Chapter 14 Analyzing Financial Statements

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potential investors should evaluate the company’s future income and growth potential on the basis of industry factors and economy-wide factors as well as individual company factors. cash flows.:     • Slides From 5 To 6 Slides # 27 Slides From 46 To 48 Investment Decision Issues: In considering an investment decision in the stock of a corporation. return.etc) 1..on-investments. 2 .…etc)  Industry Factors "Micro Level Thinking"(Such as: raw material existence. companies’ future earnings and stock prices…. EPS…. • Importatnt Investment Factors: Economy Factors "Macro Level Thinking" (Such as: political stability. supply. trained labors.  N.etc) • Return on an equity investment:   Earning dividends (Long-Term Investment) Increase in share price (Short-Term Investment) • Three types of financial statement information: Past Performance (Such as: Income. sales volume. demand vs.B: This is a very Important Chapter Ignore the following Slides from "Chapter 14 Presentation" – Not taken in 9th financial lecture . competitions…etc)   Company’s Factors (Such as: company’s financial statements .

Change in precentage = Change in amount / base (oldest) year Net Sales 2009 2008 $ 200. debt.etc) 2. 3. Horizontal Analysis (Trend Analysis) Vertical Analysis (Component Percentages) Ratio and Percentage Analysis Horizontal Analysis  • It is a comparison of the same company with previous year only to identify trends over time . 2. Future Performance (Such as: Sales and earnings trends are good indicators of future performance …. • Tools of Financial Statement Analysis 1.Present Condition (Such as: Assets. Comparison with similar companies or major competitors (Cross Sectional analysis) 2.000 $ 160..000 25 %  Trend Analysis (Gross Rate) 3 .000 Change Amount precentage $ 40.Change in amount = current (recent) year amount – base (oldest) year amount . Comparison with industry average 3.etc)  Financial Statement Analysis • Financial statement analysis is based on comparisons 1. inventory. Comparison with previous years for single company to identify trends over time (Time series analysis) 3.. various ratios ….

000 25 % 125% 100% •  Vertical Analysis (Component Percentages) Express each item on a particular statement as a percentage of a single base amount. •  On the income statement.2009) . We take oldest year amount as a base (100%) and dividing each year over the base to get gross presentage as shown in this example (Comparison of Net Sales from 2004 to 2009) 2009 2008 2007 2006 2005 2004 $ $ $ $ $ $ 200.000 152.It is a special case of Horizontal Analysis by comparing company's values with previous years (5 or 6 years) to identify trends over time.000 160.000 • 167 % 133 % 127 % 121 % 108 % 100 % • For the previous Trend Analysis (Net Sales from The Gross Rate in 2004 .000 $ 40. the base amount is Net Sales 4 .we can draw Sales between 2004 & results to gross percentage identify trends over time graphically 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 167% 133% 127% 121% 108% 100% 2009 2008 2007 2006 2005 2004 Applying Trend Analysis on 1st Example Net Sales Change 2009 2008 Amount precentage $ 200.000 145.000 $ 160.000 130.000 120.

5 % Gross Profit Margin= (Gross Profit / Net sales) *100 % = 32.5 % 15.55 % 0.25 % 20.6 % 12 % 0. On the balance sheet. the base amount is Total Assets • Vertical analysis of the income statement expresses each item as a percentage of the net sales figure.25 % Vertical Analysis 100 % 67.5 % 2. Example.75 % 0.5 % 32. In each column the net sales figure is used as the base.000 - The percentage of COGS per Sales is = (COGS / Net sales) *100 % = 67. the income statement for the month ended 31/3/ 2007: • As we discussed before: Given that: cost of goods sold = $ 270. • Every amount in the column is expressed as a percentage of net sales.25 % 0. or 100 percent.000 & Net Sales = $ 400. To compute an item’s percentage of net sales.75 % 7.3 % 0. divide the amount of that item by the amount of net sales.25 % 5 .06 % 12 % 4.5 % Profit Margin (ROS)= (Net Income / Net sales) *100 % = 7.

Debt to Equity Ratio (D2E) = (Total Liabilities / Stockholders' Equity) X 100% Financial Leverage or Leverage Multiplier = Total Assets / Stockholders' Equity 3. 6 . Debt Ratio (D2A) = (Total Liabilities / Total Assets) X 100% 2. Ratio and Percentage Analysis Summary of all ratios taken in "Accounting & Financial" course  Solvency Ratios (Long-Run Tests): 1.

Current Ratio = Current Assets / Current Liabilities 2. 4. Cash Ratio = Cash & Cash Equivalent / Current Liabilities Working Capital = Current Assets – Current Liabilities  Profitability Ratios: 1. Of Shares 7 3. Quick Ratio (ACID Test) = Quick Assets / Current Liabilities = (Cash & Cash Equivalent + Marketable Securities + Account Receivable) / Current Liabilities 3. . 4. Return on Equity (ROE) = (Net Income / Average Owners' Equity) X 100% Return on Assets (ROA) = (Net Income / Average Total Assets) X 100% Gross Profit Margin (GPM) = (Gross Profit / Net Sales) X 100% Earnings Per Share (EPS) = Net Income / No. Liquidity Ratios (Short-Run Tests): 1. 5. Return on Sales (ROS) or Net Profit Margin = (Net Income / Net Sales) X 100% 2.

Total Assets Turnover = Net Sales / Average Total Assets 2.days 4. Inventory Turnover = Net Sales or COGS/ Average Inventory = ----. 5. ROE Profit Driver Analysis: ROE  = Net Profit Net Profit Margin (ROS) Margin (ROS) X Asset Asset Turnover Turnover X Financial Financial Leverage Leverage Efficiency (Assets Management) Ratios: 1.times Inventory Turnover in days (Average Days’ Supply in Inventory) 8.days 6.times Accounts Payables Turnover in days (Average Age of Payables) = 365/ Accounts Payables Turnover = ----. Accounts Payable Turnover = COGS / Average Accounts Payable = ----. Fixed Assets Turnover = Net Sales / Average Fixed Assets Accounts Receivables Turnover =Net Credit Sales/ Average Net Accounts Receivables = ----.times 3. 7. 8 . Accounts Receivables Turnover in days (Average Collection Period or Average Age of Receivables) = 365/ Accounts Receivables Turnover = ----.

days 9.= 365/ Inventory Turnover = ----. Quality of Income (Quality of Earning) = Cash Flow from Operating Activities/ Net Income  Market Tests Ratios: 1.Price/Earnings Ratio = Current Market Price Per Share/ Earnings Per Share 2.Dividend Yield Ratio = Dividends Per Share / Market Price Per Share 9 .

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