Electronic Presentation by Douglas Cloud Pepperdine University

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Survey of Accounting
Electronic Presentation by Douglas Cloud
Pepperdine University
Carl S.Warren
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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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Chapter 9
Financial Statement Analysis
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Learning Objectives

• 1. Describe basic financial statement analytical
  procedures.
• 2. Apply financial statement analysis to assess
  the solvency of a business.
• 3. Apply financial statement analysis to assess
  the profitability of a business.
• 4. Summarize the uses and limitations of
  analytical measures.
• 5. Describe the contents of corporate annual
  reports.

After studying this chapter, you should be able
to
5
Learning Objective
1
Describe basic financial statement analytical
procedures.
6
Lincoln CompanyComparative Balance
SheetDecember 31, 2004 and 2003
Increase (Decrease) 2004 20
03 Amount Percent

• Assets
• Current assets 550,000 533,000 17,000
  3.2
• Long-term investments 95,000 177,500 (82,500) (46.
  5)
• Fixed assets (net) 444,500 470,000 (25,500) (5.4)
  
• Intangible assets 50,000 50,000
• 1,139,500 1,230,500 (91,000) (7.4)
• Liabilities
• Current liabilities 210,000 243,000
  (33,000) (13.6)
• Long-term liabilities 100,000 200,000 (100,000) (5
  0.0) 310,000 443,000 (133,000) (30.0)
• Stockholders Equity
• Preferred stock, 100 par 150,000 150,000
  
• Common stock, 10 par 500,000 500,000
• Retained earnings 179,500 137,500 42,000 30.5
• 829,500 787,500 42,000 5.3
• 1,139,500 1230,500 (91,000) (7.4)

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Lincoln CompanyComparative Balance
SheetDecember 31, 2004 and 2003
Increase (Decrease) 2004 20
03 Amount Percent

• Assets
• Current assets 550,000 533,000 17,000
  3.2
• Long-term investments 95,000 177,500 (82,500) (46.
  5)
• Fixed assets (net) 444,500 470,000 (25,500) (5.4)
  
• Intangible assets 50,000 50,000
• 1,139,500 1,230,500 (91,000) (7.4)
• Liabilities
• Current liabilities 210,000 243,000
  (33,000) (13.6)
• Long-term liabilities 100,000 200,000 (100,000) (5
  0.0) 310,000 443,000 (133,000) (30.0)
• Stockholders Equity
• Preferred stock, 100 par 150,000 150,000
  
• Common stock, 10 par 500,000 500,000
• Retained earnings 179,500 137,500 42,000 30.5
• 829,500 787,500 42,000 5.3
• 1,139,500 1230,500 (91,000) (7.4)

Horizontal Analysis
Current year (2004) 550,000 Base year
(2003) 533,000
103.2
Increase amount 17,000 Base year (2003) 533,000
3.2
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Lincoln CompanyComparative Income
StatementDecember 31, 2004 and 2003
Increase (Decrease) 2004 20
03 Amount Percent

• Sales 1,530,500 1,234,000 296,500 24.0
• Sales returns 32,500 34,000 (1,500) (4.4)
• Net sales 1,498,000 1,200,000 298,000) 24.8
• Cost of goods sold 1,043,000 820,000 223,000
  27.2
• Gross profit 455,000 380,000 75,000
  19.7
• Selling expenses 191,000 147,000 44,000
  29.9
• Administrative expenses 104,000 97,400 6,600
  6.8 Total operating expenses 295,000
  244,400 50,600 20.7
• Operating income 160,000 135,600 24,400
  18.0
• Other income 8,500 11,000 (2,500) (22.7)
• 168,500 146,600 21,900 14.9
• Other expense 6,000 12,000 (6,000) (50.0)
• Income before income tax 162,500 134,600
  27,900 20.7
• Income tax 71,500 58,100 13,400 23.1
• Net income 91,000 76,500 14,500 19.0

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Lincoln CompanyComparative Income
StatementDecember 31, 2004 and 2003
Increase (Decrease) 2004 20
03 Amount Percent

