Chapter 19

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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
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