Managerial Accounting
Weygandt • Kieso • Kimmel
Financial Statement Analysis:
The Big Picture
Chapter 14
Prepared by
Alice Sineath
Forsyth Technical Community College
And
Ellen Sweat
Georgia Perimeter College
1
Chapter 14
Financial Statement Analysis: The Big
Picture
After studying Chapter 14, you should be able to:
• Describe and apply horizontal analysis.
• Describe and apply vertical analysis.
• Identify and compute ratios used in
analyzing a company’s liquidity, solvency,
and profitability.
• Understand the concept of quality of
earnings.
2
Comparative Analysis
• Any item reported in a financial statement has
significance if:
– Its inclusion indicates that the item exists at a given
time and in a certain quantity.
• For example, when Kellogg Company reports $136.4
million on its balance sheet as cash, we know that
Kellogg did have cash and that the quantity was
$136.4 million.
3
Comparative Analysis
• Whether the amount represents an increase
over prior years, or whether it is adequate in
relation to the company's needs, cannot be
determined from the amount alone.
• The amount must be compared with other
financial data to provide more information.
4
Comparative Analysis
There are three types of comparisons to
provide decision usefulness of financial
information:
• Intracompany basis
• Intercompany basis
• Industry averages
5
Intracompany Basis
• Comparisons within a company are often useful
to detect changes in financial relationships and
significant trends.
• A comparison of Kellogg's current year's cash
amount with the prior year's cash amount shows
either an increase or a decrease.
• A comparison of Kellogg's year-end cash
amount with the amount of total assets at yearend shows the proportion of total assets in the
form of cash.
6
Intercompany Basis
• Comparisons with other companies provide
insight into a company's competitive position.
• Kellogg's total sales for the year can be compared
with the total sales of its competitors such as
Quaker Oats and General Mills.
7
Industry Averages
• Comparisons with industry averages provide
information about a company's relative
position within the industry.
• Kellogg's financial data can be compared with
the averages for its industry compiled by
financial ratings organizations such as Dun &
Bradstreet, Moody's, and Standard & Poor's.
8
Financial Statement Analysis
Three basic tools are used in financial statement
analysis :
• Horizontal analysis
• Vertical analysis
• Ratio analysis
9
Horizontal Analysis
• Is a technique for evaluating a series of financial
statement data over a period of time.
• Purpose is to determine whether an increase or
decrease has taken place.
• The increase or decrease can be expressed as either
an amount or a percentage.
10
Horizontal Analysis
11
Percentage Change in Sales
The percentage change in sales for each of the 5 years,
assuming 1997 as the base period is:
Kellogg Company
Net Sales (in millions)
Base Period 1997
2001
2000
1999
$8,853.3
$6,954.7
$6,984.2
129.62%
101.82 %
102.26%
1998
1997
$6762.1
$6,830.1
99%
100.0%
12
Horizontal Analysis
of a Balance Sheet
KELLOGG COMPANY, INC.
Condensed Balance Sheets
December 31
(In millions)
Increase (Decrease)
during 2001
2001
Assets
Current Assets
Plant assets
Other assets
Total assets
2000
Amount
$ 1,902.0 $1,617.1 $ 284.9
2,952.8 2,526.9
425.9
5,513.8
742.0 4,771.8
$10,368.6 $4,886.0 $5,482.6
Percent
17.6
16.9
643.1
112.2
13
Horizontal Analysis
of a Balance SheetIncrease (Decrease)
2001
Liabilities and
Stockholders' Equity
Current liabilities
$ 2,207.6
Long-term liabilities
7,289.5
Total liabilities
9,497.1
Stockholders' equity
Common stock
195.3
Retained earnings
and other
1,013.3
Treasury stock
(337.1)
Total stockholders'
equity
871.5
Total liabilities and
stockholders' equity $10,368.6
2000
during 2001
Amount Percent
$2,482.3
1,506.2
3,988.5
$ (274.7)
5,783.3
5,508.6
(11.1)
384.0
138.1
205.8
(10.5)
(5.1)
1,065.7
(374.0)
(52.4)
36.9
(4.9)
9.9
897.5
(26.0)
(2.9)
$4,886.0
$5,482.6
112.2
14
KELLOGG COMPANY, INC.
Condensed Income Statement
For the Years Ended December 31
(In millions)
2001
Net sales
$ 8,853.3
Cost of goods sold
4,128.5
Gross profit
4,724.8
Selling & Admin.