• Sales 1,530,500 1,234,000 296,500 24.0
• Sales returns 32,500 34,000 (1,500) (4.4)
• Net sales 1,498,000 1,200,000 298,000) 24.8
• Cost of goods sold 1,043,000 820,000 223,000
  27.2
• Gross profit 455,000 380,000 75,000
  19.7
• Selling expenses 191,000 147,000 44,000
  29.9
• Administrative expenses 104,000 97,400 6,600
  6.8 Total operating expenses 295,000
  244,400 50,600 20.7
• Operating income 160,000 135,600 24,400
  18.0
• Other income 8,500 11,000 (2,500) (22.7)
• 168,500 146,600 21,900 14.9
• Other expense 6,000 12,000 (6,000) (50.0)
• Income before income tax 162,500 134,600
  27,900 20.7
• Income tax 71,500 58,100 13,400 23.1
• Net income 91,000 76,500 14,500 19.0

Horizontal Analysis
Current year (2004) 1,498,000 Base year
(2003) 1,200,000
124.8
Increase amount 298,000 Base year
(2003) 1,200,000
24.8
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Lincoln CompanyComparative Balance Sheets
December 31, 2004 December 31, 2003
Amount Percent Amount Percent

• Assets
• Current assets 550,000 48.3 533,000 43.3
• Long-term investments 95,000 8.3 177,500 14.4
• Fixed assets (net) 444,500 39.0 470,000 38.2
• Intangible assets 50,000 4.4 50,000 4.1
  1,139,500 100.0 1,230,500 100.0
• Liabilities
• Current liabilities 210,000 18.4
  243,000 19.7
• Long-term liabilities 100,000 8.8 200,000 16.3
• 310,000 27.2 443,000 36.0
• Stockholders Equity
• Preferred stock, 100 par 150,000 13.2
  150,000 12.2 Common stock, 10
  par 500,000 43.9 500,000 40.6
• Retained earnings 179,500 15.7 137,500 11.2
• 829,500 72.8 787,500 64.0
• 1,139,500 100.0 1230,500 100.0

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Lincoln CompanyComparative Balance Sheets
December 31, 2004 December 31, 2003
Amount Percent Amount Percent

• Assets
• Current assets 550,000 48.3 533,000 43.3
• Long-term investments 95,000 8.3 177,500 14.4
• Fixed assets (net) 444,500 39.0 470,000 38.2
• Intangible assets 50,000 4.4 50,000 4.1
  1,139,500 100.0 1,230,500 100.0
• Liabilities
• Current liabilities 210,000 18.4
  243,000 19.7
• Long-term liabilities 100,000 8.8 200,000 16.3
• 310,000 27.2 443,000 36.0
• Stockholders Equity
• Preferred stock, 100 par 150,000 13.2
  150,000 12.2 Common stock, 10
  par 500,000 43.9 500,000 40.6
• Retained earnings 179,500 15.7 137,500 11.2
• 829,500 72.8 787,500 64.0
• 1,139,500 100.0 1230,500 100.0

Vertical Analysis
Current liabilities 210,000 Total
assets 1,139,500
18.4
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Lincoln CompanyComparative Balance Sheets
December 31, 2004 December 31, 2003
Amount Percent Amount Percent
Common-Size Statements

• Assets
• Current assets 550,000 48.3 533,000 43.3
• Long-term investments 95,000 8.3 177,500 14.4
• Fixed assets (net) 444,500 39.0 470,000 38.2
• Intangible assets 50,000 4.4 50,000 4.1
  1,139,500 100.0 1,230,500 100.0
• Liabilities
• Current liabilities 210,000 18.4
  243,000 19.7
• Long-term liabilities 100,000 8.8 200,000 16.3
• 310,000 27.2 443,000 36.0
• Stockholders Equity
• Preferred stock, 100 par 150,000 13.2
  150,000 12.2 Common stock, 10
  par 500,000 43.9 500,000 40.6
• Retained earnings 179,500 15.7 137,500 11.2
• 829,500 72.8 787,500 64.0
• 1,139,500 100.0 1230,500 100.0

