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© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin lide 4-1 FINANCIAL STATEMENT ANALYSIS Chapte r 14

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Page 1: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-1

FINANCIAL STATEMENT ANALYSIS

Chapter

14

Page 2: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-2

Internal Users External Users

Financial statement analysis helps users make better decisions.

Financial statement analysis helps users make better decisions.

ManagersOfficers

Internal Auditors

ShareholdersLenders

Customers

Purpose of AnalysisPurpose of Analysis

Page 3: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-3

G row thin sales

Return tostockholders

Profitm argins

Return onequity

Determ ined byanalyzing the

financialstatem ents.

F inanc ia l m easures a re often usedto rank corpora te perform ance .

E xam ple m easures inc lude :

Purpose of AnalysisPurpose of Analysis

Page 4: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-4

Resultsin standardized,

m eaningfulsubtotals.

Item s w ith certaincharacteristics aregrouped together.

C lass ifiedF inanc ia l

S ta tem ents

Helps identifysignificant

changes andtrends.

Am ounts fromseveral years

appear side by side.

C om para tiveF inanc ia l

S ta tem ents

Presented as ifthe tw o com panies

are a singlebusiness unit.

Inform ation for theparent and subsidiary

are presented.

C onsolida tedF inanc ia l

S ta tem ents

Financial Statements Are Designed for Analysis

Financial Statements Are Designed for Analysis

Page 5: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-5

Dollar & Percentage

Changes

Trend Percentages

Component Percentages

Ratios

Tools of AnalysisTools of Analysis

Page 6: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-6

Dollar Change:

Analysis Period Amount

Analysis Period Amount

Base PeriodAmount

Base PeriodAmount

DollarChangeDollar

Change == ––

Percentage Change:

Dollar Change Base PeriodAmount

PercentChange = ÷%%

Dollar and Percentage ChangesDollar and Percentage Changes

Page 7: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-7

Sales and earningsshould increase atm ore that the rate

of inflation.

In m easuring quarterlychanges, com pare tothe sam e quarter inthe previous year.

Percentages m ay bem isleading w hen the

base am ount is sm all.

E va lua ting Percentage C hangesin S a les and E arnings

Dollar and Percentage ChangesDollar and Percentage Changes

Page 8: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-8

Let’s look at the asset section of Clover Corporation’s

comparative balance sheet and income statement for 2003 and

2002.

Compute the dollar change and the percentage for cash.

Let’s look at the asset section of Clover Corporation’s

comparative balance sheet and income statement for 2003 and

2002.

Compute the dollar change and the percentage for cash.

Dollar and Percentage ChangesExample

Dollar and Percentage ChangesExample

Page 9: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-9

CLOVER CORPORATIONComparative Balance Sheets

December 31,

2003 2002Dollar

ChangePercent Change*

AssetsCurrent assets: Cash and equivalents 12,000$ 23,500$ ? ? 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$

* Percent rounded to one decimal point.

Page 10: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-10

CLOVER CORPORATIONComparative Balance Sheets

December 31,

2003 2002Dollar

ChangePercent Change*

AssetsCurrent assets: Cash and equivalents 12,000$ 23,500$ (11,500)$ ? 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$

* Percent rounded to one decimal point.

$12,000 – $23,500 = $(11,500)$12,000 – $23,500 = $(11,500)

Page 11: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-11

CLOVER CORPORATIONComparative Balance Sheets

December 31,

2003 2002Dollar

ChangePercent Change*

AssetsCurrent assets: Cash and equivalents 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$

* Percent rounded to one decimal point.

($11,500 ÷ $23,500) × 100% = 48.94%($11,500 ÷ $23,500) × 100% = 48.94%

Complete the analysis for

the other assets.

Complete the analysis for

the other assets.

Page 12: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-12

CLOVER CORPORATIONComparative Balance Sheets

December 31,

2003 2002Dollar

ChangePercent Change*

AssetsCurrent assets: Cash and equivalents 12,000$ 23,500$ (11,500)$ -48.9% Accounts receivable, net 60,000 40,000 20,000 50.0% Inventory 80,000 100,000 (20,000) -20.0% Prepaid expenses 3,000 1,200 1,800 150.0%

Total current assets 155,000$ 164,700$ (9,700) -5.9%

Property and equipment: Land 40,000 40,000 - 0.0% Buildings and equipment, net 120,000 85,000 35,000 41.2%

Total property and equipment 160,000$ 125,000$ 35,000 28.0%

Total assets 315,000$ 289,700$ 25,300$ 8.7%

* Percent rounded to one decimal point.

Page 13: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-13

Trend analysis is used to reveal patterns in data covering successive periods.

Trend analysis is used to reveal patterns in data covering successive periods.

TrendPercent

Analysis Period Amount Base Period Amount

100%= ×

Trend AnalysisTrend Analysis

Page 14: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-14

1999 is the base period so its amounts will equal 100%.

1999 is the base period so its amounts will equal 100%.

