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Contemporary Mathematics FOR BUSINESS AND CONSUMERS Brechner
Financial Statements and
Ratios
PowerPoint Presentation by Domenic Tavella, MBA
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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PERFORMANCE OBJECTIVES
Section I The Balance Sheet
15-1: Preparing a balance sheet
15-2: Preparing a vertical analysis of a balance sheet
15-3: Preparing a horizontal analysis of a balance
sheet
Section II The Income Statement
15-4: Preparing an income statement
15-5: Preparing a vertical analysis of an income
statement
15-6: Preparing a horizontal analysis of an income
statement
Section III Financial Ratios and Trend Analysis
15-7: Calculating financial ratios
15-8: Preparing a tend analysis of financial data
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet
financial statements
• A series of accounting reports summarizing a
company’s financial data compiled from business
activity over a period of time. The four most common
are the balance sheet, the income statement, the
owner’s equity statement, and the cash flow
statement.
financial analysis
• The assessment of a company’s past, present, and
anticipated future financial condition based on the
information found on the financial statements.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet
continued
balance sheet
• A financial statement illustrating the financial position
of a company in terms of assets, liabilities, and
owner’s equity as of a certain date.
financial position
• The economic resources owned by a company and
the claims against those resources at a specific point
in time.
creditor
• One to whom money is owed.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet
continued
liabilities
• Debts or obligations of a business resulting from past
transactions that require the company to pay money,
provide goods, or perform services in the future.
owner’s equity
• The resources claimed by the owner against the
assets of a business:
• Owner’s equity = Assets - Liabilities
• Also called proprietorship, capital, or net worth.
assets
• Economic resources, such as cash, inventories, and
land, buildings, and equipment owned by a business.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet
continued
accounting equation
• Algebraic expression of a company’s financial
position:
Assets = Liabilities + Owner’s equity.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Preparing a Balance Sheet
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Preparing a Balance Sheet
continued
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a publicly accessible website, in whole or in part.
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Balance Sheet Components
Assets
• Current Assets: convertible to cash within 1 year
• Cash, marketable securities, accounts receivable, notes
receivable, prepaid expenses, supplies, inventory
• Property, Plant, and Equipment
• Fixed or long term assets
• Land, buildings, machinery, and equipment
• Investments and Other Assets
• Investments, other assets, intangibles
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet Components
continued
Liabilities
• Current liabilities: due within 1 year
• Accounts payable, notes payable, salaries payable, taxes
payable
• Long-Term Liabilities: due in 1 year or more
• Mortgage payable, debenture bonds
Equity: net worth
• Owner’s equity
• Stockholder’s equity:
• Capital stock
• Retained earnings
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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STEPS
TO PREPARE A BALANCE SHEET
STEP 1
Centered at the top of the page, write the company name, type of statement,
and date.
STEP 2
In the section labeled ASSETS, list and total all of the Current Assets;
Property, Plant, and Equipment; and Investments and Other Assets.
STEP 3
Add the three components of the Assets section to get Total Assets.
STEP 4
Double-underline Total Assets.
STEP 5
In a section labeled LIABILITIES AND OWNER’S EQUITY, list and total all
Current Liabilities and Long-Term Liabilities.
STEP 6
Add the two components of the Liabilities section to get Total Liabilities.
STEP 7
List and total the Owner’s or Stockholders’ Equity.
STEP 8
Add the Total Liabilities and Owner’s Equity.
STEP 9
Double-underline Total Liabilities and Owner’s Equity.
Note: In accordance with the accounting equation, check to be sure that
Assets = Liabilities + Owner’s Equity
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet Preparation
Example
Prepare a balance sheet as of December 31,
2014, for The Music Note, a sole
proprietorship of Anthony Sullivan, using the
following information:
• Current assets, $132,500
• Property, plant, and equipment, $88,760
• Investments and other assets, $32,400
• Current liabilities, $51,150
• Long term liabilities, $87,760
• Capital, $114,750
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Balance Sheet Preparation
Example
continued
Assets:
Current Assets
Total Current Assets
Property, Plant, and Equipment
Total Property, Plant and Equipment
Investments and Other Assets
Total Investments and Other Assets
Total Assets
$132,500
132,500
88,760
88,760
32,400
32,400
$253,660
Liabilities and Owner’s Equity
Current liabilities
Total current liabilities
51,150
Long-term liabilities
Total long-term liabilities
Total liabilities
Owner’s Equity
Capital (Anthony Sullivan)
Total Owner’s Equity
Total Liabilities and Owner’s Equity
87,760
$ 51,150
87,760
138,910
114,750
114,750
$253,660
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Vertical Analysis of a Balance
Sheet
vertical analysis
• A percentage method of analyzing financial
statements whereby each item on the statement is
expressed as a percent of a base amount. On
balance sheet analysis, the base is total assets; on
income statement analysis, the base is net sales.
common-size balance sheet
• A special form of balance sheet that lists only the
vertical analysis percentages, not the dollar figures.
