Chapter 3 Notes

1. Comparing Financial Statements a. Comparative Horizontal Analysis: infers that the use of at least two consecutive financial statements (balance sheets, income statements, etc.) are analyzed. b. Common-size Vertical Analysis: where each item of the financial statement is converted to a percentage using a significant total; a vertical analysis is used to convert dollar values to percentages c. Trend Percentages: results when the difference in the dollar amount between two periods is divided by the dollar amount of the first period to find the percentage of change 2. Analysis and Interpretation of Financial Statements: looking at the various parts of the financial statements, relating the parts to each other and to the picture as a whole, and determining if any meaningful and useful interpretations can be made out of this analysis a. What is of one interest to one group may be of less interest to another group i. Managers use the information to make sure that departments are being run efficiently and profitably ii. Investors are interested in the net income, future earnings, and dividends arent necessarily concerned with internal documents iii. Creditors are interested in the debt paying ability (cash flow) of the company 3. Comparative Horizontal Analysis of Balance Sheets and Income Statements

a. Objective: to find and identify changes that have occurred over an accounting period b. The difference in dollar value reported between the two statements for each line item, subtotal, or total of the statement is calculated and identified as a positive or negative dollar value change the change is divided by the prior periods dollar amount to determine the percentage change c. Refer to page 100, Exhibit 3.1 to see a comparison between 2 years and the dollar and percent change d. Equation to calculate the dollar change and the percent change : Period 2 Period 1 = %Change/Period 1 = Percent Change e. Absolute Change : shows the dollar change from one period to the next f. Relative Change : the absolute change shown as a percentage

g. When analyzing comparative statements, both the relative and absolute change should be evaluated only those that both exceed acceptable norms should be of concern

4. Common-Size Vertical Analysis of Balance Sheets a. Common-size vertical analysis format is another technique used to analyze balance sheet information b. Common size the total assets have a value of 100 percent and the numerical value of each item being converted represents a fractional part of total assets. c. General equation i. n1 + n2 + n3 +nx = ? n ii. Each n would then be divided by ? n to get the percentage d. Advantage of common-size statements is that they show changes in proportion of individual accounts. 5. Comparative Horizontal Analysis of Income Statements a. Find the numerical value change and divide the change by the prior year to find the percentage of change b. Example i. (Sales revenue 004 sales revenue 003) / sales revenue 0003 = % change 6. Common-Size vertical analysis of income statements a. Total sales revenue takes the value of 100 percent and all other items on the income statement are expressed as a fraction of total sales revenue. b. Example i. (Dining sales revenue/total sales revenue) = % of total sales revenue c. All items but cost of sales are calculated this way Notes:

* One technique will identify problems that the other may not.

* Common-size vertical analysis method is the more appropriate one when comparing two companies whose size or scale of operation is quite different.

7. Average check, cost, and income per guest a. Averages for sales revenue and cost help analyze the income statement b. Per-guest average can be determined by using sales revenue/ guests, cost/ guests, or operating income/ guests i. ii. Example on p. 110 Can determine what areas have increased over a time period of a couple years

8. Trend results a. Looking over a greater number of periods allows us to see where business is headed b. Shows if business is increasing, decreasing, or leveling off c. To find trend percentage: Current period last period = $ change / last period =Trend % 9. Trend index analysis a. Index is calculated by assigning a value of 100 (or 100%) in period one for each item being calculated b. To find trend index for each period:

i. (Subsequent period / base period) * 100 10. Price and Cost Level Changes (Inflation and Deflation) a. When comparing income and expense items over a period, it is necessary to consider the implications of upwardly prices/costs (inflation), reverse (deflation). b. Examplewhen we try to compare sales revenue for successive periods in inflationary or deflationary times, we are comparing unequal values (last years dollar does not have the same value as this years) c. A method that will allow us to convert a previous periods dollar into current period dollars so trends can be analyzed is by using index numbers. d. Consumer price index is most commonly used and understood e. The equation for converting past periods dollars to current (real) dollars is: Index Number for Current Period Historic dollars X Index Number for Historic Period f. = Current dollars

Costs can be converted in the same way, using an appropriate trend index for the particular expenses or costs under review

g. Examplea wage trend index would be appropriate for adjusting cost of labor.