ACCOUNTING FOR
MANAGERS
University of Management and Technology
1901 North Fort Myer Drive
Arlington, VA 22209
Voice: (703) 516-0035 Fax: (703) 516-0985
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9-1
ACCT125
Carl S. Warren
Survey of Accounting (2nd ed.)
© 2004 South-Western
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9-2
ACCT125
Task Force Clip Art
included in this electronic
presentation is used with
the permission of New
Vision Technology of
Nepean Ontario, Canada.
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9-3
ACCT125
Chapter 9
Financial Statement Analysis
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9-4
ACCT125
Learning Objectives
1. Describe basic financial
statement analytical
After studying
this procedures.
2. Apply financial statement analysis to assess the solvency of
chapter, you should
a business.
be able
to:to assess the profitability
3. Apply financial statement
analysis
of a business.
4. Summarize the uses and limitations of analytical measures.
5. Describe the contents of corporate annual reports.
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9-5
ACCT125
Learning Objective
1
© 2006 UMT
Describe basic
financial statement
analytical
procedures.
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9-6
ACCT125
Lincoln Company
Comparative Balance Sheet
December 31, 2004 and 2003
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Liabilities
Current liabilities
Long-term liabilities
Stockholders’ Equity
Preferred stock, $100 par
Common stock, $10 par
Retained earnings
© 2006 UMT
Increase (Decrease)
Amount
Percent
2004
2003
$ 550,000
95,000
444,500
50,000
$1,139,500
$ 533,000
177,500
470,000
50,000
$1,230,500
$ 17,000
(82,500)
(25,500)
—
$ (91,000)
3.2%
(46.5%)
(5.4%)
$ 210,000
100,000
$ 310,000
$ 243,000
200,000
$ 443,000
$ (33,000)
(100,000)
$(133,000)
(13.6%)
(50.0%)
(30.0%)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500
$ 787,500
$1230,500
—
—
$42,000
$42,000
$(91,000)
30.5%
5.3%
(7.4%)
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(7.4%)
9-7
ACCT125
Lincoln Company
Comparative Balance Sheet
December 31, 2004 and 2003
2004
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Liabilities
Current liabilities
Long-term liabilities
Stockholders’ Equity
Preferred stock, $100 par
Common stock, $10 par
Retained earnings
© 2006 UMT
2003
$ 550,000
$ 533,000
95,000
177,500
444,500
470,000
Horizontal
Analysis:
50,000
50,000
$1,139,500
$1,230,500
Increase (Decrease)
Amount
Percent
$ 17,000
(82,500)
(25,500)
—
$ (91,000)
Current year (2004) $550,000
$ 210,000
$ 243,000$533,000
$ (33,000)
Base
year (2003)
3.2%
(46.5%)
(5.4%)
(7.4%)
100,000
$ 310,000
200,000
$ 443,000
(100,000)
$(133,000)
(13.6%)
(50.0%)
(30.0%)
500,000
179,500
$ 829,500
$1,139,500
500,000
137,500
$ 787,500
$1230,500
—
$42,000
$42,000
$(91,000)
30.5%
5.3%
(7.4%)
Increase amount
$17,000
= 3.2%
Base
year (2003)
$533,000
$ 150,000
$ 150,000
—
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9-8
ACCT125
Lincoln Company
Comparative Income Statement
December 31, 2004 and 2003
Sales
Sales returns
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Operating income
Other income
Other expense
Income before income tax
Income tax
Net income
© 2006 UMT
2004
2003
$1,530,500
32,500
$1,498,000
1,043,000
$ 455,000
$ 191,000
104,000
$ 295,000
$ 160,000
8,500
$ 168,500
6,000
$ 162,500
71,500
$ 91,000
$1,234,000
34,000
$1,200,000
820,000
$ 380,000
$ 147,000
97,400
$ 244,400
$ 135,600
11,000
$ 146,600
12,000
$ 134,600
58,100
$ 76,500
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Increase (Decrease)
Amount
Percent
$296,500
(1,500)
