Financial and Managerial
Accounting
Wild, Shaw, and Chiappetta
Fifth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 13
Analyzing Financial Statements
Conceptual Learning Objectives
C1: Explain the purpose and identify the
building blocks of analysis.
C2: Describe standards for comparisons
in analysis.
13-3
Analytical Learning Objectives
A1: Summarize and report results of
analysis.
A2: Appendix 13A – Explain the form
and assess the content of a complete
income statement (see text for details).
13-4
Procedural Learning Objectives
P1: Explain and apply methods of
horizontal analysis.
P2: Describe and apply methods of
vertical analysis.
P3: Define and apply ratio analysis.
13-5
C1
Building Blocks of Analysis
Ability to meet
short-term
obligations and
to efficiently
generate
revenues
Ability to provide
financial rewards
sufficient to
attract and retain
financing
Liquidity
and
Efficiency
Solvency
Market
Profitability
Prospects
Ability to
generate future
revenues and
meet long-term
obligations
Ability to
generate
positive
market
expectations
13-6
C2
Standards for Comparison
When interpreting measures, we need to
decide whether the measures indicate good,
bad, or average performance. We can use the
following standards or benchmarks to make
that judgment:
 Intracompany
 Competitor
 Industry
 Guidelines (rules of thumb)
13-7
C1
Tools of Analysis
Horizontal Analysis
Comparing a company’s financial condition and
performance across time.
Vertical Analysis
Comparing a company’s financial condition and
performance to a base amount.
Measurement of key relations
between financial statement
items.
Ratio
Analysis
13-8
Horizontal Analysis
Comparative Statements
P1
Calculate Change in Dollar Amount
Dollar
Analysis period – Base period
=
change
amount
amount
Since we are measuring the amount of
the change between 2013 and 2012, the
dollar amounts for 2012 become the
“base” period amounts.
Calculate Change as a Percent
Percent
change
=
Dollar change
Base period amount
×
100
13-9
P1
CLOVER CORPORATION
Comparative (partial) Balance Sheet
December 31, 2013
Dollar
2013
2012
Change
Assets
Current assets:
Cash and equivalents
$ 12,000
Accounts receivable, net
60,000
Inventory
80,000
Prepaid expenses
3,000
Total current assets
$ 155,000
Property and equipment:
Land
40,000
Buildings and equipment, net
120,000
Total property and equipment $ 160,000
Total assets
$ 315,000
* Percent rounded to first decimal point.
Percent
Change*
$ 23,500 $ (11,500)
40,000
100,000
1,200
1,800
$ 164,700 $12,000 –
$23,500 =
40,000
$(11,500)
(48.9)
0.0
85,000
($11,500 ÷
$ 125,000
$ 289,700 $23,500) × 100 =
48.9%
13-10
P1
CLOVER CORPORATION
Comparative (Partial) Balance Sheet
December 31, 2013
Dollar
2013
2012
Change
Assets
Current assets:
Cash and equivalents
$ 12,000
Accounts receivable, net
60,000
Inventory
80,000
Prepaid expenses
3,000
Total current assets
$ 155,000
Property and equipment:
Land
40,000
Buildings and equipment, net
120,000
Total property and equipment $ 160,000
Total assets
$ 315,000
* Percent rounded to first decimal point.
Percent
Change*
$ 23,500 $ (11,500)
40,000
20,000
100,000 (20,000)
1,200
1,800
$ 164,700 $ (9,700)
(48.9)
50.0
(20.0)
150.0
(5.9)
40,000
85,000
35,000
$ 125,000 $ 35,000
$ 289,700 $ 25,300
0.0
41.2
28.0
8.7
13-11
P1
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2013
2013
2012
Revenues
$520,000
$480,000
Costs and expenses:
Cost of sales
360,000
315,000
Selling and admin.
128,600
126,000
Interest expense
6,400
7,000
25,000
Income before taxes
32,000
Income taxes (30%)
7,500
9,600
Net income
$17,500
$22,400
Net income per share
$0.79
$1.01
Avg. # common shares
22,200
22,200
Percent changes rounded to first decimal point.
