Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 24

Comparative Financial Statement Analysis

24-24-22

Application Application of analytical of analytical

toolstools

Application Application of analytical of analytical

toolstools

Involves Involves transforming transforming

datadata

Involves Involves transforming transforming

datadataReduces Reduces

uncertaintyuncertaintyReduces Reduces

uncertaintyuncertainty

Learning Objective 1Explain the purpose of analysis.

Financial statement analysis helps users Financial statement analysis helps users make better decisions.make better decisions.

Financial statement analysis helps users Financial statement analysis helps users make better decisions.make better decisions.

LO1

24-24-33

Learning Objective 2Identify the building blocks of analysis.

Liquidity and efficiency-ability to meet short-term obligations and to efficiently generate revenues.

Solvency-ability to generate future revenues and meet long-term obligations.

Profitability-ability to provide financial rewards sufficient to attract and retain financing.

Market prospects-ability to generate positive market expectations.

Liquidity and efficiency-ability to meet short-term obligations and to efficiently generate revenues.

Solvency-ability to generate future revenues and meet long-term obligations.

Profitability-ability to provide financial rewards sufficient to attract and retain financing.

Market prospects-ability to generate positive market expectations.

Basic information for our analysis comes from the financial statements and the notes to those statements. In some cases, we may need to develop supplemental information to complete our analysis.

LO2

24-24-44

IntracompanyIntracompany

CompetitorCompetitor

IndustryIndustry

GuidelinesGuidelines

Learning Objective 3Describe standards for comparisons in analysis.

When we complete our analysis, it is essential to compare the results we obtained to previous years within our company, those of our competitors, other companies in our same industry, and general financial market guidelines.

LO3

24-24-55

Horizontal AnalysisHorizontal AnalysisHorizontal AnalysisHorizontal AnalysisComparing a company’s financial condition and Comparing a company’s financial condition and

performance across time.performance across time.

Learning Objective 4Identify the tools of analysis.

Vertical AnalysisVertical AnalysisComparing a company’s financial condition and Comparing a company’s financial condition and

performance to a base amount.performance to a base amount.

Ratio AnalysisRatio AnalysisMeasurement of key relations between Measurement of key relations between

financial statement items.financial statement items.

LO4

24-24-66

Calculate Change in Dollar AmountCalculate Change in Dollar Amount

DollarDollarchangechangeDollarDollar

changechangeAnalysis period Analysis period

amountamountAnalysis period Analysis period

amountamountBase periodBase period

amountamountBase periodBase period

amountamount== ––

Since we are measuring the amount of Since we are measuring the amount of the change between 2009 and 2010, the the change between 2009 and 2010, the

dollar amounts for dollar amounts for 20092009 become the become the ““basebase” period amounts.” period amounts.

Learning Objective 5Explain and apply methods of horizontal analysis.

The first task that we face is establishing the base year and then calculating changes in reference to the base.In horizontal analysis, we use the oldest year shown as the base year and determine the dollar change between the base year and the current year. For this example, 2009 is its base year.

LO5

24-24-77

Comparative Statements

Calculate Change as a PercentCalculate Change as a Percent

PercentPercentchangechange

Analysis period amountAnalysis period amount Base period amountBase period amount 100100== ××

Once we establish the base year, we can calculate the percentage change by dividing the dollar change by the base year amount and multiplying by 100.

CLOVER CORPORATIONComparative Balance Sheets

December 31

Increase (Decrease)2010 2009 Amount %

AssetsCurrent assets: Cash 12,000$ 23,500$ (11,500)$ (48.9) Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200

Total current assets 155,000 164,700

Property and equipment: Land 40,000 40,000 Buildings and equipment, net 120,000 85,000

Total property and equipment 160,000 125,000

Total assets 315,000$ 289,700$

For the dollar change in cash, we subtract the base year amount of $23,500 from the current year amount of $12,000 to determine the change in cash was a negative $11,500. We know the percentage change will be negative. To determine the percentage change, we divide the dollar change of $11,500 by the base year balance of $23,500, and multiply by 100%. The percentage change is a decrease in cash of 48.9%.

For the dollar change in cash, we subtract the base year amount of $23,500 from the current year amount of $12,000 to determine the change in cash was a negative $11,500. We know the percentage change will be negative. To determine the percentage change, we divide the dollar change of $11,500 by the base year balance of $23,500, and multiply by 100%. The percentage change is a decrease in cash of 48.9%.

$12,000 – $23,500 = $(11,500) ($11,500 ÷ $23,500) × 100 = 48.9%

LO5

24-24-88

Learning Objective 6Describe and apply methods of vertical analysis.

Calculate Common-size Percent

Common-size Common-size percentpercent

Analysis amountAnalysis amountBase amountBase amount 100100= ×

Financial Statement Base Amount

Balance Sheet Total Assets

Income Statement Revenues

Financial Statement Base Amount

Balance Sheet Total Assets

Income Statement Revenues

Common size financial statements are prepared for a single period. We express all items on the statement in terms of one component of that statement. For the income statement, we normally express all items as a percent of revenues. For the balance sheet, we generally express all items as a percent of total assets.