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Learning Objective
2
Apply financial statement analysis to assess the
solvency of a business.
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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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Solvency Measures The Short-Term Creditor
Working Capital and Current Ratio
2004 2003
Current assets 550,000 533,000 Current
liabilities 210,000 243,000
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Solvency Measures The Short-Term Creditor
Working Capital and Current Ratio
2004 2003
Current assets 550,000 533,000 Current
liabilities 210,000 243,000 Working
capital 340,000 290,000
Use To indicate the ability to meet currently
maturing obligations.
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Solvency Measures The Short-Term Creditor
Working Capital and Current Ratio
2004 2003
Current assets 550,000 533,000 Current
liabilities 210,000 243,000 Working
capital 340,000 290,000 Current ratio 2.6
2.2
Divide current assets by current liabilities
Use To indicate the ability to meet currently
maturing obligations.
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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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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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Solvency Measures The Short-Term Creditor
Accounts Receivable Turnover
2004 2003
Net sales on account 1,498,000 1,200,000 Account
s receivable (net) Beginning of year
120,000 140,000 End of year
115,000 120,000 Total 235,000
260,000 Average 117,500 130,000
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Solvency Measures The Short-Term Creditor
Accounts Receivable Turnover
2004 2003
Net sales on account 1,498,000 1,200,000 Account
s receivable (net) Beginning of year
120,000 140,000 End of year
115,500 120,000 Total 235,000
260,000 Average 117,500 130,000 Accts.
receivable turnover 12.7 9.2
Use To assess the efficiency in collecting
receivables and in the management of credit.
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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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Solvency Measures The Short-Term Creditor
Inventory Turnover
2004 2003
Cost of goods sold 1,043,000
820,000 Inventories Beginning of year
283,000 311,000 End of year
264,000 283,000 Total 547,000
594,000 Average 273,500 297,000
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Solvency Measures The Short-Term Creditor
Inventory Turnover
2004 2003
Cost of goods sold 1,043,000
820,000 Inventories Beginning of year
283,000 311,000 End of year
264,000 283,000 Total 547,000
594,000 Average 273,500 297,000 Inventory
turnover 3.8 2.8
Use To assess the efficiency in the management
of inventory.
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Solvency Measures The Short-Term Creditor
Number of Days Sales in Inventory
2004 2003
Inventories, end of year 264,000 283,000 Cost
of goods sold 1,043,000 820,000 Average daily
cost of goods sold (COGS ? 365) 2,858
2,247 Number of days sales in
inventory 92.4 125.9
Use To assess the efficiency in the management
of inventory.
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Solvency Measures The Long-Term Creditor
Ratio of Plant Assets to Long-Term Liabilities
2004 2003
Fixed assets (net) 444,500 470,000 Long-term
liabilities 100,000 200,000
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Solvency Measures The Long-Term Creditor
Ratio of Fixed Assets to Long-Term Liabilities
2004 2003
Fixed assets (net) 444,500 470,000 Long-term
liabilities 100,000 200,000 Ratio of fixed
assets to long-term liabilities 4.4 2.4
Use To indicate the margin of safety to
long-term creditors.
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Solvency Measures The Long-Term Creditor
Ratio of Liabilities to Stockholders Equity
2004 2003
Total liabilities 310,000 443,000 Total
stockholders equity 829,500 787,500
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Solvency Measures The Long-Term Creditor
Ratio of Liabilities to Stockholders Equity
2004 2003
Total liabilities 310,000 443,000 Total
stockholders equity 829,500 787,500 Ratio of
liabilities to stockholders equity 0.37 0.56