Dollars
Change
$40,000
45,000
2,600
(600)
(7,000)
(2,100)
($4,900)
Percent
Change
8.3%
14.3
2.1
( 8.6)
( 21.9)
( 21.9)
( 21.9)
13-12
P1
Horizontal Analysis
Trend Analysis
Trend analysis is used to reveal patterns in data
covering successive periods.
Trend
=
percent
Analysis period amount
Base period amount
× 100
13-13
P1
Horizontal Analysis
Trend Analysis
Berry Products
Income Information
For the Years Ended December 31,
Item
Revenues
Cost of sales
Gross profit
2013
$ 400,000
285,000
115,000
2012
$ 355,000
250,000
105,000
2011
$ 320,000
225,000
95,000
2010
$ 290,000
198,000
92,000
2009
$ 275,000
190,000
85,000
2009 is the base period (as it
is the oldest year) so its
amounts will equal 100%.
13-14
Horizontal Analysis
Trend Analysis
P1
Berry Products
Income Information
For the Years Ended December 31,
Item
Revenues
Cost of sales
Gross profit
Item
Revenues
Cost of sales
Gross profit
2013
$ 400,000
285,000
115,000
2012
$ 355,000
250,000
105,000
2011
$ 320,000
225,000
95,000
2013
2012
2011
(290,000 ¸ 275,000) ´
(198,000 ¸ 190,000) ´
(92,000 ¸ 85,000) ´
100% = 105%
100% = 104%
100% = 108%
2010
$ 290,000
198,000
92,000
2010
105%
104%
108%
2009
$ 275,000
190,000
85,000
2009
100%
100%
100%
13-15
P1
Horizontal Analysis
Trend Analysis
Berry Products
Income Information
For the Years Ended December 31,
Item
Revenues
Cost of sales
Gross profit
Item
Revenues
Cost of sales
Gross profit
2013
$ 400,000
285,000
115,000
2013
145%
150%
135%
2012
$ 355,000
250,000
105,000
2012
129%
132%
124%
2011
$ 320,000
225,000
95,000
2011
116%
118%
112%
2010
$ 290,000
198,000
92,000
2010
105%
104%
108%
2009
$ 275,000
190,000
85,000
2009
100%
100%
100%
How would this trend analysis
look on a line graph?
13-16
Horizontal Analysis
Trend Analysis
P1
160
Percentage
150
We can use the trend
percentages to construct a
graph so we can see the
trend over time.
140
130
Revenues
120
Cost of Sales
110
Gross Profit
100
2009
2010
2011
Year
2012
2013
13-17
P2
Vertical Analysis
Common-Size Statements
Calculate Common-Size Percent
Common-size
percent
=
Analysis amount
Base amount
×
100
Financial Statement
Base Amount
Balance sheet
Total assets
Income statement
Revenues
13-18
P2
CLOVER CORPORATION
Comparative (Partial) Balance Sheet
December 31, 2013
Common-Size
Percents*
2013
2012
2013
2012
Assets
Current assets:
Cash and equivalents
$ 12,000
Accounts receivable, net
60,000
Inventory
80,000
Prepaid expenses
3,000
Total current assets
$ 155,000
Property and equipment:
Land
40,000
Buildings and equipment, net
120,000
Total property and equipment $ 160,000
Total assets
$ 315,000
* Percent rounded to first decimal point.
$ 23,500
40,000
100,000
1,200
$ 164,700
40,000
85,000
$ 125,000
$ 289,700
3.8%
8.1%
($12,000 ÷
$315,000) ×
100 = 3.8%
12.7%
($23,500 ÷
$289,700) ×
100 = 8.1%
13-19
P2
CLOVER CORPORATION
Comparative (Partial) Balance Sheet
December 31, 2013
Common-Size
Percents*
2013
2012
2013
2012
Assets
Current assets:
Cash and equivalents
$ 12,000
Accounts receivable, net
60,000
Inventory
80,000
Prepaid expenses
3,000
Total current assets
$ 155,000
Property and equipment:
Land
40,000
Buildings and equipment, net
120,000
Total property and equipment $ 160,000
Total assets
$ 315,000
* Percent rounded to first decimal point.
