Accounting Principles, 5e

1
CHAPTER 18 FINANCIAL STATEMENT ANALYSIS
2
Objectives of Financial Statement Analysis

• F/S are historical data
• But we need estimated future data to make
  decisions
• However, we can start with historical data
• actual and credible
• compiled by mgt
• audited by independent CPAs
• monitored by SEC
• reviewed by investment analysts
• So F/S provide actual numbers to benchmark to
• PYs internal budgets other companies,

3
BASICS OF FINANCIAL
STATEMENT ANALYSIS

• Analyzing financial statements involves a
  Companys
• Liquidity
• Profitability
• Solvency.
• Comparisons can be made on several difference
  bases
• intracompany basis
• industry averages
• intercompany basis.

4
TOOLS OF FINANCIAL
STATEMENT ANALYSIS

• 1 Horizontal analysis (trend analysis) evaluates
  a series of financial statement data over a
  period of time.
• 2 Vertical analysis evaluates financial statement
  data expressing each item in a financial
  statement as a percent of a base amount.
• 3 Ratio analysis expresses the relationship among
  selected items of financial statement data.

5
HORIZONTAL ANALYSIS BALANCE SHEETS
6
HORIZONTAL ANALYSIS INCOME STATEMENTS
7
HORIZONTAL ANALYSIS - RETAINED EARNINGS
STATEMENTS
8
VERTICAL ANALYSIS - BALANCE SHEETS
9
VERTICAL ANALYSIS - INCOME STATEMENTS
10
FINANCIAL RATIO CLASSIFICATIONS
11
(1) CURRENT RATIO
Current Assets Current Liabilities
12
CURRENT ASSETS OF QUALITY DEPARTMENT STORE
13
(2) ACID-TEST RATIO
Quick Assets Current Liabilities
Cash, Mkt Sec, A/R
14
(3) Receivables Turnover

• Net Credit Sales
• Average Net Receivables

15
(4) Inventory Turnover

• Cost of Good Sold
• Average Inventory

16
(5) PROFIT MARGIN RATIO
Net Income Net Sales
17
(6) Asset Turnover
Net SalesAverage Assets Measure of efficiency of
assets to produce sales
18
(7) Return on Assets
Net IncomeAverage Assets
19
(8) RETURN ON COMMON STOCKHOLDERS EQUITY
Net Income Ave. Com. SH Equity




Guideline gt 15
20
(9) EARNINGS PER SHARE
Net Income Wtd Ave Com. Shares
O/S
2007
2006
263,800
208,500
9.67
7.72


27,000 27,540
27,000

2
No Guideline compare to PY if gt, its ok,
drives stock market up and down.
21
(10) PRICE-EARNINGS RATIO
MV per Share C/S Earnings per Share
2007
2006
145
93
15.0 times
12 times
9.67
7.72
Industry average

18 times
22
(11) PAYOUT RATIO
Cash Dividends Net Income
Industry average

14.5
23
(12) Debt to Total Assets Ratio

• Total Debt
• Total Assets
• 2007 2006
• 832,000 45.30 800,000 50.20
• 1,835,000 1,595,000
• Industry Average38.00

24
(13) TIMES INTEREST EARNED
Income Before Income Tx Int Exp Interest
Expense
25
(14) GROSS PROFIT RATIO
Gross Profit Net Sales
2007
2006
816,000
697,000
38.90
37.92
2,097,000
1,837,000





















26
(15) OPERATING EXPENSE RATIO
Operating Expenses (S,GA) Net Sales
2007
2006
357,000
320,000
17.02
17.42
2,097,000
1,837,000





















27
LIMITATIONS OF FINANCIAL ANALYSIS

• 1 Estimates Financial statements contain
  numerous estimates
• 2 Cost Traditional financial statements are
  based on cost and are not adjusted for
  price-level changes.
• 3 Alternative Accounting Methods Variations
  among companies in the application of GAAP may
  hamper comparability.
• 4 Atypical Data Fiscal year-end data may not be
  typical of the financial condition during the
  year.
• 5.Diversification of Firms Diversification in
  industry restricts usefulness of financial
  analysis.

28
Irregular Items

• Irregular items are separately identified on
  the income statement
• Discontinued operations
• Extraordinary items
• These items are added to NI and EPS (but
  separately disclosed)

29
Earning Power and Irregular Items
Reporting when both Discontinued Operations
and Extraordinary Items are
present.
Discontinued Operations
Extraordinary Item
LO 6 Understand the concept of earning power,
and how irregular items are presented.
30
Extraordinary Items

• Change in Accounting Principle
• Occurs when the principle used in the current
  year is different from the one used in the
  preceding year.
• Accounting rules permit a change if justified.
• Changes are reported retroactively.
• Example would include a change in inventory
  costing method such as FIFO to average cost.

31
Quality of Earnings
A company that has a high quality of earnings
provides full and transparent information that
will not confuse or mislead users of the
financial statements.

• Companies have incentives to manage income to
  meet or beat Wall Street expectations, so that
• the market price of stock increases and
• the value of stock options increase.

LO 7 Understand the concept of quality of
earnings.
32
Quality of Earnings

• Alternative Accounting Methods
• Variations among companies in the application of
  GAAP may hamper comparability and reduce quality
  of earnings.

• Pro Forma Income
• Pro forma income usually excludes items that the
  company thinks are unusual or nonrecurring.
• Some companies have abused the flexibility that
  pro forma numbers allow.

LO 7 Understand the concept of quality of
earnings.
33
Quality of Earnings

• Improper Recognition
• Some managers have felt pressure to continually
  increase earnings and have manipulated the
  earnings numbers to meet these expectations.
• Abuses include
• Improper recognition of revenue (channel
  stuffing).
• Improper capitalization of operating expenses
  (WorldCom).
• Failure to report all liabilities (Enron).

34
(No Transcript)