dess financial analysis

17-1

CHAPTER 17CHAPTER 17ANALYSIS AND

INTERPRETATION OFFINANCIAL STATEMENTS

17-2

Horizontal Analysis Vertical Analysis Common-Size Statements Trend Percentages Ratio Analysis

Methods ofMethods ofFinancial Statement AnalysisFinancial Statement Analysis

17-3

Horizontal AnalysisHorizontal Analysis

Using comparative financial statements to calculate dollar

or percentage changes in a financial statement item from

one period to the next

17-4

Vertical AnalysisVertical Analysis

For a single financial statement, each item

is expressed as a percentage of a

significant total, e.g., all income

statement items are expressed as a

percentage of sales

17-5

Common-Size StatementsCommon-Size Statements

Financial statements that show only percentages and no absolute dollar amounts

17-6

Trend PercentagesTrend PercentagesShow changes over time in

given financial statement items (can help evaluate financial

information of several years)

17-7

Ratio AnalysisRatio AnalysisExpression of logical relationships

between items in a financial statement of a single period (e.g., percentage relationship

between revenue and net income)

17-8

Horizontal Analysis ExampleHorizontal Analysis ExampleThe management of Clover Company provides you with comparative balance sheets of the years ended December 31, 1999 and 1998. Management asks you to

prepare a horizontal analysis horizontal analysis on the information.

17-10

Calculating Change in Dollar Amounts

DollarChange

Current YearFigure

Base YearFigure= –

Horizontal Analysis ExampleHorizontal Analysis Example

17-11

Calculating Change in Dollar Amounts

Since we are measuring the amount of the change between 1998 and 1999, the

dollar amounts for 1998 become the “base” year figures.

DollarChange

Current YearFigure

Base YearFigure= –


17-12

Calculating Change as a Percentage

PercentageChange

Dollar Change Base Year Figure 100%= ×


17-13

$12,000 – $23,500 = $(11,500)


17-14

($11,500 ÷ $23,500) × 100% = 48.9%


17-15


17-16

Let’s apply the sameprocedures to the

liability and stockholders’equity sections of the

balance sheet.


17-17

CLOVER CORPORATIONComparative Balance SheetsDecember 31, 1999 and 1998

Increase (Decrease)1999 1998 Amount %

Liabilities and Stockholders' EquityCurrent liabilities: Accounts payable 67,000$ 44,000$ 23,000$ 52.3 Notes payable 3,000 6,000 (3,000) (50.0) Total current liabilities 70,000 50,000 20,000 40.0Long-term liabilities: Bonds payable, 8% 75,000 80,000 (5,000) (6.3) Total liabilities 145,000 130,000 15,000 11.5Stockholders' equity: Preferred stock 20,000 20,000 - 0.0 Common stock 60,000 60,000 - 0.0 Additional paid-in capital 10,000 10,000 - 0.0 Total paid-in capital 90,000 90,000 - 0.0Retained earnings 80,000 69,700 10,300 14.8 Total stockholders' equity 170,000 159,700 10,300 6.4Total liabilities and stockholders' equity 315,000$ 289,700$ 25,300$ 8.7

17-18

Now, let’s apply the procedures to theincome statement.


17-19

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31, 1999 and 1998Increase (Decrease)

1999 1998 Amount %Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income 17,500$ 22,400$ (4,900)$ (21.9)

17-20




Sales increased by 8.3% while net income decreased by 21.9%.

17-21




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.

17-22

Vertical Analysis ExampleVertical Analysis ExampleThe management of Sample Company asks

you to prepare a vertical analysis vertical analysis for the comparative balance sheets of the

company.

17-23

Vertical Analysis ExampleVertical Analysis Example

17-24


$82,000 ÷ $483,000 = 17% rounded$30,000 ÷ $387,000 = 8% rounded

17-25


$76,000 ÷ $483,000 = 16% rounded

17-26

Trend Percentages ExampleTrend Percentages ExampleWheeler, Inc. provides you with the

following operating data and asks that you prepare a trend analysis.