$298,000)
223,000
$ 75,000
$ 44,000
6,600
$ 50,600
$ 24,400
(2,500)
$ 21,900
(6,000)
$ 27,900
13,400
$ 14,500
24.0%
(4.4%)
24.8%
27.2%
19.7%
29.9%
6.8%
20.7%
18.0%
(22.7%)
14.9%
(50.0%)
20.7%
23.1%
19.0%
9-9
ACCT125
Lincoln Company
Comparative Income Statement
December 31, 2004 and 2003
2004
Sales
Sales returns
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Operating income
Other income
Other expense
Income before income tax
Income tax
Net income
© 2006 UMT
2003
Increase (Decrease)
Amount
Percent
$1,530,500
$1,234,000
$296,500
24.0%
32,500
34,000
(1,500)
(4.4%)
$1,498,000
$1,200,000
$298,000)
24.8%
1,043,000
820,000
223,000
27.2%
$ 455,000
$ 380,000
$ 75,000
19.7%
$ 191,000 Analysis:
$ 147,000
$ 44,000
29.9%
Horizontal
104,000
97,400
6,600
6.8%
$ 295,000
$ 244,400
$ 50,600
20.7%
Current
year (2004)
$1,498,000
$ 160,000
$ 135,600
$ 24,400
18.0%
Base year
(2003)
$1,200,000
8,500
11,000
(2,500)
(22.7%)
$ 168,500
$ 146,600
$ 21,900
14.9%
Increase
amount 12,000
$298,000 (6,000)
6,000
(50.0%)
= 24.8%
$ 162,500
$ 134,600
$ 27,900
20.7%
Base
year (2003)
$1,200,000
71,500
58,100
13,400
23.1%
$ 91,000
$ 76,500
$ 14,500
19.0%
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9-10
ACCT125
Lincoln Company
Comparative Balance Sheets
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Liabilities
Current liabilities
Long-term liabilities
Stockholders’ Equity
Preferred stock, $100 par
Common stock, $10 par
Retained earnings
© 2006 UMT
December 31, 2004
Amount
Percent
December 31, 2003
Amount
Percent
$ 550,000
95,000
444,500
50,000
$1,139,500
48.3%
8.3
39.0
4.4
100.0%
$ 533,000
177,500
470,000
50,000
$1,230,500
43.3%
14.4
38.2
4.1
100.0%
$ 210,000
100,000
$ 310,000
18.4%
8.8
27.2%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
13.2%
43.9
15.7
72.8%
100.0%
$ 150,000
500,000
137,500
$ 787,500
$1230,500
12.2%
40.6
11.2
64.0%
100.0%
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9-11
ACCT125
Lincoln Company
Comparative Balance Sheets
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Liabilities
Current liabilities
Long-term liabilities
Vertical Analysis:
Stockholders’ Equity
Preferred stock, $100 par
Current
Common
stock,liabilities
$10 par
Retained
earnings
Total
assets
© 2006 UMT
December 31, 2004
Amount
Percent
December 31, 2003
Amount
Percent
$ 550,000
95,000
444,500
50,000
$1,139,500
48.3%
8.3
39.0
4.4
100.0%
$ 533,000
177,500
470,000
50,000
$1,230,500
43.3%
14.4
38.2
4.1
100.0%
$ 210,000
100,000
$ 310,000
18.4%
8.8
27.2%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
$ 150,000
13.2%
$210,000500,000
43.9
=
18.4%
15.7
$1,139,500179,500
$ 829,500
72.8%
$1,139,500
100.0%
$ 150,000
500,000
137,500
$ 787,500
$1230,500
12.2%
40.6
11.2
64.0%
100.0%
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9-12
ACCT125
Lincoln Company
Comparative Balance Sheets
Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Liabilities
Current liabilities
Long-term liabilities
Stockholders’ Equity
Preferred stock, $100 par
Common stock, $10 par
Retained earnings
© 2006 UMT
Common-Size Statements
December 31, 2004
Amount
Percent
December 31, 2003
Amount
Percent
$ 550,000
95,000
444,500
50,000
$1,139,500
48.3%
8.3
39.0
4.4
100.0%
$ 533,000
177,500
470,000
50,000
$1,230,500
43.3%
14.4
38.2
4.1
100.0%
$ 210,000
100,000
$ 310,000
18.4%
8.8
27.2%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
13.2%
43.9
15.7
72.8%
100.0%
$ 150,000
500,000
137,500
$ 787,500
$1230,500
12.2%
40.6
11.2
64.0%
100.0%
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9-13
ACCT125
Learning Objective
2
© 2006 UMT
Apply financial
statement analysis to
assess the solvency of
a business.
