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Analysis of Financial Statements
Chapter 17
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
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C1
Basics of Analysis
Reduces
uncertainty
Application
of analytical
tools
Involves
transforming
data
Financial statement analysis helps users
make better decisions.
Internal Users
Managers
Officers
Internal Auditors
External Users
Shareholders
Lenders
Customers
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C1
Building Blocks of Analysis
Liquidity and
efficiency
Solvency
Profitability
Market
prospects
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C1
Information for Analysis
1. Income Statement
2. Balance Sheet
3. Statement of
Stockholders’ Equity
4. Statement of Cash Flows
5. Notes to the Financial
Statements
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C1
Standards for Comparison
When we interpret our analysis, it is essential to
compare the results we obtained to other
standards or benchmarks.
 Intracompany
 Competitors
 Industry
 Guidelines
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C2
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.
Ratio Analysis
Measurement of key relations between financial
statement items.
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P1
Horizontal Analysis
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Comparative Statements
Calculate Change in Dollar Amount
Dollar
Change
=
Analysis Period
Amount
–
Base Period
Amount
When measuring the amount of the
change in dollar amounts, compare the
analysis period balance to the base
period balance. The analysis period is
usually the current year while the base
period is usually the prior year.
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P1
Comparative Statements
Calculate Change as a Percent
Percent
Change
=
Dollar Change
Base Period Amount
When calculating the change as a
percentage, divide the amount of the
dollar change by the base period
amount, and then multiply by 100 to
convert to a percentage.
×
100
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P1
Horizontal Analysis
$325,336 – $393,927 = $(68,591)
($(68,591) ÷ $393,927) × 100 = (17.4)%
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Horizontal Analysis
$2,656,949 – $1,991,139 = $665,810
($665,810 ÷ $1,991,139) × 100 = 33.4%
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P1
Trend Analysis
Trend analysis is used to reveal patterns in data
covering successive periods.
Trend
Percent
=
Analysis Period Amount
Base Period Amount
×
100
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P1
Trend Analysis
Polaris Industries Inc.
Income Statement Information
Using 2007 as the base year we will get the following trend information:
Examples of 2007-2011 Calculations for Revenues:
2007 is base year. Set to 100%
2008: $1,948,254 ÷ $1,780,009 × 100 = 109.5%
2009: $1,565,887 ÷ $1,780,009 × 100 = 88.0%
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Trend Analysis
We can use the trend percentages to construct a
graph so we can see the trend over time.
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P2
Vertical Analysis
Common-Size Statements
Common-size
Percent
=
Analysis Amount
Base Amount
×
100
Financial Statement
Base Amount
Balance Sheet
Total Assets
Income Statement
Revenues
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P2
Common-Size Balance Sheet
($325,336 ÷ $1,228,024) × 100 = 26.5%
($393,927 ÷ $1,061,647) × 100 = 37.1%
•Percents are rounded to tenths and thus may not exactly sum to totals and subtotals.
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Common-Size Income Statement
($1,916,366 ÷ $2,656,949) × 100 = 72.1%
($1,460,926 ÷ $1,991,139) × 100 = 73.4%
•Percents are rounded to tenths and thus may not exactly sum to totals and subtotals.
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P2
Common-Size Graphics
Common-Size Graphic of
Income Statement
Common-Size Graphic of
Asset Components
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P3
Ratio Analysis
Liquidity and
efficiency
Solvency
Profitability
Market
prospects
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P3
Liquidity and Efficiency
Current
Ratio
Inventory
Turnover
Days’ Sales
Uncollected
Acid-test
Ratio
Accounts
Receivable
Turnover
Days’ Sales
in Inventory
Total Asset
Turnover
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P3
Working Capital
Working capital represents current assets
financed from long-term capital sources
that do not require near-term repayment.
Current assets
– Current liabilities
= Working capital
More working capital suggests a strong liquidity
position and an ability to meet current obligations.
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Current Ratio
Current Ratio =
Current Assets
Current Liabilities
This ratio measures the short-term debtpaying ability of the company. A higher current
ratio suggests a strong liquidity position.
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Acid-Test Ratio
Acid-test ratio =
Cash + Short-term investments + Current
receivables
Current Liabilities
Referred to as Quick Assets
This ratio is like the current ratio but excludes current assets
such as inventories and prepaid expenses that may be
difficult to quickly convert into cash.
