principles of accounting/ financial and managerial accounting chapter 14
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© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Slide 14-1
FINANCIAL STATEMENT ANALYSIS
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
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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
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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
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Slide 14-5
Dollar & Percentage
Changes
Trend Percentages
Component Percentages
Ratios
Tools of AnalysisTools of Analysis
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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
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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
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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
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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.
© 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 = $(11,500)
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Slide 14-11
CLOVER CORPORATIONComparative Balance Sheets
December 31,
2003 2002Dollar
ChangePercent Change*
AssetsCurrent assets: Cash and equivalents 12,000$ 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 ÷ $23,500) × 100% = 48.94%
Complete the analysis for
the other assets.
Complete the analysis for
the other assets.
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Slide 14-12
CLOVER CORPORATIONComparative Balance Sheets
December 31,
2003 2002Dollar
ChangePercent Change*
AssetsCurrent assets: Cash and equivalents 12,000$ 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.
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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
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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
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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
© 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 ÷ $289,700) × 100% = 8.1%
13-16
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Slide 14-17 CLOVER CORPORATION
Comparative Balance SheetsDecember 31,
Common-size
Percents*2003 2002 2003 2002
AssetsCurrent assets: Cash and equivalents 12,000$ 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
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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
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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
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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
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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.
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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
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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
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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
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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.
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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!