Chapter 17

Financial Statement
Analysis
Accounting, 21st Edition
Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

© Copyright 2004 South-Western, a division
of Thomson Learning. All rights reserved.
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Some
Some of
of the
the action
action has
has been
been automated,
automated,
so
so click
click the
themouse
mouse when
when you
you see
see this
this
lightning
lightning bolt
bolt in
in the
thelower
lower right-hand
right-hand
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Objectives
Objectives
1. List the basic financial statement analytical
procedures. After
After studying
studying this
this
2. Apply financial
statement
chapter,
you
should
chapter,
youanalysis
shouldto assess the
solvency of a business.
be
be able
able to:
to:
3. Apply financial statement analysis to assess the
profitability of a business.
4. Summarize the uses and limitations of analytical
measures.
5. Describe the contents of corporate annual
reports.

Horizontal
Horizontal Analysis
Analysis
What
What isis horizontal
horizontal
analysis?
analysis?

Horizontal
Horizontal Analysis
Analysis
It’s
It’s an
an analysis
analysis of
of the
the percentage
percentage
increases
increases and
and decreases
decreases of
of
related
related items
items in
in comparative
comparative
financial
financial statements.
statements.

Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005

Balance
Balance Sheet
Sheet

Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)

$ (91,000)
(7.4%)

2006
2005
Assets
Current assets
$ 550,000 $ 533,000
Long-term investments
95,000
177,500
Fixed assets (net)
444,500
470,000
Intangible assets
50,000
50,000
Total assets
$1,139,500 $1,230,500
Liabilities
Current liabilities
$ 210,000 $ 243,000 $ (33,000)
Long-term liabilities
100,000
200,000 (100,000)
Total liabilities
$ 310,000 $ 443,000 $(133,000)
Stockholders’ Equity
Preferred 6% stock, $100 par$ 150,000 $ 150,000

Common stock, $10 par
500,000
500,000

Retained earnings
179,500
137,500 $42,000
Total stockholders’ equity $ 829,500 $ 787,500 $42,000
Total liab. & SE
$1,139,500 $1230,500 $(91,000)

(13.6%)
(50.0%)
(30.0%)

30.5%
5.3%
(7.4%)

Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005

Increase (Decrease)
2006
2005
Amount
Percent
$ 550,000 $ 533,000 $ 17,000
3.2%
95,000
177,500
(82,500) (46.5%)
444,500 Analysis:
470,000
(25,500)
(5.4%)
Horizontal
50,000
50,000

Difference
$1,139,500
$1,230,500$17,000
$ (91,000)
(7.4%)

Assets
Current assets
Long-term investments
Fixed assets (net)
Intangible assets
Total assets
=
Liabilities
Base year (2005) $533,000
Current liabilities
$ 210,000 $ 243,000 $ (33,000)
Long-term liabilities
100,000
200,000 (100,000)
Total liabilities
$ 310,000 $ 443,000 $(133,000)
Stockholders’ Equity
Preferred 6% stock, $100 par$ 150,000 $ 150,000

Common stock, $10 par
500,000
500,000

Retained earnings
179,500
137,500 $42,000
Total stockholders’ equity $ 829,500 $ 787,500 $42,000
Total liab. & SE
$1,139,500 $1230,500 $(91,000)

3.2%

(13.6%)
(50.0%)
(30.0%)

30.5%
5.3%
(7.4%)

Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005

Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)

$ (91,000)
(7.4%)

2006
2005
Assets
Current assets
$ 550,000 $ 533,000
Long-term investments
95,000
177,500
Fixed assets (net)
444,500
470,000
Intangible assets
50,000
50,000
Total assets
$1,139,500 $1,230,500
Horizontal Analysis:
Liabilities
Current liabilities
$ 210,000 $ 243,000 $ (33,000) (13.6%)
Difference
$(82,500)
Long-term liabilities
100,000
200,000 (100,000)
(50.0%)
= (46.5%)
Total liabilities
$ 310,000
$ 443,000
$(133,000) (30.0%)
Base
year (2005)
$177,500
Stockholders’ Equity
Preferred stock, $100 par $ 150,000 $ 150,000

