14 Financial
Statement Analysis
FINANCIAL
ACCOUNTING
2ND EDITION
PowerPoint Presentation by
Gail B. Wright
BY
DUCHAC, REEVE, & WARREN
Professor of Accounting
Bryant University
© Copyright 2007 Thomson South-Western, a part
of The Thomson Corporation. Thomson, the Star
Logo, and South-Western are trademarks used
herein under license.
1
LG 1
HORIZONTAL, VERTICAL
ANALYSES
• Basic financial statement analysis begins
with
– Evaluating relative size of changes in account
balances (horizontal)
– Evaluating relative size of account balances
(vertical)
2
HORIZONTAL ANALYSIS:
Assets
Largest $ increase
Largest % increase
Total assets increased $273 million (27.2%)
3
HORIZONTAL ANALYSIS:
Equity
4
LG 1
VERTICAL ANALYSIS
• On the balance sheet
– Each item is expressed as a % of total assets
• On the income statement
– Each item is expressed as a % of net sales
5
LG 1
COMMON-SIZED
STATEMENTS
• Starts with horizontal, vertical
analysis
– Shows comparisons in
percentages
– Shows 2 or more years of data
– Allows for $ & % comparisons
6
LG 2
PROFITABILITY
ANALYSIS
• Rate earned on stockholders’ equity
– Stockholders’ rate of return
• Rate earned on total assets
– Rate of return earned by what is invested in
assets
• Comprehensive profitability analysis
– Detailed analysis of rate of return on
stockholders’ equity
7
LG 2
RATE EARNED ON
STOCKHOLDERS’ EQUITY
Return on Stockholders’ Equity (ROE) =
Net Income / Ave. Stockholders’ Equity
8
LG 2
PIXAR vs. DREAMWORKS:
ROE
Pixar
Net Income
Beginning
Stockholders Equity
Ending Stockholders Equity
ROE
Dreamworks
$141.7
940.5
$333
<12.4>
1,220.1
826.9
13.1%
?
Pixar ROE: 141.7 / {(940.5 + 1220.1)/2}
9
LG 2
RATE EARNED ON TOTAL
ASSETS
Return on Total Assets (ROA) =
Net Income / Ave. Total Assets
10
LG 2
PIXAR vs. DREAMWORKS:
ROA
Pixar
Net Income
Dreamworks
Beginning Total Assets
$141.7
1,002.0
$333
681.4
Ending Total Assets
1275.0
1,200.0
ROA
?
35.4%
Dreamworks ROA: 333 / {(681.4 + 1200.0)/2}
11
LG 2
COMPREHENSIVE ROE
Rate Earned on Stockholders’ Equity (ROE) =
ROA * Leverage
{Net Income/ Ave TA} * {Ave TA/Ave Stockholders’ Equity}
12
LG 2
PIXAR vs. DREAMROWKS:
Comprehensive ROE
ROE =
ROA
Leverage
Pixar
13.1%
12.4%
1.05
Dreamworks
81.8%
35.4%
2.31
13
LG 3
MARGIN & ASSET
EFFICIENCY ANALYSIS
• Margin & efficiency analyses examine
– Profit margins
– Efficient use of assets
14
LG 3
DUPONT FORMULA
ROA = Profit Margin * Asset Turnover
=
Net Income/Ave TA =
Net Income/Net Sales * Net Sales/Ave TA
15
LG 3
EXHIBIT 6
$1 assets generates $x
sales
$1 sales generates x
cents profits
16
LG 3
PIXAR vs. DREAMROWKS:
Dupont Analysis
Pixar
12.4%
Profit
Margin
51.8%
Dreamworks
35.4%
30.9%
ROA =
Asset
Turnover
0.24
1.15
17
LG 3
ASSET EFFICIENCY:
Components
• Asset efficiency
– Examine major asset accounts
• Accounts receivable turnover
• Inventory turnover
• Fixed asset turnover
18
LG 3
ACCOUNTS RECEIVABLE
ANALYSIS
• Measures efficiency of collection
• Reflects liquidity
Accounts receivable turnover = Net Sales / (Ave. AR)
Days sales in Receivables = Ave AR/Ave Daily Sales
19
LG 3
PIXAR vs. DREAMWORKS:
Accounts Receivable Turnover
Pixar
Dreamworks
$273.5
204.9
$1078.2
132.3
Ending AR
82.0
386.1
Accounts Receivable Turnover
1.91
4.16
Net Sales
Beginning AR
Pixar Turnover: 273.5 / {(204.9 + 82.0)/2}
20
LG 3
Dreamworks collects its
accounts receivable more than
twice as fast as Pixar measured
in terms of the number of times
receivables are collected within
the year.
21
LG 3
PIXAR vs. DREAMWORKS:
Days Sales in Receivables
Beginning AR
Pixar
204.9
Dreamworks
132.3
Ending AR
82.0
386.1
Average AR
$143.45
$259.20
Net Sales
$273.5
$1078.2
Average daily sales (Sales/365)
$0.75
$2.95
Days Sales in Receivables
191.3
87.9
22
LG 3
Dreamworks collects its
accounts receivable more than
twice as fast as Pixar measured
in days receivables have been
outstanding.
23
LG 3
INVENTORY ANALYSIS
• Measures inventory efficiency
– Avoid tying up funds in inventory
– Avoid obsolescence
• Reflects liquidity
Inventory Turnover = CGS / (Ave. Inventory)
Days Sales in Inventory = Ave Inventory/ (CGS/365)
24
LG 3
PIXAR vs. DREAMWORKS:
Inventory Turnover
Pixar
Dreamworks
Beginning Inventory
$29.9
107.7
$566.2
427.5
Ending Inventory
140.0
519.9
Inventory Turnover
0.24
1.2
Cost merchandise sold
Pixar Turnover: 29.9 / {(107.7 + 140.0)/2}
25
LG 3
Dreamworks turns its inventory
5 times as fast as Pixar
measured in terms of the
number of times inventory
turns over within the year.
