Analysis of Financial Statements

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Analysis ofFinancial Statements

• Topic 7

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Analytical Objectives
Financial Statement Analysis is the examination
of both the relationships among financial
statement numbers and the trends of those numbers
over time.
Major Tools Include

• Horizontal Analysis
• Common-Size Financial Statements
• Ratio Analysis

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Framework forFinancial Statement Analysis

• Horizontal Analysis (Trend Analysis)
• Analysis of a companys a series of financial
  statement data over a period of time. Its purpose
  is to determine the increase or decrease that has
  taken place, expressed as either an amount or
  percentage. It is used primarily in intracompany
  comparisons.

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Change since Current year amount Base year
amount base period
Base year amount
Current results Current year amount in
relation to base period Base
year amount
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• Common-Size Financial Statements (Vertical
  Analysis) Analysis of a companys single-year
  financial statements. Financial statements are
  standardized by a measure of size, either sales
  or total assets. All amounts are stated in terms
  of a percentage of the size measure.

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Common-Size Income Statement

• Remember that for Common-Size Income Statements,
  the denominator -- the entire pie -- is equal to
  Net Sales.

100 Net Sales
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Common-Size Income Statement

• Condensed Comparative Income Statement
• 19X1 Percent 19X0 Percent
• Net sales 5,700 100.0 6,600 100.0
• Cost of goods sold 4,000 70.2 4,800
  72.7
• Gross profit on sales 1,700 29.8 1,800
  27.3
• Selling expense 1,120 19.7 1,200 18.2
• General expense 400 7.0 440
  6.7
• Total operating expenses 1,520 26.7 1,640
  24.9
• Operating income (loss) 180 3.1 160 2.4
• Other revenue (expense) 80 1.4
  130 2.0
• Income before taxes 260 4.5 290 4.4
• Income tax 80 1.4 85 1.3
• Net income 180 3.1 205 3.1

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Common-Size Balance Sheet

• Remember that for Common-Size Balance Sheets, the
  denominator -- the entire pie -- is equal to
  the total assets for the year.
• The denominator can also be total liabilities

100 Total Assets
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Common-Size Balance Sheet

• Condensed Comparative Balance Sheet
• 19X1 19X0
• Cash 200 4.76 300 7.14
• Inventory 1,000 23.80 800 19.04
• Land Building (net) 3,000 71.43 3,200 76.19
• Total Assets 4,200 100 4,300 100
• Accounts Payable 800 19.4 1,000 23.80
• Long-Term Debt 3,000 71.43 1,500 35.71
• Total Equity 400 9.52 1,800 42.85
• Total Liab. Equity 4,200 100 4,300 100

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• Ratio Analysis Analysis of a companys financial
  statements by computing ratios and comparing them
  against both trends and industry averages.

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LIMITATIONS OF FINANCIAL ANALYSIS

• ESTIMATES F/S CONTAIN ESTIMATES (EX. DEPR. EXP.)
  IF THESE ARE INACCURATE, RATIOS AND ARE
  INACCURATE.
• COST F/S ARE BASED ON COST AND ARE NOT ADJUSTED
  FOR INFLATION
• ALTERNATIVE ACCTG METHODS A CO. MAY USE FIFO,
  ANOTHER LIFO.
• END-OF-YEAR DATA MAY NOT BE TYPICAL OF THE
  FINANCIAL CONDITION DURING THE YEAR.

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Ratio Analysis

• Liquidity ratios
• Current Ratio
• Quick Ratio
• Receivable Turnover
• Average Days Sales Uncollected
• Inventory Turnover
• Average Days Inventory On Hand

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Ratio Analysis

• Profitability ratios
• Profit Margin
• Assets Turnover
• Return on Asset
• Return on Equity
• Earnings per Share
• Price-Earnings Ratio
• Pay-Out Ratio

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Ratio Analysis

• Long-term solvency ratios
• Debt-Equity ratio
• Interest Coverage Ratio
• Debt to Total Asset Ratio
• Cash Flow Adequacy ratios
• Cash Flow Yield
• Cash Flow to Asset
• Free Cash Flow