Common stock, $10 par
500,000
500,000

Retained earnings
179,500
137,500 $42,000
30.5%
Total stockholders’ equity $ 829,500 $ 787,500 $42,000
5.3%
Total liab. & SE
$1,139,500 $1230,500 $(91,000)
(7.4%)

Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005

Okay,
Okay, go
go to
to the
the next
next slide
slideIncrease (Decrease)
2006
2005
and
the
Assets
and calculate
calculate
the Amount Percent
Current assets
$ 550,000 $ 533,000 $ 17,000
3.2%
percentage
change
for
percentage
for (82,500) (46.5%)
Long-term investments
95,000change
177,500
Fixed assets (net)
444,500
470,000
(25,500)
(5.4%)
fixed
assets.
fixed
assets.
Intangible assets
50,000
50,000

Total assets
$1,139,500 $1,230,500 $ (91,000)
(7.4%)
Liabilities
Current liabilities
Horizontal
$ 210,000 Analysis:
$ 243,000 $ (33,000) (13.6%)
Long-term liabilities
100,000
200,000 (100,000) (50.0%)
Total liabilities
$ Difference
310,000 $ 443,000 ?$(133,000) (30.0%)
= ?
Stockholders’ Equity
Base year (2005)
?
Preferred 6% stock, $100 par$ 150,000 $ 150,000

Common stock, $10 par
500,000
500,000

Retained earnings
179,500
137,500 $42,000
30.5%
Total stockholders’ equity $ 829,500 $ 787,500 $42,000
5.3%
Total liab. & SE
$1,139,500 $1230,500 $(91,000)
(7.4%)

Lincoln Company
Comparative Balance Sheet
December 31, 2006 and 2005

Increase (Decrease)
Amount
Percent
$ 17,000
3.2%
(82,500) (46.5%)
(25,500)
(5.4%)

$ (91,000)
(7.4%)

2006
2005
Assets
Current assets
$ 550,000 $ 533,000
Long-term investments
95,000
177,500
Fixed assets (net)
444,500
470,000
Intangible assets
50,000
50,000
Total assets
$1,139,500 $1,230,500
Liabilities
Current liabilities
$ 210,000 $ 243,000 $ (33,000)
Long-term liabilities
100,000
200,000 (100,000)
Total liabilities
$ 310,000 $ 443,000 $(133,000)
Stockholders’ Equity
Preferred 6% stock, $100 par$ 150,000 $ 150,000

Common stock, $10 par
500,000
500,000

Retained earnings
179,500
137,500 $42,000
Total stockholders’ equity $ 829,500 $ 787,500 $42,000
Total liab. & SE
$1,139,500 $1230,500 $(91,000)

(5.4%)
(5.4%)
(13.6%)
(50.0%)
(30.0%)

30.5%
5.3%
(7.4%)

Lincoln Company
Comparative Income Statement
December 31, 2006 and 2005

Income
Income Statement
Statement

Increase (Decrease)
2006
2005
Amount
Percent
Sales
$1,530,500$1,234,000$296,500 24.0%
Sales returns
32,50034,000(1,500)
(4.4%)
Net sales
$1,498,000$1,200,000$298,000 24.8%
Cost of goods sold
1,043,000820,000223,000
27.2%
Gross profit
$ 455,000$ 380,000$ 75,000 19.7%
Selling expenses
$ 191,000$ 147,000$ 44,000 29.9%
Administrative expenses
104,00097,4006,600
6.8%
Total operating expenses $ 295,000$ 244,400$ 50,600 20.7%
Operating income
$ 160,000$ 135,600$ 24,400 18.0%
Other income
8,50011,000(2,500)
(22.7%)
$ 168,500
$ 146,600$ 21,900 14.9%
Other expense
6,00012,000(6,000)
(50.0%)
Income before income tax $ 162,500$ 134,600$ 27,900
20.7%
Income tax
71,50058,10013,400
23.1%
Net income
$ 91,000$ 76,500$ 14,500
19.0%