All items are expressed as a percent of total assets.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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STEPS
TO PREPARE A VERTICAL ANALYSIS OF A
BALANCE SHEET
STEP 1 Use the percentage formula, Rate = Portion ÷ Base,
to find the percentage of each item on the balance
sheet. Use each item as the portion and total assets as
the base.
STEP 2 Round each answer to the nearest tenth of a percent.
Note: A 0.1% differential may sometimes occur due
to rounding.
STEP 3 List the percent of each balance sheet item in a
column to the right of the monetary amount.
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a publicly accessible website, in whole or in part.
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Vertical Analysis Example
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a publicly accessible website, in whole or in part.
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Vertical Analysis Example
continued
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a publicly accessible website, in whole or in part.
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Horizontal Analysis of a Balance
Sheet
comparative balance sheet
• Balance sheet prepared with the data from the
current year or operating period side-by-side with the
figures from one or more previous periods.
horizontal analysis
• Method of analyzing financial statements whereby
each item of the current period is compared in
dollars and percent with the corresponding item from
a previous period.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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STEPS
TO PREPARE A HORIZONTAL ANALYSIS OF A
BALANCE SHEET
STEP 1
Set up a comparative balance sheet format with the current period
listed first and the previous period listed next.
STEP 2
Label the next two columns:
Increase (Decrease)
Amount Percent
STEP 3
For each item on the balance sheet, calculate the dollar difference
between the current and previous period and enter this figure in
the Amount column. Enter all decreases in parentheses.
STEP 4
Calculate the percent change (increase or decrease) using the
percentage formula:
Amount of change, Step 3 (portion)
Percent change (rate) =
Previous period amount (base)
Enter the percent change, rounded to the nearest tenth percent, in
the Percent column. Once again, enter all decreases in
parentheses.
STEP 5
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a publicly accessible website, in whole or in part.
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Horizontal Analysis Example
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a publicly accessible website, in whole or in part.
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Horizontal Analysis Examplecontinued
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a publicly accessible website, in whole or in part.
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The Income Statement
income, operating, or profit and loss statement
• Financial statement summarizing the operations of a
business over a period of time.
• Illustrates the amount of revenue earned, expenses
incurred, and the resulting profit or loss:
• Revenue – Expenses = Profit (or loss)
revenue
• The primary source of money, both cash and credit,
flowing into the business from its customers for goods
sold or services rendered over a period of time.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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The Income Statement
continued
expenses
• Costs incurred by a business in the process of
earning revenue.
profit or loss
• The difference between revenue earned and
expenses incurred during an operating period.
• Profit when revenue is greater than expenses; loss
when expenses are greater than revenue.
• Profit is also known as earnings or income.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Preparing an Income Statement
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a publicly accessible website, in whole or in part.
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Income Statement Components
Revenue:
Gross sales
- Sales returns and allowances
- Sales discounts
Net Sales
Gross Margin:
Net sales
-Cost of goods sold
Gross margin or Gross profit
Cost of Goods Sold:
Merchandise inventory (beginning)
+ Net purchases
+ Freight in
Goods available for sale
- Merchandise inventory (ending)
Cost of goods sold
Total Operating Expenses:
Gross margin
-Total operating expenses
Income before taxes
Net Income:
Income before taxes
-Income tax
.
Net income (loss)
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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STEPS
STEP 1
TO PREPARE AN INCOME STATEMENT
Centered at the top of the page, write the company name, type of statement, and period of
time covered by the statement (for example, “Year ended Dec. 31, 2011” or “April 2011”).
STEP 2
In a two-column format, calculate:
a. Net Sales:
Gross sales
–
Sales returns and allowances
–
Sales discounts
Net Sales
b. Cost of Goods Sold:
Merchandise inventory (beginning)
+
Net purchases
+
Freight in
Goods available for sale
–
Merchandise inventory (ending)
Cost of goods sold
c. Gross Margin:
Net sales
–
Cost of goods sold
Gross margin
d. Total Operating Expenses:
Sum of all operating expenses
e. Income before Taxes:
Gross margin
–
Total operating expenses
Income before taxes
f. Net Income:
Income before taxes
–
Income tax
Net income (loss)
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Preparing an Income Statement
Example
Use the following financial information to construct an
income statement for the first quarter of 2014 from the
following information:
• Gross sales: $240,000
• Sales discounts: $43,500
• Beginning inventory, Jan. 1: $86,400
• Ending inventory, March 31: $103,200
• Net purchases: $76,900
• Total operating expenses: $108,000
• Income tax: $14,550
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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Income Statement Example
Revenue
Gross sales
Sales discounts
Net sales
Cost of Goods Sold
Merchandise Inv. Jan
Net purchases
Goods available for sale
Less: Merchandise Inv. Mar. 31
Cost of Goods Sold
Gross Margin
Operating Expenses
Total Operating Expenses
Income before Taxes
Income Tax
Net Income
$240,000
43,500
$196,500
86,400
76,900
163,300
103,200
. 60,100
136,400
108,000
28,400
14,550
$13,850
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to
a publicly accessible website, in whole or in part.
