollar of sales.
Stock Investment Ratios
12.
Price Earning Ratio
Market Price Per Share
Earnings Per Share
Profitability Measure.
Identifies the market price
of $1 of earnings
13.
Dividend Yield
Market Price
Dividends (annualized)
Market Price Per Share
Identifies Cash Flow to
Stockholders as a percentage
of market value
14.
Book Value per
Share common stock
Total Equity – Pfd Equity
Number of common shares
Outstanding
Indicates the recorded
accounting amount of value
per share of stock
-5Helen's House of Cards, Inc.
Comparative Balance Sheets
As of December 31, 2008 & 2007 respectively
(This is the same company we used in Chapter 17)
Assets
2011
Current
Cash
Accounts Receivable
Merchandise Inventory
Supplies
Total Current Assets
$
$
$
$
$
138,750
90,000
78,000
1,000
307,750
Investments
Long Term (Available for Sale) Investments
$
75,000
Property, Plant, & Equipment
Land
Equipment
Less Accumulated Depreciation
Buildings
Less Accumulated Depreciation
Total Property, Plan, & Equipment
Total Assets
$
$
$
$
$
$
$
12,000
112,000
(10,000)
140,000
(28,000)
226,000
608,750
Liabilities & Owner's Equity
Current Liabilities
Accounts Payable
Salaries & Wages Payable
Income Taxes Payable
Interest Payable
Total Current Liabilities
$
$
$
$
$
Long Term Liabilities
Long Term Notes Payable
Owner's Equity
Preferred Stock 4%, 100 Par
Common Stock
Paid in Capital in Excess of Par
Retained Earnings
Total Owner's Equity
Total Liabilities and Owners Equity
2010
$
60,400
$ 110,000
$
58,000
$
1,600
$ 30,000
Increase
(Decrease)
$
$
$
$
$
78,350
20,000)
20,000
(600)
77,750
$
48,000
$
27,000
$
$
$
$
$
$
$
92,000
(36,000)
140,000
(21,000)
175,000
453,000
$
$
$
$
$
$
$
12,000
20,000
26,000
(7,000)
51,000
155,750
110,000
2,800
3,000
4,750
120,550
$
$
$
$
$
82,000
11,200
4,200
1,000
98,400
$
$
$
$
$
28,000
(8,400)
(1,200)
3,750
22,150
$
85,000
$
10,000
$
75,000
$
$
$
$
$
$
100,000
175,000
40,000
88,200
403,200
608,750
$
$
$
$
$
$
100,000
150,000
10,000
84,600
344,600
453,000
$
$
$
$
$
$
-025,000
30,000
3,600
58,600
155,750
-6Helen's House of Cards, Inc.
Income Statement
For the Year Ended December 31, 2011
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Salaries & Wages Expense
Supplies Expense
Rent Expense
Depreciation Expense - Equipment
Depreciation Expense - Buildings
Interest Expense
Miscellaneous Expense
Total Operating Expenses
Operating Income
Other Income & Expense
Loss on Sale of Investments
Gain On Sale of Equipment
Income Before Taxes
Income Taxes
Net Income
$
$
$
$
$
$
$
$
$
$
$
$
500,000
266,000
234,000
$
$
130,500
103,500
$
$
$
$
6,000
109,500
21,900
87,600
62,000
4,650
36,000
4,000
7,000
4,750
12,100
(2,000)
8,000
Additional Information
(1) Land was purchased for Cash in the amount of $12,000
(2) Investments Costing $30,000 were sold for $28,000 resulting in a $2,000 loss.
(3) Investment Costing $57,000 were purchased for Cash.
(4) Equipment Costing $50,000 was purchased for Cash
(5) Fully Depreciated Equipment costing $30,000 was sold for $8,000 resulting in a $8,000 gain.
(6) Dividends Declared and paid amounted to $84,000.
(7) Issued additional Common Stock and received cash proceeds in the amount of $55,000.
(8) Borrowed an $75,000 cash by issuing additional notes payable.
-7Helen's House of Cards
Statement of Cash Flows (Indirect Method)
For the Year Ended December 31, 2011
Cash from Operations
Net Income
87,600
Adjustments to Convert Net Income to Operating Cash Flow
Add Depreciation
Add Loss on Sale Investments
Subtract Gain on Sale of Equipment
Add decrease in accounts receivable
Less increase in inventory
Add decrease in supplies
Add increase in accounts payable
Subtract decrease in wages payable
Subtract decrease in income taxes payable
Add increase in interest payable
Cash from Operations
11,000
2,000
(8,000)
20,000
(20,000)
600
28,000
(8,400)
(1,200)
3,750
Cash used in Investing Activities
Cash from Sale of Investments
Cash used to purchase
Cash used to purchase land
Cash used to purchase equipment
Cash received from sale of equipment
Cash used in investing activities
28,000
(57,000)
(12,000)
(50,000)
8,000
Cash from financing activities
Received cash from issuance of notes payable
Cash received from issuance of common stock
Cash used to pay dividends
Cash from financing activities
75,000
55,000
(84,000)
Increase in Cash
Beginning Cash
Ending Cash
Other significant financing activities
(None in this example)
27,750
115,350
(83,000)
46,000
78,350
60,400
138,750