Lincoln Company
Comparative Income Statement
December 31, 2006 and 2005

Increase (Decrease)
2006
2005
Amount
Percent
Sales
$1,530,500$1,234,000$296,500 24.0% 24.0%
Sales returns
32,50034,000(1,500)
(4.4%)
Net sales
$1,498,000$1,200,000$298,000 24.8%
Cost of goods sold
1,043,000820,000223,000
27.2%
Gross profit
$ 455,000$ 380,000$ 75,000 19.7%
Horizontal
Analysis:
Selling expenses
$ 191,000$
147,000$ 44,000 29.9%
Administrative expenses
104,00097,4006,600
6.8% Total
Increase
amount
$296,500
operating expenses
$ 295,000$
244,400$
50,600 20.7%
= 18.0%
24.0%
Operating income
$
160,000$
135,600$
24,400
Base year (2005) $1,234,000
Other income
8,50011,000(2,500)
(22.7%)
$ 168,500
$ 146,600$ 21,900 14.9%
Other expense
6,00012,000(6,000)
(50.0%)
Income before income tax $ 162,500$ 134,600$ 27,900
20.7%
Income tax
71,50058,10013,400
23.1%
Net income
$ 91,000$ 76,500$ 14,500
19.0%

Lincoln Company
Comparative Income Statement
December 31, 2006 and 2005

Increase (Decrease)
2006
2005
Amount
Percent
Sales
$1,530,500$1,234,000$296,500 24.0%
Sales returns
32,50034,000(1,500)
(4.4%)
Net sales
$1,498,000$1,200,000$298,000 24.8% 24.8%
Cost of goods sold
1,043,000820,000223,000
27.2%
Gross profit
$ 455,000$ 380,000$ 75,000 19.7%
Selling expenses
$ 191,000$ 147,000$ 44,000 29.9%
Administrative expenses
104,00097,4006,600
6.8% Total
operating expenses
$ 295,000$ 244,400$ 50,600 20.7%
Horizontal
Analysis:
Operating income
$ 160,000$
135,600$ 24,400 18.0%
Other income
8,50011,000(2,500)
(22.7%)
Increase
amount
$298,000
$ 168,500
$ 146,600$ 21,900 14.9%
= 24.8%
Other expense
6,00012,000(6,000)
Base year
(2005) $1,200,000 (50.0%)
Income before income tax $ 162,500$ 134,600$ 27,900
20.7%
Income tax
71,50058,10013,400
23.1%
Net income
$ 91,000$ 76,500$ 14,500
19.0%

Vertical
Vertical Analysis
Analysis
A
A percentage
percentage analysis
analysis can
can be
be
used
used to
to show
show the
the relationship
relationship
of
of each
each component
component to
to aa total
total
within
within aa single
single statement.
statement.

Vertical
Vertical Analysis
Analysis
The
The total,
total, or
or 100%
100% item,
item,
on
on the
the balance
balance sheet
sheet isis
“total
“total assets.”
assets.”

Lincoln Company
Comparative Balance Sheet
December 31, 2006
Amount Percent

Assets
Current assets
$ 550,000
Long-term investments
95,000
Property, plant, & equip. (net) 444,500
Intangible assets
50,000
Total assets
$1,139,500
Liabilities
Current liabilities
$ 210,000
Long-term liabilities
100,000
Vertical
Analysis:
Total
liabilities
$ 310,000
Stockholders’ Equity
Current assets
$550,000
Preferred stock, 6%, $100 par $ 150,000 =
Common
Totalstock,
assets
$10 par $1,139,500
500,000
Retained earnings
179,500
Total stockholders’ equity
$ 829,500
Total liab. & SE
$1,139,500