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9-14
ACCT125
Solvency Analysis
Solvency is the ability of a business to meet its financial
obligations (debts) as they are due.
Solvency analysis focuses on the ability of a business to pay or
otherwise satisfy its current and noncurrent liabilities.
This ability is normally assessed by examining balance sheet
relationships.
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9-15
ACCT125
Solvency Measures — The Short-Term Creditor
Working Capital and Current Ratio
2004
Current assets
$550,000
Current liabilities 210,000
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2003
$533,000
243,000
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9-16
ACCT125
Solvency Measures — The Short-Term Creditor
Working Capital and Current Ratio
2004
Current assets
$550,000
Current liabilities 210,000
Working capital
$340,000
2003
$533,000
243,000
$290,000
Use: To indicate the ability to meet
currently maturing obligations.
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9-17
ACCT125
Solvency Measures — The Short-Term Creditor
Working Capital and Current Ratio
2004
Current assets
$550,000
Current liabilities 210,000
Working capital
$340,000
Current ratio
2.6
2003
$533,000
Divide
243,000
$290,000 current
2.2 assets by
current
liabilities
Use: To indicate the ability to meet
currently maturing obligations.
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9-18
ACCT125
Solvency Measures — The Short-Term Creditor
Acid-Test Ratio
2004
2003
Quick assets:
Cash
$ 90,500 $ 64,700
Marketable securities
75,000
60,000
Accounts receivable (net) 115,000 120,000
Total
$280,500 $244,700
Current liabilities
$210,000 $243,000
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9-19
ACCT125
Solvency Measures — The Short-Term Creditor
Acid-Test Ratio
2004
2003
Quick assets:
Cash
$ 90,500 $ 64,700
Marketable securities
75,000
60,000
Accounts receivable (net) 115,000 120,000
Total
$280,500 $244,700
Current liabilities
$210,000 $243,000
Acid-test ratio
1.3
1.0
Use: To indicate instant debt-paying ability.
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9-20
ACCT125
Solvency Measures — The Short-Term Creditor
Accounts Receivable Turnover
Net sales on account
Accounts receivable (net):
Beginning of year
End of year
Total
Average
© 2006 UMT
2004
2003
$1,498,000 $1,200,000
$ 120,000 $ 140,000
115,000
120,000
$ 235,000 $ 260,000
$ 117,500 $ 130,000
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9-21
ACCT125
Solvency Measures — The Short-Term Creditor
Accounts Receivable Turnover
Net sales on account
Accounts receivable (net):
Beginning of year
End of year
Total
Average
Accts. receivable turnover
2004
2003
$1,498,000 $1,200,000
$ 120,000 $ 140,000
115,500
120,000
$ 235,000 $ 260,000
$ 117,500 $ 130,000
12.7
9.2
Use: To assess the efficiency in collecting
receivables and in the management of credit.