$ 23,500
40,000
100,000
1,200
$ 164,700
40,000
85,000
$ 125,000
$ 289,700
3.8%
19.0%
25.4%
1.0%
49.2%
8.1%
13.8%
34.5%
0.4%
56.9%
12.7% 13.8%
38.1% 29.3%
50.8% 43.1%
100.0% 100.0%
13-20
P2
CLOVER CORPORATION
Comparative (Partial) Balance Sheets
December 31, 2013
2013
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable
Notes payable
Total current liabilities
Long-term liabilities:
Bonds payable, 8%
Total liabilities
Shareholders' equity:
Preferred stock
Common stock
Additional paid-in capital
Total paid-in capital
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity
* Percent rounded to first decimal point.
2012
Common-Size
Percents*
2013
2012
$ 67,000 $ 44,000
3,000
6,000
$ 70,000 $ 50,000
21.3%
1.0%
22.2%
15.2%
2.1%
17.3%
75,000
80,000
$ 145,000 $ 130,000
23.8%
46.0%
27.6%
44.9%
20,000
20,000
60,000
60,000
10,000
10,000
$ 90,000 $ 90,000
80,000
69,700
$ 170,000 $ 159,700
$ 315,000 $ 289,700
6.3%
19.0%
3.2%
28.6%
25.4%
54.0%
100.0%
6.9%
20.7%
3.5%
31.1%
24.1%
55.1%
100.0%
13-21
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2013
Common-Size
Percents*
2013
2012
2013
2012
Revenues
$ 520,000 $ 480,000
100.0% 100.0%
Costs and expenses:
Cost of sales
360,000
315,000
69.2%
65.6%
Selling and admin.
128,600
126,000
24.7%
26.3%
Interest expense
6,400
7,000
1.2%
1.5%
Income before taxes
$ 25,000 $ 32,000
4.8%
6.7%
Income taxes (30%)
7,500
9,600
1.4%
2.0%
Net income
$ 17,500 $ 22,400
3.4%
4.7%
Net income per share
$
0.79 $
1.01
Avg. # common shares
22,200
22,200
* Rounded to first decimal point.
P2
13-22
P2
Vertical Analysis
Common-Size Graphics
This is a graphical analysis of Clover
Corporation’s common-size income
statement for 2013.
Interest Income Taxes
1.4%
Expense
1.2%
Net Income
3.4%
Selling and
Admin.
24.7%
Cost of Sales
69.2%
13-23
P3
Ratio Analysis
Liquidity
and
Efficiency
Solvency
Profitability
Market
Prospects
Let’s use the following financial
statements for Norton Corporation for
our ratio analysis.
13-24
P3
NORTON CORPORATION
Balance Sheet
December 31, 2013
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
2013
2012
$ 30,000
20,000
12,000
3,000
$ 65,000
$ 20,000
17,000
10,000
2,000
$ 49,000
165,000
116,390
$ 281,390
$ 346,390
123,000
128,000
$ 251,000
$ 300,000
13-25
NORTON CORPORAT ION
Balance Sheet
December 31, 2013
P3
2012
2013
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable
Notes payable, short-term
Total current liabilities
Long-term liabilities:
Notes payable, long-term
Total liabilities
Shareholders' equity:
Common stock, $1 par value
Additional paid-in capital
Total paid-in capital
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity
$
$
39,000
3,000
42,000
$
$
40,000
2,000
42,000
70,000
$ 112,000
78,000
$ 120,000
27,400
158,100
$ 185,500
48,890
$ 234,390
17,000
113,000
$ 130,000
50,000
$ 180,000
$ 346,390
$ 300,000
13-26
P3
NORTON CORPORATION
Income Statement
For the Years Ended December 31
Revenues
Cost of sales
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before taxes
Less income taxes (30%)
Net income
$
$
$
$
$
2013
494,000
140,000
354,000
270,000
84,000
7,300
76,700
23,010
53,690
$
$
$
$
$
2012
450,000
127,000
323,000
249,000
74,000
8,000
66,000
19,800
46,200
13-27
Ratio Analysis
Liquidity and Efficiency
P3
Current
Ratio
Inventory
Turnover
Acid-Test
Ratio
Days’ Sales
Uncollected
Accounts
Receivable
Turnover
Days’ Sales
in Inventory
Total Asset
Turnover
13-28
P3
Ratio Analysis
Liquidity and Efficiency
NORTON CORPORATION
2013
Use this information
to calculate the
liquidity and
efficiency ratios
for Norton
Corporation.