3,523.6
Nonrecurring charges
33.3
Income from operations 1,167.9
Interest expense
351.5
Other income
(expense), net
(12.3)
Income before taxes
804.1
Income tax expense
322.1
Net income
$ 482.0
2000
$6,954.7
3,327.0
3,627.7
2,551.4
86.5
989.8
137.5
Increase (Decrease)
during 2001
Amount Percent
$1,898.6
27.3
801.5
24.1
1,097.1
30.2
972.2
38.1
(53.2) (61.5)
178.1
18.0
214.0
155.6
15.4
867.7
280.0
$ 587.7
(27.7) (179.9)
(63.6)
(7.3)
42.1
15.0
$ (105.7) (18.0)
15
Let’s Review
In horizontal analysis, each item is
expressed as a percentage of the:
a.
b.
c.
d.
net income amount.
stockholders’ equity amount.
total assets amount.
base-year amount.
16
Let’s Review
In horizontal analysis, each item is
expressed as a percentage of the:
a.
b.
c.
d.
net income amount.
stockholders’ equity amount.
total assets amount.
base-year amount.
17
Vertical Analysis
• Is a technique for evaluating financial
statement data that expresses each item
in a financial statement as a percent of
a base amount.
• Total assets is always the base amount
in vertical analysis of a balance sheet.
• Net sales is always the base amount in
vertical analysis of an income
statement.
18
KELLOGG COMPANY, INC.
Condensed Balance Sheets
December 31
(In millions)
2001
Assets
Amount Percent
Current Assets $ 1,902.0
18.3
Property Assets
2,952.8
28.5
Other assets
5,513.8
53.2
Total assets
$10,368.6 100.0%
2000
z
Amount
Percent
$1,617.1
33.1
2,526.9
51.7
742.0
15.2
$4,886.0
100.0%
19
KELLOGG COMPANY, INC.
Condensed Balance Sheets
December 31
(In millions)
2001
Liabilities and
Amount
2000
Percent* Amount Percent*
Stockholders' Equity
Current liabilities
Long-term liabilities
Total liabilities
Stockholders' equity
Common stock
Retained earnings
and other
Treasury stock
Total stockholders'
equity
Total liabilities and
stockholders' equity
$ 2,207.6
7,289.5
9,497.1
91.6
21.3
$2,482.3
70.3
1,506.2
3,988.5
81.6
50.8
30.8
195.3
1.9
205.8
4.2
1,013.3
(337.1)
9.8
(3.3)
1,065.7
(374.0)
21.8
(7.6)
871.5
8.4
$10,368.6
100.0
897.5
$4,886.0
18.4
100.0
*Percentages may be rounded up or down
20
KELLOGG COMPANY, INC.
Condensed Income Statement
For the Years Ended December 31
(In millions)
2001
Amount Percent*
$8,853.3
100.0
Net sales
Cost of goods sold 4,128.5
Gross profit
4,724.8
Selling & admin.
3,523.6
Nonrecurring chgs.
33.3
Income operations 1,167.9
Interest expense
351.5
Other income
(expense),net
(12.3)
Income before
income taxes
804.1
Income tax ex.
322.1
Net income
$ 482.0
*Percentages may be rounded up
46.6
53.4
39.8
0.4
13.2
4.0
(0.1)
9.1
3.6
5.5
or down
2000
Amount Percent*
$6,954.7
100.0
3,327.0
3,627.7
2,551.4
86.5
989.8
137.5
47.8
52.2
36.7
1.3
14.2
2.0
15.4
0.2
867.7
280.0
$ 587.7
12.4
4.0
8.4
21
Condensed Income Statements
For the Year Ended December 31, 2001
(in millions)
Kellogg Company, Inc.
Amount Percent*
Net sales
Cost of goods sold
Gross profit
Selling and administrative
expenses
Nonrecurring charges
Income from operations
Other expenses and
revenues (including
income taxes)
Net income
General Mills,Inc
Amount Percent*
$8,853.3 100.0
4,128.5 46.6
4,724.8 53.4
$7,949.0 100.0
4,767.0 60.0
3,182.0 40.0
3,523.6 39.8
33.3 0.4
1,167.9 13.2
1,909.0 24.0
190.0 2.4
1,083.0 13.6
685.9
$ 482.0
7.7
5.5
622.0
$ 461.0
7.8
5.8
*Percentages may be rounded up or down
22
Ratio Analysis
23
Ratios
• Three types:
Liquidity ratios
Solvency ratios
Profitability ratios
• Can provide clues to underlying conditions that
may not be apparent from an inspection of the
individual components.
• Single ratio by itself is not very meaningful.
24
Liquidity Ratios
Measure the short-term ability of the
enterprise to pay its maturing
obligations and to meet unexpected
needs for cash.
WHO CARES?
