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How Well Am I Doing?Financial Statement
Analysis
Chapter14
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Limitations of Financial Statement Analysis

• Differences in accounting methods between
  companies sometimes make comparisons difficult.

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Limitations of Financial Statement Analysis
Analysts should look beyond the ratios.
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Statements in Comparative and Common-Size Form
Analytical techniques used to examine
relationships among financial statement items

• Dollar and percentage
• changes on statements

• Common-size statements

• Ratios

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Horizontal Analysis

• Horizontal analysis shows the changes between
  years in the financial data in both dollar and
  percentage form.

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Horizontal Analysis

• Calculating Change in Dollar Amounts

2001 is the base year.
Calculating Change as a Percentage
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Horizontal Analysis
Information on the following slides illustrate a
horizontal analysis of Clover, Cos December 31,
2002 and 2001, comparative balance sheets and
income statements.
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Horizontal Analysis
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Horizontal Analysis
12,000 23,500 (11,500)
(11,500 23,500) 100 48.9
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Horizontal Analysis
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Horizontal Analysis
Lets move from the Balance Sheet to the Income
Statement of Clover Co.
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Horizontal Analysis
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Horizontal Analysis
Sales increased by 8.3 yet net income decreased
by 21.9.
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Horizontal Analysis
There were increases in both cost of goods sold
(14.3) and operating expenses (2.1). These
increased costs more than offset the increase in
sales, yielding an overall decrease in net income.
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Trend Analysis
Trend percentages state several years
financial data in terms of a base year, which
equals 100 percent.
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Trend Analysis
Look at the income information for Berry, Inc.
for the years 2002 through 2006. We will do a
trend analysis on these amounts to see what we
can learn about the company.
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Trend Analysis

• Berry, Inc.Income Information
• For the Years Ended December 31

The base year is 2002, and its amounts will equal
100.
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Trend Analysis

• Berry, Inc.Income Information
• For the Years Ended December 31

2003 Amount 2002 Amount 100 ( 290,000
275,000 ) 100 105 ( 198,000 190,000
) 100 104 ( 92,000 85,000 )
100 108
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Trend Analysis

• Berry, Inc.Income Information
• For the Years Ended December 31

Trends at Berry, Inc., indicated that cost of
goods sold is increasing faster than sales, which
is slowing the increase in gross margin.
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Trend Analysis
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Common-Size Statements
Common-size statements use percentages to express
the relationship of individual components to a
total within a single period. This is also known
as vertical analysis.
Lets take another look at the information from
the comparative income statements of Clover Co.
for 2002 and 2001.
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Common-Size Statements
Net sales is usually the base and is expressed as
100.
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Common-Size Statements
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Gross Margin Percentage
Gross profit percentage indicates how much of
each sales dollar is left after deducting the
cost of goods sold to cover operating expenses
and a profit.
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Common-Size Statements
What conclusions can we draw?
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Lets use the financial statements of Norton
Corporation to complete a ratio analysis.
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Ratio Analysis The Common Stockholder

• Use this information to calculate ratios to
  measure the well-being of the common stockholders
  of Norton Corporation.

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Earnings Per Share
Indicates how much income was earned for each
share of common stock outstanding.
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Price-Earnings Ratio
This measure is often used by investors as a
general guideline in gauging stock values.
Generally, the higher the price-earnings ratio,
the more opportunity a company has for growth.
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Dividend Payout Ratio
Gauges the portion of current earnings being paid
out in dividends. Investors seeking current
income would like this ratio to be large.
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Dividend Yield Ratio
Dividend Yield Ratio
Dividends Per Share Market Price Per Share

Identifies the return, in terms of cash
dividends, on the current market price of the
stock.
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Return on Total Assets
Measures how well assets have been employed.
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Return on Common Stockholders Equity
Indicates how well the company employed the
owners investments to earn income.
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Financial Leverage

• Financial leverage involves acquiring assets
  with funds at a fixed rate of interest.

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Book Value Per Share
Measures the amount that would be distributed to
holders of each share of common stock if all
assets were sold at their balance sheet carrying
amounts and if all creditors were paid off.
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Ratio Analysis The Short-Term Creditor

• We will use this information to calculate
  ratios to measure the well-being of the
  short-term creditors for Norton Corporation.

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Working Capital
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Current Ratio
Measures the ability of the company to pay
current debts as they become due.
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Acid-Test (Quick) Ratio
Quick assets are Cash, Marketable Securities,
Accounts Receivable and current Notes Receivable.
This ratio is like the current ratio but excludes
current assets such as inventories that may be
difficult to quickly convert into cash.
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Accounts Receivable Turnover
Measures how many times a company converts its
receivables into cash each year.
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Average Collection Period
Measures, on average, how many days it takes to
collect an account receivable.
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Inventory Turnover
Measures the number of times merchandise
inventory is sold and replaced during the year.
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Average Sale Period
Measures how many days, on average, it takes to
sell the inventory.
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Ratio Analysis The Long-Term Creditor

• Use this information to calculate ratios to
  measure the well-being of the long-term creditors
  for Norton Corporation.

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Times Interest Earned Ratio
The most common measure of the ability of a
firms operations to provide protection to the
long-term creditor.
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Debt-to-Equity Ratio
Measures the amount of assets being provided by
creditors for each dollar of assets being
provided by the owners of the company.
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Published Sources of Financial Ratios
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End of Chapter 14