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9-22
ACCT125
Solvency Measures — The Short-Term Creditor
Number of Days’ Sales in Receivables
2004
2003
Accounts receivable (net)
end of year
$ 115,000 $ 120,000
Net sales on account
$1,498,000 $1,200,000
Average daily sales on
on account (sales  365) $
4,104 $
3,288
Number of days’ sales in
receivables
28
36.5
Use: To assess the efficiency in collecting
receivables and in the management of credit.
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9-23
ACCT125
Solvency Measures — The Short-Term Creditor
Inventory Turnover
Cost of goods sold
Inventories:
Beginning of year
End of year
Total
Average
© 2006 UMT
2004
2003
$1,043,000 $ 820,000
$ 283,000 $ 311,000
264,000
283,000
$ 547,000 $ 594,000
$ 273,500 $ 297,000
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9-24
ACCT125
Solvency Measures — The Short-Term Creditor
Inventory Turnover
Cost of goods sold
Inventories:
Beginning of year
End of year
Total
Average
Inventory turnover
2004
2003
$1,043,000 $ 820,000
$ 283,000 $ 311,000
264,000
283,000
$ 547,000 $ 594,000
$ 273,500 $ 297,000
3.8
2.8
Use: To assess the efficiency in the
management of inventory.
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9-25
ACCT125
Solvency Measures — The Short-Term Creditor
Number of Days’ Sales in Inventory
2004
Inventories, end of year $ 264,000
Cost of goods sold
$1,043,000
Average daily cost of
goods sold
(COGS  365)
$
2,858
Number of days’ sales
in inventory
92.4
2003
$283,000
$820,000
$
2,247
125.9
Use: To assess the efficiency in the
management of inventory.
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9-26
ACCT125
Solvency Measures — The Long-Term Creditor
Ratio of Plant Assets to Long-Term Liabilities
Fixed assets (net)
Long-term liabilities
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2004
$444,500
$100,000
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2003
$470,000
$200,000
9-27
ACCT125
Solvency Measures — The Long-Term Creditor
Ratio of Fixed Assets to Long-Term Liabilities
Fixed assets (net)
Long-term liabilities
Ratio of fixed assets to
long-term liabilities
2004
$444,500
$100,000
2003
$470,000
$200,000
4.4
2.4
Use: To indicate the margin of safety
to long-term creditors.
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9-28
ACCT125
Solvency Measures — The Long-Term Creditor
Ratio of Liabilities to Stockholders’ Equity
2004
Total liabilities
$310,000
Total stockholders’ equity $829,500
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2003
$443,000
$787,500
9-29
ACCT125
Solvency Measures — The Long-Term Creditor
Ratio of Liabilities to Stockholders’ Equity
2004
Total liabilities
$310,000
Total stockholders’ equity $829,500
Ratio of liabilities to
stockholders’ equity
0.37
2003
$443,000
$787,500
0.56
Use: To indicate the margin of safety to creditors.
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9-30
ACCT125
Solvency Measures — The Long-Term Creditor
Number of Times Interest Charges Earned
2004
2003
Income before income tax
$ 900,000 $ 800,000
Add interest expense
300,000
250,000
Amount available for interest $1,200,000 $1,050,000
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9-31
ACCT125
Solvency Measures — The Long-Term Creditor
Number of Times Interest Charges Earned
2004
2003
Income before income tax
$ 900,000 $ 800,000
Add interest expense
300,000
250,000
Amount available for interest $1,200,000 $1,050,000
Number of times earned
4.0
4.2
Use: To assess the risk to debtholders in terms
of number of times interest charges were
earned.
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9-32
ACCT125
Learning Objective
3
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Apply financial
statement analysis to
assess the profitability
of a business.
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9-33
ACCT125
Profitability Analysis
Profitability is the ability of an entity to earn profits.
This ability to earn profits depends on the effectiveness and
efficiency of operations as well as resources available.
Profitability analysis focuses primarily on the relationship
between operating results reported in the income statement and
resources reported in the balance sheet.