Short-term creditors such as bankers
and suppliers
25
Liquidity Ratios
•
•
•
•
•
•
•
Working capital
Current ratio
Current cash debt coverage ratio
Inventory turnover ratio
Days in inventory
Receivables turnover ratio
Average collection period
26
Working Capital
Indicates immediate short-term debtpaying ability
Current Assets - Current Liabilities
27
Current Ratio
Indicates short-term debt-paying ability
Current Assets
Current Liabilities
28
Current Cash Debt
Coverage Ratio
Indicates short-term debt-paying ability
(cash basis)
Cash provided by operations
Average current liabilities
29
Inventory Turnover Ratio
Indicates liquidity of inventory
Cost of Goods Sold
Average Inventory
30
Days in Inventory
Indicates liquidity of inventory and
inventory management
365 days
Inventory Turnover Ratio
31
Receivables Turnover Ratio
Indicates liquidity of receivables
Net Credit Sales
Average Gross Receivables
32
Average Collection Period
Indicates liquidity of receivables and
collection success.
365 days
Receivables Turnover Ratio
33
Solvency Ratios
Measure the ability of the enterprise to
survive over a long period of time
WHO CARES?
Long-term creditors and stockholders
34
Solvency Ratios
•
•
•
•
Debt to total assets ratio
Cash debt coverage ratio
Times interest earned ratio
Free cash flow
35
Debt to Total Assets Ratio
Indicates % of total assets provided by
creditors
Total Liabilities
Total Assets
36
Cash Debt Coverage Ratio
Indicates long-term debt-paying ability
(cash basis)
Cash provided by operations
Average total liabilities
37
Times Interest Earned Ratio
Indicates company’s ability to meet interest
payments as they come due
Net Income Before Interest
Expense & Income Tax
Interest Expense
38
Free Cash Flow
Indicates cash available for paying dividends or expanding
operations
Cash Provided By Operations
-
Capital Expenditures
-
Dividends Paid
Free Cash Flow
39
Profitability Ratios
Measure the income or operating success of an enterprise
for a given period of time
WHO CARES? Everybody
WHY? A company’s income affects:
• its ability to obtain debt and equity financing
• its liquidity position
• its ability to grow

40
Profitability Ratios
•
•
•
•
•
•
•
•
Earnings per share (EPS)
Price-earnings ratio
Gross profit rate
Profit margin ratio
Return on assets ratio
Assets turnover ratio
Payout ratio
Return on common stockholders’ equity ratio
41
Earnings Per Share (EPS)
Indicates net income earned on each
share of common stock sales
Net Income - Preferred Stock
Average common shares outstanding
42
Price Earnings Ratio
Indicates relationship between market
price per share and earnings per share
Stock Price Per Share
Earnings Per Share
43
Gross Profit Rate
Indicates margin between selling
price and cost of good sold
Gross profit
Net sales
44
Profit Margin Ratio
Indicates net income generated by each
dollar of sales
Net income
Net sales
Higher value suggests favorable
return on each dollar of sales.
45
Return On Assets Ratio
Reveals the amount of net income
generated by each dollar invested
Net income
Average total assets
Higher value suggests favorable
efficiency.
46
Asset Turnover Ratio
Indicates how efficiently assets are
used to generate sales
Net sales
Average total assets
47
Payout Ratio
Indicates % of earnings distributed in the
form of cash dividends
Cash dividends decl. on common stock
Net income
48
Return on Common Stockholders’
Equity Ratio
Indicates profitability of common
stockholders’ investment
Net income - preferred stock dividends
Average common stockholders’ equity
49
Limitations Of
Financial Analysis
• Horizontal, vertical, and ratio analysis are
frequently used in making significant
business decisions.
• One should be aware
of the limitations of
these tools and the
financial statements.
50
Alternative Accounting Methods
• One company may use the FIFO method,
while another company in the same
industry may use LIFO.
• If the inventory is significant for both
companies, it is unlikely that their current
ratios are comparable.
• In addition to differences in inventory
costing methods, differences also exist in
reporting such items as depreciation,
depletion, and amortization.
51
Quality of Earnings
Indicates the level of full and transparent
information that is provided to users of the
financial statements.
52
Pro Forma Income
A measure of the net income generated
that usually excludes items that the
company thinks are unusual or
nonrecurring.
53
Relationships among Profitability
Measures
54
Let’s Review
In vertical analysis, the base amount for
depreciation expense is generally:
a. net sales.
b. depreciation expense in a previous year.
c. gross profit.
d. fixed assets.
55
Let’s Review
In vertical analysis, the base amount for
depreciation expense is generally:
a. net sales.
b. depreciation expense in a previous year.
c. gross profit.
d. fixed assets.
56
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57