Berry ProductsIncome Information

For the Years Ended December 31,

Item 2003 2002 2001 2000 1999Revenues 400,000$ 355,000$ 320,000$ 290,000$ 275,000$ Cost of sales 285,000 250,000 225,000 198,000 190,000 Gross profit 115,000 105,000 95,000 92,000 85,000

Item 2003 2002 2001 2000 1999Revenues 400,000$ 355,000$ 320,000$ 290,000$ 275,000$ Cost of sales 285,000 250,000 225,000 198,000 190,000 Gross profit 115,000 105,000 95,000 92,000 85,000

Item 2003 2002 2001 2000 1999Revenues 105% 100%Cost of sales 104% 100%Gross profit 108% 100%

Item 2003 2002 2001 2000 1999Revenues 105% 100%Cost of sales 104% 100%Gross profit 108% 100%

Item 2003 2002 2001 2000 1999Revenues 145% 129% 116% 105% 100%Cost of sales 150% 132% 118% 104% 100%Gross profit 135% 124% 112% 108% 100%

Item 2003 2002 2001 2000 1999Revenues 145% 129% 116% 105% 100%Cost of sales 150% 132% 118% 104% 100%Gross profit 135% 124% 112% 108% 100%

(290,000 275,000) 100% = 105%(198,000 190,000) 100% = 104%(92,000 85,000) 100% = 108%

Trend Analysis - ExampleTrend Analysis - Example

Page 15: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-15

Examine the relative size of each item in the financial statements by computing component (or common-

sized) percentages.

Component Percent

100%Analysis Amount

Base Amount= ×

Financial Statement Base Amount

Balance Sheet Total Assets

Income Statement Revenues

Financial Statement Base Amount

Balance Sheet Total Assets

Income Statement Revenues

Component PercentagesComponent Percentages

Page 16: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-16 CLOVER CORPORATION

Comparative Balance SheetsDecember 31,

Common-size Percents*

2003 2002 2003 2002Assets

Current assets: Cash and equivalents 12,000$ 23,500$ 3.8% 8.1% 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$ 100.0% 100.0%

* Percent rounded to first decimal point.

Complete the common-size analysis for the other assets.

($12,000 ÷ $315,000) × 100% = 3.8%($12,000 ÷ $315,000) × 100% = 3.8%

($23,500 ÷ $289,700) × 100% = 8.1%($23,500 ÷ $289,700) × 100% = 8.1%

13-16

Page 17: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 14-17 CLOVER CORPORATION

Comparative Balance SheetsDecember 31,

Common-size

Percents*2003 2002 2003 2002

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.

13-17

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Slide 14-18

CLOVER CORPORATIONComparative Balance Sheets

December 31, Common-size

Percents*2003 2002 2003 2002

Liabilities and Shareholders' EquityCurrent liabilities: Accounts payable 67,000$ 44,000$ Notes payable 3,000 6,000

Total current liabilities 70,000$ 50,000$

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

Total liabilities 145,000$ 130,000$

Shareholders' equity: Preferred stock 20,000 20,000 Common stock 60,000 60,000 Additional paid-in capital 10,000 10,000

Total paid-in capital 90,000$ 90,000$ Retained earnings 80,000 69,700

Total shareholders' equity 170,000$ 159,700$ Total liabilities and shareholders' equity 315,000$ 289,700$

* Percent rounded to first decimal point.

Complete the common-size analysis for the liabilities and equity accounts.

CLOVER CORPORATIONComparative Balance Sheets

December 31,

Common-size

Percents*2003 2002 2003 2002

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.

13-18

Page 19: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-19 CLOVER CORPORATION

Comparative Income StatementsFor the Years Ended December 31,

Common-size Percents*

2003 2002 2003 2002Revenues 520,000$ 480,000$ Costs and expenses: Cost of sales 360,000 315,000 Selling and admin. 128,600 126,000 Interest expense 6,400 7,000

Income before taxes 25,000$ 32,000$ Income taxes (30%) 7,500 9,600

Net income 17,500$ 22,400$

Net income per share 0.79$ 1.01$

Avg. # common shares 22,200 22,200 * Rounded to first decimal point.

Compute the common-size percentages for revenues and expenses.

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31,Common-size

Percents*2003 2002 2003 2002

Revenues 520,000$ 480,000$ 100.0% 100.0%Costs and expenses: Cost of sales 360,000 315,000 69.2% 65.6% Selling and admin. 128,600 126,000 24.7% 26.3% Interest expense 6,400 7,000 1.2% 1.5%

Income before taxes 25,000$ 32,000$ 4.8% 6.7%Income taxes (30%) 7,500 9,600 1.4% 2.0%

Net income 17,500$ 22,400$ 3.4% 4.7%

Net income per share 0.79$ 1.01$

Avg. # common shares 22,200 22,200 * Rounded to first decimal point.

13-19

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Slide 14-20

Past perform ance topresent perform ance.

Other com panies toyour com pany.

Along w ith dollar and percentage changes,trend percentages, and com ponent percentages,

ratios can be used to com pare:

A ratio is a sim ple m athem atical expressionof the relationship betw een one item and another.