Common size financial statements are prepared for a single period. We express all items on the statement in terms of one component of that statement. For the income statement, we normally express all items as a percent of revenues. For the balance sheet, we generally express all items as a percent of total assets.

LO6

24-24-99

CLOVER CORPORATIONComparative Balance Sheets

December 31,

Common-size

Percents*2010 2009 2010 2009

AssetsCurrent assets: Cash and equivalents 12,000$ 23,500$ 3.8% 8.1% Accounts receivable, net 60,000 40,000 19.0% 13.8% Inventory 80,000 100,000 25.4% 34.5% Prepaid expenses 3,000 1,200 1.0% 0.4%

Total current assets 155,000$ 164,700$ 49.2% 56.9%

Property and equipment: Land 40,000 40,000 12.7% 13.8% Buildings and equipment, net 120,000 85,000 38.1% 29.3%

Total property and equipment 160,000$ 125,000$ 50.8% 43.1%

Total assets 315,000$ 289,700$ 100.0% 100.0%

* Percent rounded to first decimal point.

($12,000 ÷ $315,000) × 100 = 3.8%

($23,500 ÷ $289,700) × 100 = 8.1%

We want to express all line-items on the financial statement in terms of total assets, so we set total assets equal to 100%. We calculate the percentage of total assets made up of cash and cash equivalents. We divide the total cash and cash equivalents for 2009 by the total assets for 2009, and multiply the result by 100%. At the end of 2009, cash and cash equivalents make up 3.8% of total assets. The same measure shows the percentage for 2008 to be 8.1%.

We want to express all line-items on the financial statement in terms of total assets, so we set total assets equal to 100%. We calculate the percentage of total assets made up of cash and cash equivalents. We divide the total cash and cash equivalents for 2009 by the total assets for 2009, and multiply the result by 100%. At the end of 2009, cash and cash equivalents make up 3.8% of total assets. The same measure shows the percentage for 2008 to be 8.1%.

You can see that accounts receivable make up 19% of total assets in 2010, and 13.8% in 2009. There was a drop in total current assets and an increase in property and equipment from 2009 to 2010.

You can see that accounts receivable make up 19% of total assets in 2010, and 13.8% in 2009. There was a drop in total current assets and an increase in property and equipment from 2009 to 2010.

LO6

24-24-1010

CLOVER CORPORATIONComparative Balance Sheets

December 31,

Common-size

Percents*2010 2009 2010 2009

Liabilities and Shareholders' EquityCurrent liabilities: Accounts payable 67,000$ 44,000$ 21.3% 15.2% Notes payable 3,000 6,000 1.0% 2.1%

Total current liabilities 70,000$ 50,000$ 22.2% 17.3%

Long-term liabilities: Bonds payable, 8% 75,000 80,000 23.8% 27.6%

Total liabilities 145,000$ 130,000$ 46.0% 44.9%

Shareholders' equity: Preferred stock 20,000 20,000 6.3% 6.9% Common stock 60,000 60,000 19.0% 20.7% Additional paid-in capital 10,000 10,000 3.2% 3.5%

Total paid-in capital 90,000$ 90,000$ 28.6% 31.1%Retained earnings 80,000 69,700 25.4% 24.1%

Total shareholders' equity 170,000$ 159,700$ 54.0% 55.1%Total liabilities and shareholders' equity 315,000$ 289,700$ 100.0% 100.0%

* Percent rounded to first decimal point.

Here is our vertical analysis for the liabilities and equity side of the balance sheet.

LO6

24-24-1111

Learning Objective 7Define and apply ratio analysis.

Ratios are among the more widely used tools of financial analysis because they help us uncover conditions and trends.

A ratio expresses a mathematical relation between two qualities. It can be expressed as a percent, rate, or proportion. For example the current ratio:

Current assets Current liabilities

For more ratios see Exhibit 24.7 in your book.

Current ratio ═

LO7

24-24-1212

A good analysis report usually consists of six sections:

Executive summary-brief focus on important analysis results and conclusions.Executive summary-brief focus on important analysis results and conclusions.

Analysis overview-background on the company, its industry, and its economic setting.Analysis overview-background on the company, its industry, and its economic setting.

Evidential matter-financial statements and information used in the analysis, including ratios, trends, comparisons, statistics, and all analytical measures assembled.Evidential matter-financial statements and information used in the analysis, including ratios, trends, comparisons, statistics, and all analytical measures assembled.

Assumptions-identification of important assumptions regarding a company’s industry and economic environment, and other important assumptions for estimates.Assumptions-identification of important assumptions regarding a company’s industry and economic environment, and other important assumptions for estimates.

Key factors-list of important favorable and unfavorable factors, both quantitative and qualitative.Key factors-list of important favorable and unfavorable factors, both quantitative and qualitative.

Inferences-forecasts, estimates, interpretations, and conclusions drawing on all sections of the report.Inferences-forecasts, estimates, interpretations, and conclusions drawing on all sections of the report.

LO8

Learning Objective 8Summarize and report results of financial statement

24-24-1313

End of Chapter 24