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Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER 19 FINANCIAL STATEMENT ANALYSIS BASICS OF FINANCIAL STATEMENT ANALYSIS • Analysing financial statements involves evaluating three characteristics of a company: 1. its liquidity 2. its profitability 3. its solvency COMPARATIVE ANALYSIS • Three types of comparisons: – Intracompany basis – Intercompany basis – Industry averages COMPARATIVE ANALYSIS • Three tools: – Horizontal analysis – Vertical analysis – Ratio analysis HORIZONTAL ANALYSIS Change since base period Current year amount — Base year amount ——————————————————————— Base year amount ANY COMPANY INC. Assumed Net Sales For the Year Ended December 31 (in millions) 2003 2002 2001 2000 1999 $ 6,562.8 $ 6,295.4 $ 6,190.6 $ 5,786.6 $ 5,181.4 121% 119% 112% 100% 127% VERTICAL ANALYSIS • Expresses each item in a financial statement as a percent of a base amount (total assets or net sales) ANY COMPANY, INC. Condensed Balance Sheets (Partial) December 31 (in millions) Assets Current assets Capital assets Other assets Total assets 2002 Amount $1,496.5 2,888.8 666.2 $5,051.5 Percent 29.6 57.2 13.2 100.0% 2001 . Amount Percent $1,467.7 30.1 2,733.3 56.9 636.6 13.0 $4,837.6 100.0% RATIO ANALYSIS Liquidity Ratios Measure short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. Profitability Ratios Revenues - Expenses Since 1892 = Net Income Measure the income or operating success of an enterprise for a given period of time. Solvency Ratios XYZ Co. Measure the ability of the enterprise to survive over a long period of time. LIQUIDITY RATIOS • • • • • • • Current ratio Acid test ratio Cash current debt coverage ratio Receivables turnover Collection period Inventory turnover Days sales in inventory CURRENT RATIO • Measures short-term debt-paying ability Current ratio = Current assets Current liabilities (Discussed in Chapter 4) ACID TEST RATIO • Measures immediate short-term debtpaying ability Acid test ratio = Cash + temporary investments + net receivables Current liabilities (Discussed in Chapter 9) CASH CURRENT DEBT COVERAGE RATIO • Measures short-term debt-paying ability (cash basis) Cash current debt coverage ratio = Cash provided by operating activities Average current liabilities (Discussed in Chapter 18) RECEIVABLES TURNOVER • Measures liquidity of receivables Receivables turnover = Net credit sales Average net receivables (Discussed in Chapter 9) COLLECTION PERIOD • Measures number of days receivables are outstanding Collection period = 365 days Receivables turnover (Discussed in Chapter 9) INVENTORY TURNOVER • Measures liquidity of inventory Inventory turnover = Cost of goods sold Average inventory (Discussed in Chapter 5) DAYS SALES IN INVENTORY • Measures number of days inventory is on hand Days in inventory = 365 days Inventory turnover (Discussed in Chapter 5) PROFITABILITY RATIOS • • • • • • Profit margin Gross profit margin Cash return on sales Asset turnover Return on assets Return on common shareholders’ equity • • • • • • Book value per share Cash flow per share Earnings per share (EPS) Price-earnings (PE) ratio Payout ratio Dividend yield PROFIT MARGIN • Measures net income generated by each dollar of sales Profit margin = Net income Net sales (Discussed in Chapter 5) GROSS PROFIT MARGIN • Measures margin between selling price and cost of goods sold generated by each dollar of sales Gross profit margin = Gross profit Net sales (Discussed in Chapter 5) CASH RETURN ON SALES • Measures net cash flow generated by each dollar of sales Cash return on sales = Net cash provided by operating activities Net sales (Discussed in Chapter 18) ASSET TURNOVER • Measures how efficiently assets are used to generate sales Asset turnover = Net sales Average total assets (Discussed in Chapter 10) RETURN ON ASSETS • Measures overall profitability of assets Return on assets = Net income Average total assets (Discussed in Chapter 10) RETURN ON COMMON SHAREHOLDERS’ EQUITY • Measures profitability of common shareholders’ investment Return on common shareholders’ equity = Net income Average common shareholders’ equity (Discussed in Chapter 14) BOOK VALUE PER SHARE • Measures the equity (net assets) per common share Book value per share = Common shareholders’ equity Number of common shares (Discussed in Chapter 14) CASH FLOW PER SHARE • Measures the net cash flow per common share Cash flow per share = Net cash provided by all activities Number of common shares (Discussed in Chapter 18) EARNINGS PER SHARE (EPS) • Measures net income earned on each common share Earnings per share = Net income Number of common shares (Discussed in Chapter 15) PRICE-EARNINGS (PE) RATIO • Measures relationship between market price per share and earnings per share Price-earnings ratio = Share price Earnings per share (Discussed in Chapter 15) PAYOUT RATIO • Measures % of earnings distributed in the form of cash dividends Payout ratio = Cash dividends Net income (Discussed in Chapter 15) DIVIDEND YIELD • Measures rate of return earned from dividends Dividend yield = Cash dividends per share Share price (Discussed in Chapter 15) SOLVENCY RATIOS • • • • Debt to total assets Interest coverage Cash interest coverage Cash total debt coverage DEBT TO TOTAL ASSETS • Measures % of total assets provided by creditors Debt to total assets = Total liabilities Total assets (Discussed in Chapter 16) INTEREST COVERAGE • Measures ability to meet interest payments as they come due Interest coverage = Income before interest expense and income tax expense (EBIT) Interest expense (Discussed in Chapter 16) CASH INTEREST COVERAGE • Measures cash available to meet interest payments as they come due (cash basis) Cash interest coverage = Income before interest expense, income tax expense, and amortization expense (EBITDA) Interest expense (Discussed in Chapter 16) CASH TOTAL DEBT COVERAGE • Measures long-term debt-paying ability (cash basis) Cash total debt coverage ratio = Net cash provided by operating activities Average total liabilities (Discussed in Chapter 18) LIMITATIONS OF FINANCIAL ANALYSIS • Estimates • Historical cost • Alternative accounting methods • Atypical data • Diversification COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd. 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