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P3
Accounts Receivable Turnover
Accounts receivable
turnover
Average accounts receivable =
=
Net sales
Average accounts receivable,
net
(Beginning acct. rec. + Ending acct. rec.)
2
This ratio measures how
many times a company
converts its receivables
into cash each year.
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P3
Inventory Turnover
Inventory turnover =
Average inventory =
Cost of goods sold
Average inventory
(Beginning inventory + Ending inventory)
2
This ratio measures the
number of times
merchandise is sold and
replaced during the year.
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P3
Days’ Sales Uncollected
Day's sales = Accounts receivable, net
× 365
uncollected
Net sales
Provides insight into how frequently a
company collects its accounts receivable.
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P3
Days’ Sales in Inventory
Day's sales in
Inventory
=
Ending inventory
× 365
Cost of goods sold
This ratio is a useful measure in evaluating
inventory liquidity. If a product is demanded
by customers, this formula estimates how
long it takes to sell the inventory.
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P3
Total Asset Turnover
Net sales
Total asset turnover =
Average total assets
Average assets =
(Beginning assets + Ending assets)
2
This ratio reflects a
company’s ability to use
its assets to generate
sales. It is an important
indication of operating
efficiency.
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P3
Solvency
Debt
Ratio
Equity
Ratio
Pledged Assets
to Secured
Liabilities
Times
Interest
Earned
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P3
Debt and Equity Ratios
Total liabilities
Total equity
Total liabilities and equity
Amount
$ 8,000,000
4,000,000
$ 12,000,000
Ratio
66.7% [Debt ratio]
33.3% [Equity ratio]
100.0%
$8,000,000 ÷ $12,000,000 = 66.7%
The debt ratio expresses total liabilities as a percent of
total assets. The equity ratio provides complementary
information by expressing total equity as a percent of total
assets.
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P3
Debt-to-Equity Ratio
Total liabilities
Debt-to-equity ratio =
Total equity
This ratio measures what portion of a company’s
assets are contributed by creditors. A larger debt-toequity ratio implies less opportunity to expand
through use of debt financing.
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P3
Times Interest Earned
Income before interest and
taxes
Times interest earned =
Interest expense
Net income
+ Interest expense
+ Income taxes
= Income before interest and taxes
This is the most common measure of the
ability of a company’s operations to provide
protection to long-term creditors.
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P3
Profitability
Profit
Margin
Return on
Total Assets
Return on Common
Stockholders’ Equity
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P3
Profit Margin
Profit margin =
Net income
Net sales
This ratio describes a company’s ability to
earn net income from each sales dollar.
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Return on Total Assets
Return on total asset =
Net income
Average total
assets
Return on total assets measures how well
assets have been employed by the
company’s management.
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Return on Common Stockholders’
Equity
Return on common stockholders'
equity =
Net income - Preferred dividends
Average common stockholders'
equity
This measure indicates how well the
company employed the stockholders’ equity
to earn net income.
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P3
Market Prospects
Price-Earnings
Ratio
Dividend
Yield
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P3
Price-Earnings Ratio
Price-earnings ratio =
Market price per common share
Earnings per share
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.
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P3
Dividend Yield
Annual cash dividends per share
Dividend yield =
Market price per share
This ratio identifies the return, in terms of cash
dividends, on the current market price per share
of the company’s common stock.
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Summary of Ratios
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Global View
Horizontal and Vertical Analysis
Horizontal and vertical analyses help eliminate many differences between U.S. GAAP
and IFRS when analyzing and interpreting financial statements. However, when
fundamental differences in reporting regimes impact financial statements, the user
must exercise caution when drawing conclusions.
Ratio Analysis
Ratio analysis of financial statements also helps eliminate differences between U.S.
GAAP and IFRS. Importantly, the use of ratio analysis is fine, with some possible
changes in interpretation depending on what is and what is not included in certain
accounting measures across U.S. GAAP and IFRS. Care must be taken in drawing
inferences from a comparison of ratios across reporting regimes.
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A1
Analysis Reporting
The purpose of financial statement analyses is to
reduce uncertainty in business decisions through a
rigorous and sound evaluation. A financial statement
analysis report directly addresses the building blocks of
analysis and documents the reasoning.
1.
2.
3.
4.
5.
6.
Executive Summary
Analysis Overview
Evidential Matter
Assumptions
Key Factors
Inferences
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A2
Appendix 17A: Sustainable Income
Extraordinary
Items
Discontinued
Segments
Continuing
Operations
Net Income
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End of Chapter 17