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STEPS
TO PREPARE A VERTICAL ANALYSIS OF AN
INCOME STATEMENT
STEP 1 Use the percentage formula, Rate = Portion ÷ Base,
to find the rate of each item on the income statement.
Use each item as the portion and net sales as the
base.
STEP 2 Round each answer to the nearest tenth of a percent.
Note: A 0.1% differential may sometimes occur due
to rounding.
STEP 3 List the percentage of each statement item in a
column to the right of the monetary amount.
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a publicly accessible website, in whole or in part.
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Vertical Analysis of an Income
Statement
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a publicly accessible website, in whole or in part.
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Vertical Analysis of an Income
continued
Statement
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a publicly accessible website, in whole or in part.
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STEPS
TO PREPARE A HORIZONTAL ANALYSIS OF AN
INCOME STATEMENT
STEP 1
Set up a comparative income statement format with the current
period listed first and the previous period listed next.
STEP 2
Label the next two columns:
Increase (Decrease)
Amount Percent
STEP 3
For each item on the income statement, calculate the dollar
difference between the current and previous period and enter this
figure in the Amount column. Enter all decreases in parentheses.
STEP 4
Calculate the percent change (increase or decrease) using the
percentage formula:
Amount of change, Step 3 (portion)
Percent change (rate) =
Previous period amount (base)
Enter the percent change, rounded to the nearest tenth percent, in
the Percent column. Once again, enter all decreases in
parentheses.
STEP 5
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a publicly accessible website, in whole or in part.
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Horizontal Analysis of an Income
Statement
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a publicly accessible website, in whole or in part.
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Horizontal Analysis of an Income
continued
Statement
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a publicly accessible website, in whole or in part.
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Financial Ratios
liquidity ratios
• Tell how well a company can pay off its short-term debts and
meet unexpected needs for cash.
efficiency ratios
• Indicate how effectively a company uses its resources to
generate sales.
leverage ratios
• Show how and to what degree a company has financed its
assets.
profitability ratios
• Tell how much of each dollar of sales, assets, and owner’s
investment resulted in net profit.
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a publicly accessible website, in whole or in part.
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Liquidity Ratios
working capital
• Is the difference between current assets and current
liabilities at a point in time. Theoretically, the amount
of money left over if all the current liabilities were
paid off by current assets.
current ratio, or working capital ratio
• Is the comparison of a firm’s current assets to
current liabilities.
acid test, or quick ratio
• Indicates a firm’s ability to quickly liquidate assets to
pay off current debt.
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a publicly accessible website, in whole or in part.
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Efficiency Ratios
average collection period
• Indicates how quickly a firm’s credit accounts are being
collected. Expressed in days.
inventory turnover
• Tells the number of times during an operating period that the
average inventory was sold.
asset turnover ratio
• Tells the number of dollars in sales a firm generates from each
dollar it has invested in assets.
asset turnover ratio
• Tells the number of dollars in sales a firm generates from each
dollar it has invested in assets.
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a publicly accessible website, in whole or in part.
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Leverage Ratios
debt-to-assets ratio
• Measures to what degree the assets of the firm have
been financed with borrowed funds, or leveraged.
debt-to-equity ratio
• Compares the total debt of a firm to the owner’s
equity.
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a publicly accessible website, in whole or in part.
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Profitability Ratios
gross profit margin
• An assessment of how well the cost of goods sold category of
expenses was controlled. Expressed as a percent of net sales.
net profit margin
• An assessment of management’s overall ability to control the
cost of goods sold and the operating expenses of a firm.
• Expressed as a percent of net sales.
return on investment
• The amount of profit generated by a firm in relation to the
amount invested by the owners. Expressed as a percent of
owner’s equity.
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a publicly accessible website, in whole or in part.
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Trend Analysis of Financial Data
trend analysis
• The use of index numbers to calculate percentage
changes of a company’s financial data for several
successive operating periods.
index numbers
• Are used in trend analysis indicating changes in
magnitude of financial data over a period of time.
Calculated by setting a base period equal to 100%
and calculating other periods in relation to the base
period.
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a publicly accessible website, in whole or in part.
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STEPS
FOR PREPARING A TREND ANALYSIS
STEP 1 Choose a base year and let it equal 100%.
STEP 2 Calculate the index number for each succeeding
year.
Yearly amount
Index number =
Base year amount
STEP 3 Round each index number to the nearest tenth of a
percent.
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a publicly accessible website, in whole or in part.
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Trend Analysis Example
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a publicly accessible website, in whole or in part.
42