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1Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
Financial Statement AnalysisChapter 13
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Perform a horizontal analysis
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Horizontal Analysis•Study of percentage changes from year-to-year
•Two steps:1. Compute dollar amount of change2. Divide dollar amount of change by base-period amount
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Exercise 13-16AMcMahon Music Company
Comparative Income StatementsYears Ended December 31, 2012 and 2011
2012 2011 $ Change
% Change
Total revenue $1,007,000
$917,000 $90,000
9.8%
Expenses: Cost of goods sold $477,000 $408,75
0$68,250 14.3%
Selling & gen’l expense
287,000 265,000 22,000 7.7%
Interest expense 23,500 13,500 10,000 74.1% Income tax expense
105,500 84,650 20,850 24.6%
Total expenses 893,000 771,900 121,100 15.7% Net income $184,000 $145,10
0$38,900 26.8%
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Trend Percentages•Form of horizontal analysis•Base year selected and set equal to 100%
▫Amount of each following year stated as a percent of base
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Trend %Any year
Base year
Perform a vertical analysis
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Vertical Analysis•Shows relationship of a financial-
statement item to its base▫For Income Statement, total revenue is the
base
▫For Balance Sheet, total assets is the base
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Vertical analysis %
Total revenue
Each income statement item
Prepare common-size financial statements
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Common-Size Statements•Report only vertical analysis percents▫No dollar amounts
•Help in the comparison of different companies▫Financial results in terms of a common
denominator
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Benchmarking•Compares company to a standard set by others▫Often a key competitor
•Facilitated by common-size statements
•Has goal of improvement
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Analyze the statement of cash flows
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Cash-Flow Signs of Healthy Company
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Use ratios to make business decisions
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Ratio Categories
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Ability to Pay Current Liabilities
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Working Capital & Current Ratio
17
Working capital
Current assets
Current liabilities
Current ratio
Current assets
Current liabilities
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Quick (Acid-Test) Ratio
18
Cash + Short-term investments + Net current receivables
Current liabilities
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Measuring Turnover and the Cash Conversion Cycle
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Inventory Turnover
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Cost of goods sold
Average inventory
(Beginning inventory + Ending inventory)/2)
Days’ inventory outstandi
ng
365Inventory turnover
Accounts Receivable Turnover
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Net sales
Average net accounts receivable
(Beginning net receivables + Ending net receivables)/2)
Days’-Sales-In-Receivables
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One day’s sales
Net sales
365 days
Days’ sales in average accounts
receivable
Average net accounts receivable
One day’s sales
Accounts Payables Turnover
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Cost of goods sold
Average accounts payable
365Days’ payable
outstanding Payables turnover
Cash Conversion Cycle
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DIO DPODSO
DIO = Days’ Inventory OutstandingDSO = Days’ Sales OutstandingDPO = Days’ Payable Outstanding
Measuring Leverage: Overall Ability to Pay Debts
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Debt ratio
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Total liabilities
Total assets
Times-Interest-Earned
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Income from operations
Interest expense
Exercise 13-22A
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2012 2011 Cash $50,000 $49,000 Short-term investments 28,000 27,000 Net receivables 115,000 128,000 Inventory 240,000 268,000 Prepaid expenses 22,000 8,000 Total assets 510,000 540,000 Total current liabilities 207,000 262,000 Long-term debt 97,000 174,000 Income from operations 301,000 150,000 Interest expense 41,000 42,000
Exercise 13-22A
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Working capital
Current assets
Current liabilities
Current assets
Cash + Short-term investments + Net receivables + Inventory +
Prepaid expenses
$50,000 + 28,000 + 115,000 + 240,000 + 22,000
2012
$455,000
$455,000
$262,000
$193,000
Exercise 13-22A
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Working capital
Current assets
Current liabilities
Current assets
Cash + Short-term investments + Net receivables + Inventory +
Prepaid expenses
$49,000 + 27,000 + 128,000 + 268,000 + 8,000
2011
$480,000
$480,000
$207,000
$248,000
Exercise 13-22A
31
Current ratio
Current assets
Current liabilities
$455,000 $262,0001.74
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2012
2011
$480,000
$207,0002.32
Exercise 13-22A
32
Cash + Short-term investments + Net current receivables
Current liabilities
Quick ratio 2012 =
$50,000 +28,000 + 115,000
$207,000
.93
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Exercise 13-22A
33
Cash + Short-term investments + Net current receivables
Current liabilities
Quick ratio 2011 =
$49,000 + 27,000 + 128,000
$262,000
.78
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Exercise 13-22A
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Debt ratioTotal liabilities
Total assets
Current liabilities +
Long-term debt
$207,000 +97,000$304,000
$510,000
2012
.60
2011 $262,000 + 174,000$436,000
$540,000.81
Exercise 13-22A
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Income from operations
Interest expense
Times Interest Earned
2012$301,000
$41,000
$150,000
$42,000
7.34
3.572011
Measuring Profitability
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Gross margin & Operating profit Percentages
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Operating profit %
Net sales
Gross margin Gross
margin %
Operating income
Net sales
DuPont Analysis
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Return on assets
Net profit
marginAsset
turnover
Leverage ratio
Return on equity
Leverage ratio
Return on
equity
Net incom
eNet
sales
Net sales
Average total
assets
Average total
assetsAverage common equity
Net incom
eAverage common equity
Rate of Return (Net Profit Margin) on Sales
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Net income
Net sales
Asset Turnover
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Net sales
Average total assets
Rate of Return on Total Assets
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Rate of Return on
SalesAsset
turnover
Leverage (Equity Multiplier) Ratio
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Average total assets
Average common stockholders’ equity
Rate of Return on Common Equity
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Net income – Preferred dividends
Average common stockholders’ equity
Earnings per Share
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Net income –Preferred dividends
Average number of common shares outstanding
Use other measures to make investment decisions
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Analyzing Stock Investments
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Price/Earnings Ratio
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Market price per share of common stock
Earnings per share
Dividend Yield
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Dividend per share of common stock
Market price per share of common stock
Book Value
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Total stockholders’
equityPreferred equity
Weighted-average number of common shares outstanding
Measure the economic value added by operations
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Economic Value Added (EVA ®)•Combines accounting and finance data •Measures if operations have increased
stockholder wealth▫Positive EVA® suggests increase in wealth
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Net income
Interest expense
Capital charge
Cost of Capital
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Notes payable
Current maturities
of long-term debt
Long-term debt
Stockholders’ equity
Capital charge =
Cost of
capital
Red Flags in Financial Statement Analysis•Earnings problems•Decreased cash flow•Too much debt•Inability to collect receivables•Buildup of inventories•Trends of sales, inventory and receivables
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Efficient Markets•Market prices fully reflect all information
▫Managers cannot fool market with accounting manipulations
▫Market sets fair price for stock•Appropriate investment strategy:
▫Manage risk▫Diversify investments▫Minimize transaction costs
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