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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 Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved 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 17 - 3 C1 BUILDING BLOCKS OF ANALYSIS Liquidity and efficiency Solvency Profitability Market prospects 17 - 4 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 17 - 5 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 17 - 6 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. 17 - 7 P1 HORIZONTAL ANALYSIS 17 - 8 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. 17 - 9 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 17 - 10 P1 HORIZONTAL ANALYSIS 1,587 – 1,670 = (83) [(83) ÷ 1,670] × 100 = (5.0)% 17 - 11 P1 HORIZONTAL ANALYSIS 14,492 – 14,883 = (391) [(391) ÷ 14,883] × 100 = (2.6)% 17 - 12 P1 TREND ANALYSIS Trend analysis is used to reveal patterns in data covering successive periods. Trend Percent = Analysis Period Amount Base Period Amount ×100 17 - 13 P1 TREND ANALYSIS Adidas 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 ÷ 10,381) × 100 = 139.6% 17 - 14 P1 TREND ANALYSIS We can use the trend percentages to construct a graph so we can see the trend over time. 17 - 15 P2 VERTICAL ANALYSIS Common-Size Statements Common-size Percent = Analysis Amount Base Amount × Financial Statement Base Amount Statement of Financial Position Total Assets Income Statement Revenues 100 17 - 16 P2 COMMON-SIZE STATEMENT OF FINANCIAL POSITION (1,587 ÷ 11,599) × 100 = 13.7% (1,670 ÷ 11,651) × 100 = 14.3% 17 - 17 P2 COMMON-SIZE INCOME STATEMENT (7,352 ÷ 14,492) × 100 = 50.7% 17 - 18 P2 COMMON-SIZE GRAPHICS 17 - 19 P3 RATIO ANALYSIS Liquidity and efficiency Solvency Profitability Market prospects 17 - 20 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 17 - 21 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. 17 - 22 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. 17 - 23 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. 17 - 24 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. 17 - 25 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. 17 - 26 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. 17 - 27 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. 17 - 28 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. 17 - 29 P3 DAYS’ PURCHASES IN ACCOUNTS PAYABLE Accounts Payable = Accounts payable × 365 Cost of goods sold This ratio is a useful measure in evaluating how long the business takes to pay its credit suppliers. 17 - 30 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. 17 - 31 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. 17 - 32 P3 SOLVENCY Debt Ratio Equity Ratio Debt-to-Equity Ratio Times Interest Earned 17 - 33 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. 17 - 34 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. 17 - 35 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. 17 - 36 P3 PROFITABILITY Profit Margin Return on Total Assets Return on Ordinary Shareholders’ Equity 17 - 37 P3 PROFIT MARGIN Profit margin = Net profit Net sales This ratio describes a company’s ability to earn net profit from each sales dollar. 17 - 38 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. 17 - 39 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. 17 - 40 P3 MARKET PROSPECTS Price-Earnings Ratio Dividend Yield 17 - 41 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. 17 - 42 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. 17 - 43 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 17 - 44 END OF CHAPTER 17