17-27

Trend Percentages ExampleTrend Percentages ExampleWheeler, Inc. provides you with the

following operating data and asks that you prepare a trend analysis.

$1,991 - $1,820 = $171$1,991 - $1,820 = $171

17-28

Trend Percentages ExampleTrend Percentages ExampleUsing 1995 as the base year, we develop

the following percentage relationships.

$1,991 - $1,820 = $171$1,991 - $1,820 = $171$171 ÷ $1,820 = 9% rounded$171 ÷ $1,820 = 9% rounded

17-29

Trend linefor Sales

17-30

Ratios can be expressed in three different ways:

1. Ratio (e.g., current ratio of 2:1) 2. % (e.g., profit margin of 2%) 3. $ (e.g., EPS of $2.25)

CAUTION! “Using ratios and percentages without considering the underlying causes may be

hazardous to your health!” lead to incorrect conclusions.”

RatiosRatios

17-31

Categories of RatiosCategories of Ratios Liquidity Ratios

Indicate a company’s short-term debt-paying ability

Equity (Long-Term Solvency) RatiosShow relationship between debt and equity financing in a company

Profitability TestsRelate income to other variables

Market TestsHelp assess relative merits of stocks in the marketplace

17-32

Liquidity RatiosCurrent (working capital) ratioAcid-test (quick) ratio Cash flow liquidity ratioAccounts receivable turnoverNumber of days’ sales in accounts

receivableInventory turnover Total assets turnover

651

10 Ratios You Must Know10 Ratios You Must Know

17-33

Equity (Long-Term Solvency) RatiosEquity (stockholders’ equity) ratio Equity to debt


17-34

Profitability Tests Return on operating assetsNet income to net sales (return on

sales or “profit margin”“profit margin”)Return on average common

stockholders’ equity (ROEROE) Cash flow marginEarnings per share Times interest earned Times preferred dividends earned

$


17-35

Market Tests Earnings yield on common stockPrice-earnings ratio Payout ratio on common stock Dividend yield on common stock Dividend yield on preferred stock Cash flow per share of common

stock


17-36

Now, let’s look at Norton

Corporation’s 1999 and 1998 financial

statements.

17-40

Now, let’s calculate the 10 ratios based

on Norton’s financial statements.

17-41

NORTON CORPORATION1999

Cash 30,000$ Accounts receivable, net Beginning of year 17,000 End of year 20,000 Inventory Beginning of year 10,000 End of year 12,000 Total current assets 65,000 Total current liabilities 42,000 Sales on account 494,000 Cost of goods sold 140,000

We will use this

informationto calculatethe liquidity

ratios for Norton.

17-42

Working Capital*Working Capital*

12/31/99Current assets 65,000$ Current liabilities (42,000) Working capital 23,000$

The excess of current assets over current liabilities.

* While this is not a ratio, it does give an indication of a company’s liquidity.

17-43

Current (Working Capital) RatioCurrent (Working Capital) Ratio

CurrentRatio

$65,000 $42,000= = 1.55 : 1

Measures the abilityof the company to pay current

debts as they become due.

CurrentRatio

Current Assets Current Liabilities=

#1#1

17-44

Acid-Test (Quick) RatioAcid-Test (Quick) Ratio

Quick Assets Current Liabilities=Acid-Test

Ratio

Quick assets are Cash,Marketable Securities,

Accounts Receivable (net) andcurrent Notes Receivable.

#2#2

17-45


Ratio

Norton Corporation’s quick assets consist of cash of

$30,000 and accounts receivable of $20,000.

Acid-Test (Quick) RatioAcid-Test (Quick) Ratio#2#2

17-46


Ratio

$50,000 $42,000 = 1.19 : 1=Acid-Test

Ratio

Acid-Test (Quick) RatioAcid-Test (Quick) Ratio#2#2

17-47

Sales on Account Average Accounts Receivable

Accounts ReceivableTurnover

=

Accounts Receivable TurnoverAccounts Receivable Turnover

= 26.70 times $494,000 ($17,000 + $20,000) ÷ 2

Accounts ReceivableTurnover

=

This ratio measures how many times a company converts its

receivables into cash each year.

