# Financial Statement Analysis

```Chapter 17
FINANCIAL STATEMENT ANALYSIS
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
Winston Kwok, Ph.D., CA
17 - 2
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. Statement of Profit or Loss and
Other Comprehensive Income
(Income Statement)
2. Statement of Financial Position
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes to the Financial Statements
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C2
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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P1
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.
&times;
100
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P1
HORIZONTAL ANALYSIS
1,587 – 1,670 = (83)
[(83) &divide; 1,670] &times; 100 = (5.0)%
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P1
HORIZONTAL ANALYSIS
14,492 – 14,883 = (391)
[(391) &divide; 14,883] &times; 100 = (2.6)%
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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
&times;100
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P1
TREND ANALYSIS
Income Statement Information
Using 2009 as the base year we will get the following trend information:
Examples of 2013 Calculations for Net Sales:
2009 is base year. Set to 100%
2013: (14,492 &divide; 10,381) &times; 100 = 139.6%
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P1
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
&times;
Financial Statement
Base Amount
Statement of Financial Position
Total Assets
Income Statement
Revenues
100
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P2
COMMON-SIZE
STATEMENT OF FINANCIAL POSITION
(1,587 &divide; 11,599) &times; 100 = 13.7%
(1,670 &divide; 11,651) &times; 100 = 14.3%
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P2
COMMON-SIZE INCOME STATEMENT
(7,352 &divide; 14,492) &times; 100 = 50.7%
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P2
COMMON-SIZE GRAPHICS
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P3
RATIO ANALYSIS
Liquidity
and
efficiency
Solvency
Profitability
Market
prospects
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P3
LIQUIDITY AND EFFICIENCY
Current
Ratio
Days’ Sales
Uncollected
Acid-test
Ratio
Days’ Sales
in Inventory
Accounts
Receivable
Turnover
Inventory
Turnover
Accounts
Payable
Turnover
Total Asset
Turnover
Days’
Purchases in
Accounts
Payable
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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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P3
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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P3
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
ACCOUNTS PAYABLE TURNOVER
Cost of goods sold
Accounts payable turnover =
Average accounts payable
Average accounts
payable =
(Beginning accounts payable +
Ending accounts payable)
2
A short-term liquidity
measure used to quantify
the rate at which a company
pays off its suppliers.
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P3
DAYS’ SALES UNCOLLECTED
Day's sales = Accounts receivable, net
&times; 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
&times; 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
DAYS’ PURCHASES IN ACCOUNTS
PAYABLE
Accounts
Payable
=
Accounts payable
&times; 365
Cost of goods sold
This ratio is a useful measure in evaluating
how long the business takes to pay its credit
suppliers.
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P3
CASH CONVERSION CYCLE
The sum of the days’ sales uncollected and the
days’ sales in inventory subtracting the days’
purchases in accounts payable. It represents
the number of days a firm’s cash remains tied
up within the operations of the business.
The lower the cash conversion cycle, the more
healthy a company generally is.
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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
Debt-to-Equity
Ratio
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 &divide; \$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
Times interest earned = expense and income taxes
Interest expense
Net profit
+ 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 Ordinary
Shareholders’
Equity
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P3
PROFIT MARGIN
Profit margin =
Net profit
Net sales
This ratio describes a company’s ability
to earn net profit from each sales dollar.
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P3
RETURN ON TOTAL ASSETS
Return on total asset =
Net profit
Average total
assets
Return on total assets measures how well
assets have been employed by the
company’s management.
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P3
RETURN ON ORDINARY SHAREHOLDERS'
EQUITY
Return on ordinary shareholders'
equity =
Net profit - Preference dividends
Average ordinary shareholders'
equity
This measure indicates how well the
company employed the shareholders’ equity
to earn net profit.
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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 ordinary share
Earnings per share
This measure is often used by investors as a
general guideline in gauging share 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 ordinary shares.
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A1
ANALYSIS REPORTING
A good analysis report usually consists of six sections:
1. Executive summary
2. Analysis overview
3. Evidential matter
4. Assumptions
5. Key factors
6. Inferences
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END OF CHAPTER 17
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