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9-34
ACCT125
Profitability Measures — The Common Stockholder
Ratio of Net Sales to Assets
2004
2003
$1,498,000 $1,200,000
Net sales
Total assets:
Beginning of year
$1,053,000 $1,010,000
End of year
1,044,500
1,053,000
Total
$2,097,500 $2,063,000
Average
$1,048,750 $1,031,500
Excludes long-term investments
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9-35
ACCT125
Profitability Measures — The Common Stockholder
Ratio of Net Sales to Assets
2004
2003
$1,498,000 $1,200,000
Net sales on account
Total assets:
Beginning of year
$1,053,000 $1,010,000
End of year
1,044,500
1,053,000
Total
$2,097,500 $2,063,000
Average
$1,048,750 $1,031,500
Ratio of net sales to assets
1.4
1.2
Use: To assess the effectiveness
of the use of assets.
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9-36
ACCT125
Profitability Measures — The Common Stockholder
Rate Earned on Total Assets
Net income
Plus interest expense
Total
Total assets:
Beginning of year
End of year
Total
Average
© 2006 UMT
2004
$ 91,000
6,000
$ 97,000
2003
$ 76,500
12,000
$ 88,500
$1,230,500 $1,187,500
1,139,500
1,230,500
$2,370,000 $2,418,000
$1,185,000 $1,209,000
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9-37
ACCT125
Profitability Measures — The Common Stockholder
Rate Earned on Total Assets
2004
$ 91,000
6,000
$ 97,000
2003
$ 76,500
12,000
$ 88,500
Net income
Plus interest expense
Total
Total assets:
Beginning of year
$1,230,500 $1,187,500
End of year
1,139,500
1,230,500
Total
$2,370,000 $2,418,000
Average
$1,185,000 $1,209,000
Rate earned on total assets
8.2%
7.3%
Use: To assess the profitability of the assets.
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9-38
ACCT125
Profitability Measures — The Common Stockholder
Rate Earned on Stockholders’ Equity
Net income
Stockholders’ equity:
Beginning of year
End of year
Total
Average
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2004
$ 91,000
2003
$ 76,500
$ 787,500
$ 750,000
829,500
787,500
$1,617,000 $1,537,500
$ 808,500
$ 768,750
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9-39
ACCT125
Profitability Measures — The Common Stockholder
Rate Earned on Stockholders’ Equity
Net income
Stockholders’ equity:
Beginning of year
End of year
Total
Average
Rate earned on equity
2004
$ 91,000
2003
$ 76,500
$ 787,500
$ 750,000
829,500
787,500
$1,617,000 $1,537,500
$ 808,500
$ 768,750
11.3%
10.0%
Use: To assess the profitability of the
investment by stockholders.
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9-40
ACCT125
Profitability Measures — The Common Stockholder
Rate Earned on Common Stockholders’ Equity
2004
2003
Net income
$ 91,000
$ 76,500
Less preferred dividends
9,000
9,000
Remainder—common stock $ 82,000
$ 67,500
Common stockholders’ equity:
Beginning of year
$ 637,500 $ 600,000
End of year
679,500
637,500
Total
$1,317,000 $1,237,500
Average
$ 658,500 $ 618,750
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9-41
ACCT125
Profitability Measures — The Common Stockholder
Rate Earned on Common Stockholders’ Equity
2004
2003
Net income
$ 91,000
$ 76,500
Less preferred dividends
9,000
9,000
Remainder—common stock $ 82,000
$ 67,500
Common stockholders’ equity:
Beginning of year
$ 637,500 $ 600,000
End of year
679,500
637,500
Total
$1,317,000 $1,237,500
Average
$ 658,500 $ 618,750
Rate earned on common equity 12.5%
10.9%
Use: To assess the profitability of the
investment by common stockholders.