RatiosRatios

Page 21: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-21

NORTON CORPORATION2003

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 15,000 Total current assets 65,000 Total current liabilities 42,000 Total liabilities 103,917 Total assets Beginning of year 300,000 End of year 346,390 Revenues 494,000

NORTON CORPORATION2003

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 15,000 Total current assets 65,000 Total current liabilities 42,000 Total liabilities 103,917 Total assets Beginning of year 300,000 End of year 346,390 Revenues 494,000

Use this information to calculate the

liquidity ratios for Norton

Corporation.

Page 22: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-22

Working capital Working capital is the excess of current assets over current liabilities.

Working capital Working capital is the excess of current assets over current liabilities.

Working CapitalWorking Capital

Page 23: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-23

CurrentRatio

Current Assets Current Liabilities

=

CurrentRatio

$65,000 $42,000

= = 1.55 : 1

This ratio measures the short-term debt-paying ability of the

company.

This ratio measures the short-term debt-paying ability of the

company.

Current RatioCurrent Ratio

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Slide 14-24

Quick assets are cash, marketable securities, and receivables.

Quick assets are cash, marketable securities, and receivables.

This ratio is like the currentratio but excludes current assets such as inventories that may be

difficult to quickly convert into cash.

This ratio is like the currentratio but excludes current assets such as inventories that may be

difficult to quickly convert into cash.

Quick Assets Current Liabilities

=QuickRatio

Quick RatioQuick Ratio

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Slide 14-25

Quick Assets Current Liabilities

=QuickRatio

$50,000 $42,000

= 1.19 : 1=QuickRatio

This ratio is like the currentratio but excludes current assets such as inventories that may be

difficult to quickly convert into cash.

This ratio is like the currentratio but excludes current assets such as inventories that may be

difficult to quickly convert into cash.

Quick RatioQuick Ratio

Page 26: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-26

A measure of creditor’s long-term risk. A measure of creditor’s long-term risk.

The smaller the percentage of assets that are financed by debt, the smaller the risk

for creditors.

A measure of creditor’s long-term risk. A measure of creditor’s long-term risk.

The smaller the percentage of assets that are financed by debt, the smaller the risk

for creditors.

Debt RatioDebt Ratio

Page 27: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-27

Ratios help usersunderstand

financial relationships.

Ratios provide forquick com parison

of com panies.

U ses

M anagem ent m ay enterinto transactions m erely

to im prove the ratios.

Ratios do not help w ithanalysis of the com pany's

progress tow ardnonfinancial goals.

Lim ita tions

Uses and Limitations of Financial Ratios

Uses and Limitations of Financial Ratios

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Slide 14-28

An income statement can be prepared in either a multiple-step or single-step format.

An income statement can be prepared in either a multiple-step or single-step format.

The single-step format is simpler.The multiple-step format provides

more detailed information.

The single-step format is simpler.The multiple-step format provides

more detailed information.

Measures of ProfitabilityMeasures of Profitability

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Slide 14-29

Proper Heading {Gross Margin {Operating Expenses {

{Non- operating Items

Income Statement (Multiple-Step) ExampleIncome Statement (Multiple-Step) Example

Remember to compute EPS.

Remember to compute EPS.

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Slide 14-30

Proper Heading {Income Statement (Single-Step) ExampleIncome Statement (Single-Step) Example

Expenses & Losses {

Revenues & Gains {

Remember to compute EPS.

Remember to compute EPS.

Page 31: Principles of Accounting/ Financial and Managerial Accounting Chapter 14

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Slide 14-31

Use this information to calculate the profitability

ratios for Norton

Corporation.

NORTON CORPORATION

2003Number of common shares outstanding all of 2003 27,400 Net income 53,690$ Shareholders' equity Beginning of year 180,000 End of year 234,390 Revenues 494,000 Cost of sales 140,000 Total assets Beginning of year 300,000 End of year 346,390

NORTON CORPORATION

2003Number of common shares outstanding all of 2003 27,400 Net income 53,690$ Shareholders' equity Beginning of year 180,000 End of year 234,390 Revenues 494,000 Cost of sales 140,000 Total assets Beginning of year 300,000 End of year 346,390

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Slide 14-32

This ratio is generally consideredthe best overall measure of a

company’s profitability.

This ratio is generally consideredthe best overall measure of a

company’s profitability.

Return On Assets (ROA)Return On Assets (ROA)

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Slide 14-33

This measure indicates how well the company employed the owners’

investments to earn income.

This measure indicates how well the company employed the owners’

investments to earn income.

Return On Equity (ROE)Return On Equity (ROE)

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Slide 14-34

Can beaudited orunaudited.

Annual andquarterlyfinancialreports.

Reports filedw ith the SEC bypublicly ow ned

com panies.

Internet andother freesources.

Detailedanalyses by

financialanalysts.

Sources of Financial InformationSources of Financial Information

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Slide 14-35

End of Chapter 14

No more ratios, please!