Cash
$
30,000
Accounts receivable, net
Beginning of year
17,000
End of year
20,000
Inventory
Beginning of year
10,000
End of year
12,000
Total current assets
65,000
Total current liabilities
42,000
Total assets
Beginning of year
300,000
End of year
346,390
Revenues
494,000
Cost of sales
140,000
13-29
P3
Working Capital
Working capital is the amount of current assets less
current liabilities. A company needs adequate
working capital to meet current debts, to carry
sufficient inventories, and to take advantage of cash
discounts.
Current assets
Current liabilities
Working capital
Dec. 31, 2013
$
65,000
(42,000)
$
23,000
13-30
P3
Current Ratio
Current
=
ratio
Current assets
Current liabilities
Current
=
ratio
$65,000
= 1.55 : 1
$42,000
This ratio measures the
short-term debt-paying
ability of the company.
13-31
P3
Acid-Test Ratio
Quick assets
Acid-test =
Current liabilities
ratio
Quick assets are Cash, Short-Term Investments,
and Current Receivables.
Acid-test = $50,000 = 1.19 : 1
$42,000
ratio
This ratio is like the current
ratio but excludes current assets such as
inventories and prepaid expenses that may take
time to covert into cash or may expire over time
and not be converted into cash at all.
13-32
P3
Accounts Receivable Turnover
Accounts
Net sales
receivable =
Average accounts receivable/net
turnover
Accounts
$494,000
= 26.7 times
receivable =
($17,000 + $20,000) ÷ 2
turnover
This ratio measures how many
times a company converts its
receivables into cash each year.
13-33
P3
Inventory Turnover
Inventory
turnover
Inventory
turnover
Cost of goods sold
=
Average inventory
$140,000
=
= 12.73 times
($10,000 + $12,000) ÷ 2
This ratio measures the number
of times merchandise is sold and
and replaced during the year.
13-34
P3
Days’ Sales Uncollected
Days’ sales
=
uncollected
A/R, net
Net sales
´ 365
Days’ sales
$20,000
=
´ 365 = 14.8 days
uncollected
$494,000
This ratio measures the liquidity
of receivables.
13-35
P3
Days’ Sales in Inventory
Days’ sales
=
in inventory
Ending inventory
Cost of goods sold
´ 365
Days’ sales
$12,000
=
´ 365 = 31.29 days
in inventory
$140,000
This ratio measures the liquidity
of inventory.
13-36
P3
Total Asset Turnover
Total asset
Net sales
=
turnover
Average total assets
Total asset
$494,000
=
= 1.53 times
turnover
($300,000 + $346,390) ÷ 2
This ratio measures the
efficiency of assets in producing
sales.
13-37
Ratio Analysis
Solvency
Solvency Ratios
P3
Debt
Ratio
Equity
Ratio
Debt-to-Equity
Ratio
Times
Interest
Earned
13-38
P3
Solvency
Use this information to calculate the solvency
ratios for Norton Corporation.
NORTON CORPORATION
2013
Net income before interest
expense and income taxes
Interest expense
$
84,000
7,300
Total shareholders' equity
234,390
Total liabilities
112,000
Total assets
346,390
13-39
P3
Debt Ratio
Total liabilities
Debt
=
ratio
Total assets
Debt
=
ratio
$112,000
= 32.3%
$346,390
This ratio measures what portion of a
company’s assets are contributed by
creditors.