Use To indicate the margin of safety to
creditors.
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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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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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Learning Objective
3
Apply financial statement analysis to assess the
profitability of a business.
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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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Profitability Measures The Common Stockholder
Ratio of Net Sales to Assets
2004 2003
Net sales 1,498,000 1,200,000 Total
assets Beginning of year 1,053,000 1,010,000
End of year 1,044,500 1,053,000 Total 2,097,5
00 2,063,000 Average 1,048,750 1,031,500
Excludes long-term investments
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Profitability Measures The Common Stockholder
Ratio of Net Sales to Assets
2004 2003
Net sales on account 1,498,000 1,200,000 Total
assets Beginning of year 1,053,000 1,010,000
End of year 1,044,500 1,053,000 Total 2,097,5
00 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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Profitability Measures The Common Stockholder
Rate Earned on Total Assets
2004 2003
Net income 91,000 76,500 Plus interest
expense 6,000 12,000 Total 97,000
88,500 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
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Profitability Measures The Common Stockholder
Rate Earned on Total Assets
2004 2003
Net income 91,000 76,500 Plus interest
expense 6,000 12,000 Total 97,000
88,500 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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Profitability Measures The Common Stockholder
Rate Earned on Stockholders Equity
2004 2003
Net income 91,000 76,500 Stockholders
equity Beginning of year 787,500
750,000 End of year 829,500 787,500 Total 1,6
17,000 1,537,500 Average 808,500 768,750
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Profitability Measures The Common Stockholder
Rate Earned on Stockholders Equity
2004 2003
Net income 91,000 76,500 Stockholders
equity Beginning of year 787,500
750,000 End of year 829,500 787,500 Total 1,6
17,000 1,537,500 Average 808,500
768,750 Rate earned on equity 11.3 10.0
Use To assess the profitability of the
investment by stockholders.
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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 Remaindercommon stock
82,000 67,500 Common stockholders
equity Beginning of year 637,500
600,000 End of year 679,500 637,500 Total 1,3
17,000 1,237,500 Average 658,500
618,750
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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 Remaindercommon stock
82,000 67,500 Common stockholders
equity Beginning of year 637,500
600,000 End of year 679,500 637,500 Total 1,3
17,000 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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Profitability Measures The Common Stockholder
Earnings Per Share on Common Stock
2004 2003
Net income 91,000 76,500 Less preferred
dividends 9,000 9,000 Remaindercommon stock
82,000 67,500 Shares of common
stock 50,000 50,000
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Profitability Measures The Common Stockholder
Earnings Per Share on Common Stock
2004 2003
Net income 91,000 76,500 Less preferred
dividends 9,000 9,000 Remaindercommon stock
82,000 67,500 Shares of common
stock 50,000 50,000 Earnings per share on
common 1.64 1.35
Use To assess the profitability of the
investment by common stockholders.
44
Profitability Measures The Common Stockholder
Price-Earnings Ratio
2004 2003
Market price per share of common 20.50 13.50 Ear
nings per share on common 1.64 1.35
45
Profitability Measures The Common Stockholder
Price-Earnings Ratio
2004 2003
Market price per share of common 20.50 13.50 Ear
nings per share on common 1.64
1.35 Price-earnings ratio on common 12.5 10.0

Use To indicate future earnings prospects, based
on the relationship between market value of
common stock and earnings.
46
Profitability Measures The Common Stockholder
Dividend Yield
2004 2003
Dividends per share of common 0.80
0.60 Market price per share of common 20.50 13.5
0
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Learning Objective
4
Summarize the uses and limitations of analytical
measures.
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Summary of Analytical Measures
Solvency measures
Working Capital Current ratio Acid-test
ratio Accounts receivable turnover Number of
days sales in receivables Inventory turnover
Number of days sales in inventory Ratio of fixed
assets to long-term liabilities Ratio of
liabilities to stockholders equity Number of
times interest charges earned
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Summary of Analytical Measures
Profitability measures
Ratio of net sales to assets Rate earned on total
assets Rate earned on stockholders equity Rate
earned on common stockholders equity
Earnings per share on common stock Price earnings
ratio Dividends per share of common
stock Dividend yield
50
Learning Objective
5
Describe the contents of corporate annual
reports.
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Profitability Measures The Common Stockholder
Dividend Yield
2004 2003
Dividends per share of common 0.80
0.60 Market price per share of common 41.00 27.0
0 Dividend yield on common stock 1.95 2.23
Use To indicate the rate of return to common
stockholders in terms of dividends.
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Corporate Annual Reports
In addition to financial statements, the annual
report includes

• 1. Financial Highlights
• 2. Presidents Letter to the Stockholders
• 3. Management Report
• 4. Independent Auditors Report
• 5. Historical Summary

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Chapter 9
The End
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