#3#3 Average, net accounts receivable

Net, credit sales

17-48Number of Days’ SalesNumber of Days’ Salesin Accounts Receivablein Accounts Receivable

Measures, on average, how many days it takes to collect an

account receivable.

Days’ Salesin AccountsReceivables

= 365 Days Accounts Receivable Turnover

= 13.67 days= 365 Days 26.70 Times


#4#4

17-49Number of Days’ SalesNumber of Days’ Salesin Accounts Receivablein Accounts Receivable

In practice, would 45 days be a desirable number of days in

receivables?

#4#4Days’ Salesin AccountsReceivables

= 365 Days Accounts Receivable Turnover

= 13.67 days= 365 Days 26.70 Times


17-50

Inventory TurnoverInventory Turnover

Cost of Goods Sold Average Inventory

InventoryTurnover =

Measures the number of timesinventory is sold and

replaced during the year.

= 12.73 times $140,000 ($10,000 + $12,000) ÷ 2

InventoryTurnover =

#5#5

17-51

Inventory TurnoverInventory Turnover

Cost of Goods Sold Average Inventory

InventoryTurnover =

Would 5 be a desirable number of times for inventory to turnover?

= 12.73 times $140,000 ($10,000 + $12,000) ÷ 2

InventoryTurnover =

#5#5

17-52Equity, or Long–TermEquity, or Long–TermSolvency RatiosSolvency Ratios

This is part of the information to calculate the equity, or long-term

solvency ratios of Norton Corporation.NORTON CORPORATION

1999Net operating income 84,000$ Net sales 494,000 Interest expense 7,300 Total stockholders' equity 234,390

17-53NORTON CORPORATION1999

Common shares outstanding Beginning of year 17,000 End of year 27,400 Net income 53,690$ Stockholders' equity Beginning of year 180,000 End of year 234,390 Dividends per share 2 Dec. 31 market price/share 20 Interest expense 7,300 Total assets Beginning of year 300,000 End of year 346,390

Here is therest of the

informationwe will

use.

17-54

Equity RatioEquity Ratio

EquityRatio = Stockholders’ Equity

Total Assets

EquityRatio = $234,390

$346,390 67.7%=

Measures the proportionof total assets provided by

stockholders.

#6#6

17-55

Net Income to Net SalesNet Income to Net SalesA/K/A Return on Sales or Profit MarginA/K/A Return on Sales or Profit Margin

Net Incometo

Net Sales= Net Income

Net Sales

Net Incometo

Net Sales= $53,690

$494,000 = 10.9%

Measures the proportion of the sales dollarwhich is retained as profit.

#7#7

17-56

Net Income to Net SalesNet Income to Net SalesA/K/A Return on Sales or Profit MarginA/K/A Return on Sales or Profit Margin

Net Incometo

Net Sales= Net Income

Net Sales

Net Incometo

Net Sales= $53,690

$494,000 = 10.9%

Would a 1% return on sales be good?

#7#7

17-57Return on Average Common Return on Average Common Stockholders’ Equity (ROE)Stockholders’ Equity (ROE)

Return onStockholders’

Equity=

Net Income Average Common

Stockholders’ Equity

= $53,690 ($180,000 + $234,390) ÷ 2 = 25.9%

Return onStockholders’

EquityImportant measure of theincome-producing ability

of a company.

#8#8

17-58

Earningsper Share

Earnings Available to Common StockholdersWeighted-Average Number of Common

Shares Outstanding=

Earningsper Share

$53,690 (17,000 + 27,400) ÷ 2= = $2.42

The financial press regularly publishesactual and forecasted EPS amounts.

#9#9Earnings Per ShareEarnings Per Share

17-59

Price-Earnings RatioPrice-Earnings RatioA/K/A P/E MultipleA/K/A P/E Multiple

Price-EarningsRatio

Market Price Per Share EPS=

Price-EarningsRatio = $20.00

$ 2.42 = 8.3 : 1

#10#10

Provides some measure of whether the stock is under or overpriced.

dess financial analysis

Documents