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9-42
ACCT125
Profitability Measures — The Common Stockholder
Earnings Per Share on Common Stock
2004
Net income
$ 91,000
Less preferred dividends
9,000
Remainder—common stock $ 82,000
Shares of common stock
50,000
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2003
$ 76,500
9,000
$ 67,500
50,000
9-43
ACCT125
Profitability Measures — The Common Stockholder
Earnings Per Share on Common Stock
2004
Net income
$ 91,000
Less preferred dividends
9,000
Remainder—common stock $ 82,000
Shares of common stock
50,000
Earnings per share on common $1.64
2003
$ 76,500
9,000
$ 67,500
50,000
$1.35
Use: To assess the profitability of the
investment by common stockholders.
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ACCT125
Profitability Measures — The Common Stockholder
Price-Earnings Ratio
2004
Market price per share of common $20.50
Earnings per share on common
$ 1.64
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2003
$13.50
$ 1.35
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ACCT125
Profitability Measures — The Common Stockholder
Price-Earnings Ratio
2004
Market price per share of common $20.50
Earnings per share on common
$ 1.64
Price-earnings ratio on common
12.5
2003
$13.50
$ 1.35
10.0
Use: To indicate future earnings prospects,
based on the relationship between
market value of common stock and
earnings.
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ACCT125
Profitability Measures — The Common Stockholder
Dividend Yield
2004
Dividends per share of common
$ 0.80
Market price per share of common $20.50
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2003
$ 0.60
$13.50
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ACCT125
Profitability Measures — The Common Stockholder
Dividend Yield
2004
Dividends per share of common
$ 0.80
Market price per share of common $41.00
Dividend yield on common stock
1.95%
2003
$ 0.60
$27.00
2.23%
Use: To indicate the rate of return to common
stockholders in terms of dividends.
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ACCT125
Learning Objective
4
© 2006 UMT
Summarize the uses
and limitations of
analytical measures.
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ACCT125
Summary of Solvency Measures
Working Capital
Current Ratio
Acid-Test Ratio
Accounts Receivable
Turnover
Number of Days’ Sales in
Receivables
Inventory Turnover
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Number of Day’s Sales in
Inventory
Ratio of Fixed Assets to Longterm Liabilities
Ratio of Liabilities to
Stockholder’s Equity
Number of Times Interest
Charges Earned
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ACCT125
Summary of Profitability
Measures
Ratio of Net Sales to Assets
Rate Earned on Total Assets
Rate Earned on Stockholders’
Equity
Rate Earned on Common
Stockholders’ Equity
© 2006 UMT
Earning Per Share of
Common Stock
Price/Earnings Ratio
Dividends Per Share of
Common Stock
Dividend Yield
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ACCT125
Summary of Analytical Measures
Percentages, ratios, turnover rates, and other measure of
financial performance are useful indicators of past
performance and predictors of future performance.
However, analytic measures cannot substitute for sound
judgment.
In selecting an interpreting analytical measures, you must
take into account conditions peculiar to a given industry.
Moody’s, among others, publishes comparison ratios for a
number of industries.
Historical records are perhaps the best indicator of the firm’s
future performance, so analyses of trends in ratios over time
is more helpful than a single “snapshot” view of the ratios.
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ACCT125
Learning Objective
5
© 2006 UMT
Describe the contents
of corporate annual
reports.
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ACCT125
Corporate Annual Reports
In addition to financial statements, the
annual report includes:
1.
2.
3.
4.
5.
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Financial Highlights
President’s Letter to the Stockholders
Management Report
Independent Auditors’ Report
Historical Summary
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ACCT125
Financial Highlights
Sometimes called Results in Brief, the financial highlights
summarizes the operating results of the firm.
The President’s Letter usually offers reasons for an increase
or decrease in net income, changes in plans, purchases and
sales of plants, new financial commitments, social
responsibility, and future plans.
Management Discussion and Analysis provides critical
information to inform investors.
All publicly held companies must have an independent audit
of their financial statements. The Independent Auditor’s
Report usually offers a meaningless endorsement.
The Historical Summary presents past results to enable
horizontal comparison to the current period.
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