13-40
P3
Equity Ratio
Total equity
Equity
=
ratio
Total assets
Equity
=
ratio
$234,390
= 67.7%
$346,390
This ratio measures what portion of a
company’s assets are contributed by
owners.
13-41
P3
Debt-to-Equity Ratio
Debt-toequity
ratio
Debt-toequity
ratio
Total liabilities
=
Total equity
$112,000
= $346,390
= 32%
This ratio measures the solvency of
companies.
13-42
P3
Times Interest Earned
Times
interest =
earned
Income before interest expense
and income taxes
Interest expense
Times
$84,000
interest =
= 11.51
$7,300
earned
This is the most common measure of the
ability of a firm’s operations to provide
protection to the long-term creditor.
13-43
Ratio Analysis
Profitability
P3
Profit
Margin
Basic
Earnings per
Share
Gross
Margin
Return on
Total Assets
Book Value
per Common
Share
Return on
Common
Stockholders’
Equity
13-44
P3
Profitability
Use this
information to
calculate the
profitability
ratios for
Norton
Corporation.
NORTON CORPORATION
2013
Number of common shares
outstanding all year
Net income
27,400
$
53,690
Shareholders' equity
Beginning of year
180,000
End of year
234,390
Revenues
494,000
Cost of sales
140,000
Total assets
Beginning of year
300,000
End of year
346,390
13-45
P3
Profit Margin
Profit
=
margin
Net income
Net sales
$53,690
Profit
= 10.87%
=
margin $494,000
This ratio describes a
company’s ability to earn a net
income from sales.
13-46
P3
Gross Margin
Gross
Net sales - Cost of sales
=
margin
Net sales
Gross $494,000 - $140,000
= 71.66%
=
margin
$494,000
This ratio measures the amount
remaining from $1 in sales that is left
to cover operating expenses and a
profit after considering cost of sales.
13-47
P3
Return on Total Assets
Return on =
Net income
total assets
Average total assets
Return on
$53,690
=
= 16.61%
total assets ($300,000 + $346,390) ÷ 2
This ratio is generally considered
the best overall measure of a
company’s profitability.
13-48
P3
Return on Common
Stockholders’ Equity
Return on
common
Net income - Preferred dividends
=
stockholders’
Average common stockholders’
equity
equity
Return on
$53,690 - $0
common =
= 25.9%
stockholders’ ($180,000 + $234,390) ÷ 2
equity
This measure indicates how well the
company employed the owners’
investments to earn income.
13-49
P3
Book Value per Common Share
Book value Shareholders’ equity applicable to
per
common shares
=
common
Number of common shares
share
outstanding
This ratio measures
liquidation at reported
amounts.
13-50
P3
Basic Earnings per Share
Basic
earnings
Net income - Preferred dividends
=
per
Weighted-average common
share
shares outstanding
Basic
earnings
$53,690 - $0
=
= $1.96 per share
per
27,400
share
This measure indicates how much
income was earned for each share of
common stock outstanding.
13-51
P3
Market Prospects
Use this
information
to calculate
the market
ratios for
Norton
Corporation.
NORTON CORPORATION
December 31, 2013
Earnings per share
Market price
Annual dividend per share
$
1.96
15.00
2.00
13-52
P3
Price-Earnings Ratio
Price-earnings
ratio
=
Price-earnings
ratio
$15.00
=
$1.96
Market price per common share
Earnings per share
= 7.65 times
This measure is often used by investors as a general
guideline in gauging stock values. Generally, the
higher the price-earnings ratio, the more opportunity
a company has for growth.
13-53
P3
Dividend Yield
Dividend = Annual cash dividends per share
Market price per share
yield
Dividend = $2.00
= 13.3%
yield
$15.00
This ratio identifies the return, in terms of
cash dividends, on the current market
price of the stock.
13-54
A1
Summarizing Results
A financial statement analysis report helps by directly
assessing the building blocks of analysis and by
identifying weaknesses in inference and by requiring
explanation. It usually consists of six sections:
 Executive summary
 Analysis overview
 Evidential matter
 Assumptions
 Key factors
 Inferences
13-55
End of Chapter 13
13-56