26
LG 3
PIXAR vs. DREAMWORKS:
Days Sales in Inventory
Beginning Inventory
Pixar
107.7
Dreamworks
427.5
Ending Inventory
140.0
519.9
Average Inventory
$123.85
$473.7
Cost of goods sold
$29.9
$566.2
Average daily COGS (Sales/365)
$0.082
$1.55
Days Sales in Inventory
1,510
306
27
LG 3
Dreamworks turns out its
pictures more than 5 times as
fast as Pixar measured in days
pictures have been in
production.
28
LG 3
FIXED ASSET ANALYSIS
• Measures efficiency in use of fixed assets
– Measures dollars sales generated by $1 fixed assets
Fixed Asset Turnover = Sales / (Ave. Fixed Assets)
29
LG 3
PIXAR vs. DREAMWORKS:
Fixed Asset Turnover
Pixar
Dreamworks
Beginning Fixed assets
$273.5
115.0
$1078.2
89.8
Ending Fixed assets
125.6
86.0
Fixed Asset Turnover
2.27
12.27
Net Sales
Pixar Turnover: 273.5 / {(115.0 + 125.6)/2}
30
LG 3
Dreamworks generates more
than 5 times the sales dollars
as Pixar during the year.
31
LG 4
LEVERAGE ANALYSIS
• Measures liquidity, solvency
–
–
–
–
–
Current ratio
Quick ratio
Fixed assets to long-term liabilities
Liabilities to equity
# Times interest charges earned
32
LG 4
PIXAR vs. DREAMWORKS:
Current Ratio
Current assets
Current liabilities
Working capital (CA – CL)
Current ratio
Pixar
$939.0
Dreamworks
$727.8
54.9
152.9
$884.1
$574.9
17.1
4.76
33
LG 4
A current ratio > 2.0 shows
excellent ability to pay shortterm borrowings. Both Pixar &
DreamWorks have high current
ratios.
34
LG 4
PIXAR vs. DREAMWORKS:
Quick Ratio
Quick assets*
Current liabilities
Quick ratio
Pixar
$936.8
Dreamworks
$450.9
54.9
152.9
17.06
2.95
*Quick assets: cash, marketable securities, & receivables
35
LG 4
If the standard measurement
for the quick ratio is > 1.0,
what can you say about the
quick ratio for Pixar &
DreamWorks?
36
LG 4
PIXAR vs. DREAMWORKS:
Fixed Assets to Long-Term Liabilities
Fixed assets
Long-term liabilities
Fixed assets to Long-term
liabilities
Pixar
$125.6
Dreamworks
$89.7
0
217.2
NA
0.41
37
LG 4
If DreamWorks finances 41%
of its fixed assets with long
term debt, what can you say
about how Pixar finances its
fixed assets?
38
LG 4
PIXAR vs. DREAMWORKS:
Liabilities to Stockholders’ Equity
Total liabilities
Total stockholders’ equity
Ratio liabilities to stockholders’
equity
Pixar
$54.9
Dreamworks
$373.1
1,220.1
826.9
0.04
0.45
39
LG 4
Both Pixar & DreamWorks are
conservative (< 1) in their use
of liabilities to finance assets.
40
LG 4
PIXAR vs. DREAMWORKS:
# Times Interest Charges Earned
Net Income
+ Tax expense
+ Interest expense
Available for interest charges
# Times interest charges earned
Pixar
$141.7
Dreamworks
$333
79.4
90.3
0
15.0
$221.1
$438.3
NA
29.2
41
LG 4
DreamWorks can cover its
interest charges more than 29
times. Interpret Pixar’s ratio.
42
LG 5
STOCKHOLDER RATIOS
• Earnings per share
• Price earnings ratio
• Dividend Yield
43
LG 5
PIXAR vs. DREAMWORKS:
Earnings per Share
Net Income
Pixar
$141.7
Dreamworks
$333
Shares common stock outstanding
56.76
81.4
EPS
$2.50
$4.09
44
LG 5
A share of DreamWorks stock
earned more than a share of
Pixar’s stock. What is the
importance of trends in EPS?
45
LG 5
PIXAR vs. DREAMWORKS:
Price-Earnings Ratio
Market price per share C/S
EPS
Price-Earnings ratio
Pixar
$90.06
Dreamworks
$37.44
2.50
4.09
36.02
$9.15
46
LG 5
Investors are willing to pay 36
times Pixar’s earning for a
share of stock? Compare with
DreamWorks.
47
LG 5
DIVIDEND YIELD
• Dividend yield calculates the rate of return
to common shareholders in terms of cash
dividends
• Neither Pixar not DreamWorks pay
dividends
48
LG 6
ANALYTICAL MEASURES:
Summary
• Industry, capital structure, operations affect
measures used
• Measures of financial position, operating
results assess past performance
– Industry, general economic trends should be
considered
• Interrelationships among measures should
be considered
49
LG 7
CONTENTS ANNUAL
REPORTS
• Corporate annual reports must include
– Management Discussion & Analysis
• Interprets financial statements
• Assesses future of company
– Report on adequacy of internal control
– Report on fairness of financial statements
50
• "My great concern is not whether you have
failed, but whether you are content with
your failure."
- Abraham Lincoln (1809-1865)
51