Balance
Balance
Sheet
Sheet
December
31, 2005
Amount

Percent

48.3%
8.3
39.0
4.4
100.0%

$ 533,000
177,500
470,000
50,000
$1,230,500

43.3%
14.4
38.2
4.1
100.0%

18.4%
8.8
27.2%

$ 243,000
200,000
$ 443,000

19.7%
16.3
36.0%

13.2%
48.3%

$ 150,000
500,000
137,500
$ 787,500
$1,230,500

12.2%
40.6
11.2
64.0%
100.0%

43.9
15.7
72.8%
100.0%

Lincoln Company
Comparative Balance Sheet
December 31, 2006
Amount Percent

December 31, 2005
Amount Percent

Assets
Current assets
$ 550,000
48.3%
$ 533,000 43.3%
43.3%
Long-term investments
95,000
8.3
177,500
14.4
Property, plant, & equip. (net) 444,500
39.0
470,000
38.2
Intangible assets
50,000
4.4
50,000
4.1
Total assets
$1,139,500 100.0%
$1,230,500 100.0%
Liabilities
Current liabilities
$ 210,000
18.4%
$ 243,000
19.7%
Long-term liabilities
100,000
8.8
200,000
16.3
Vertical
Analysis:
Total liabilities
$ 310,000
27.2%
$ 443,000
36.0%
Stockholders’ Equity
Current assets
$533,000
Preferred 6% stock, $100 par $ 150,000
13.2%
$ 150,000
12.2%
= 43.3%
Common stock, $10 par Total assets
500,000
43.9
$1,230,500500,000
40.6
Retained earnings
179,500
15.7
137,500
11.2
Total stockholders’ equity
$ 829,500
72.8%
$ 787,500
64.0%
Total liab. & SE
$1,139,500 100.0%
$1,230,500 100.0%

Lincoln Company
Comparative Balance Sheet
December 31, 2006
Amount Percent

Assets
Current assets
$ 550,000
Long-term investments
95,000
Property, plant, & equip. (net) 444,500
Intangible assets
50,000
Total assets
$1,139,500
Liabilities
Current liabilities
$ 210,000
Long-term liabilities
100,000
Total liabilities
$ 310,000
Stockholders’ Equity
Preferred 6% stock, $100 par $ 150,000
Common stock, $10 par
500,000
Retained earnings
179,500
Total stockholders’ equity
$ 829,500
Total liab. & SE
$1,139,500

December 31, 2005
Amount Percent

48.3%
8.3
39.0
4.4
100.0%

$ 533,000
177,500
470,000
50,000
$1,230,500

43.3%
14.4
38.2
4.1
100.0%

18.4%
8.8
27.2%

$ 243,000
200,000
$ 443,000

19.7%
16.3
36.0%

13.2%
43.9
15.7
72.8%
100.0%

$ 150,000
500,000
137,500
$ 787,500
$1,230,500

12.2%
40.6
11.2
64.0%
100.0%

Lincoln Company
Income
Income
Comparative Income Statement
Statement
For the Years Ended December 31, 2006 and 2005
Statement
2006
2005
Amount
Percent
Amount Percent
Sales
$1,530,500102.2%
$1,234,000102.8%
Sales returns
32,5002.234,000
2.8
Net sales
$1,498,000100.0%
$1,200,000100.0%
Cost of goods sold
1,043,00069.6820,000
68.3
Gross profit
$ 455,00030.4%$ 380,000
31.7%
Selling expenses
$ 191,00012.8%$ 147,000
12.3%
Net
sales
Net sales
Administrative expenses
104,0006.997,400
8.1
Total operating expenses
$ 295,00019.7%$
244,400
20.4%
isis 100.0%
100.0%
Income from operations
$ 160,00010.7$ 135,600
11.3%
Other income
8,5000.611,000
0.9
$ 168,500
11.3%$ 146,600
12.2%
Other expense
6,0000.412,000
1.0
Income before income tax
$ 162,50010.9%$ 134,600
11.2%
Income tax expense
71,5004.858,100
4.8
Net income
$ 91,0006.1%$ 76,500
6.4%

Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount
Percent
Amount Percent
Sales
$1,530,500102.2%
$1,234,000102.8%
Sales returns
32,5002.234,000
2.8
Net sales
$1,498,000100.0%
$1,200,000100.0%
Cost of goods sold
1,043,00069.6820,000
68.3
Gross profit
$ 455,00030.4%$ 380,000
31.7%
Selling expenses
$ 191,00012.8%$
147,000
12.3%
191,000
12.8%
Administrative expenses
104,0006.997,400
8.1
Total operating expenses
$ 295,00019.7%$ 244,400
20.4%
Income from operations
$ 160,00010.7$ 135,600
11.3%
Other income
8,5000.611,000
0.9
$ Vertical
168,500 Analysis:
11.3%$ 146,600
12.2%
Other expense
6,0000.412,000
1.0
Selling
Income
beforeexpenses
income tax $191,000
$ 162,50010.9%$ 134,600
11.2%
= 12.8%
Income
tax
expense
71,5004.858,100
4.8
Net sales
$1,498,000
Net income
$ 91,0006.1%$ 76,500
6.4%

Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount
Percent
Amount Percent
Sales
$1,530,500102.2%
$1,234,000102.8%
Sales returns
32,5002.234,000
2.8
Net sales
$1,498,000100.0%
$1,200,000100.0%
Cost of goods sold
1,043,00069.6820,000
68.3
Gross profit
$ 455,00030.4%$ 380,000
31.7%
Selling expenses
$ 191,00012.8%$ 147,000
12.3%
Administrative expenses
104,0006.997,400
8.1
Total operating expenses
$ 295,00019.7%$ 244,400
20.4%
Income from operations
$ 160,00010.7$ 135,600
11.3%
Other income
8,5000.611,000
0.9
$ 168,500
11.3%$ 146,600
12.2%
Other expense
6,0000.412,000
1.0
Income before income tax
$ 162,50010.9%$ 134,600
11.2%
Income tax expense
71,5004.858,100
4.8
Net income
$ 91,0006.1%$ 76,500
6.4%

Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2006 and 2005
2006
2005
Amount
Percent
Amount Percent
Sales
$1,530,500102.2%
$1,234,000102.8%
Sales returns
32,5002.234,000
2.8
Net sales
$1,498,000100.0%
$1,200,000100.0%
Cost of goods sold
1,043,00069.6820,000
68.3
Gross profit
$ 455,00030.4%$ 380,000
31.7%
Selling expenses
$ 191,00012.8%$ 147,000
12.3%
Administrative expenses
104,0006.997,400
8.1
Total operating expenses
$ 295,00019.7%$ 244,400
20.4%
Income from operations
$ 160,00010.7$ 135,600
11.3%
Other income
8,5000.611,000
0.9
$ 168,500
11.3%$ 146,600
12.2%
Other expense
6,0000.412,000
1.0
Income before income tax
$ 162,50010.9%$ 134,600
11.2%
Income tax expense
71,5004.858,100
4.8
Net income
$ 91,0006.1%$ 76,500
6.4%

Common
Common Size
Size Statements
Statements
Vertical
Vertical analysis
analysis with
with both
both dollar
dollar and
and
percentage
percentage amounts
amounts isis also
also useful
useful in
in
comparing
comparing one
one company
company with
with another
another
or
or with
with industry
industry averages.
averages. Such
Such
comparisons
comparisons are
are easier
easier to
to make
make with
with
the
the use
use of
of common-size
common-size statements
statements in
in
which
which all
all items
items are
are expressed
expressed in
in
percentages.
percentages.

Common-Size
Common-Size Income
Income Statement
Statement

Solvency
Solvency Analysis
Analysis
 Solvency is the ability of a business to
meet its financial obligations (debts) as
they are due.
 Solvency analysis focuses on the ability
of a business to pay or otherwise satisfy
its current and noncurrent liabilities.
 This ability is normally assessed by
examining balance sheet relationships.

Current Position Analysis
Working
Working Capital
Capital and
and Current
Current Ratio
Ratio
Current assets
Current liabilities
Working capital
Current ratio

2006
$550,000
210,000
$340,000
2.6

2005
$533,000
243,000
$290,000
2.2

Use:
to
meet
Use: To
To indicate
indicate the
the ability
abilityDivide
to
meet
Divide
currently
current
currently maturing
maturing obligations.
obligations.
current
assets
assetsby
by
current
current
liabilities
liabilities

Current Position Analysis
Quick
Quick Ratio
Ratio
Quick assets:
Cash
Marketable securities
Accounts receivable (net)
Total
Current liabilities
Quick ratio

2006

2005

$ 90,500
75,000
115,000
$280,500
$210,000
1.3

$ 64,700
60,000
120,000
$244,700
$243,000
1.0

Use:
Use: To
To indicate
indicate instant
instant debt-paying
debt-paying ability.
ability.

Accounts Receivable Analysis
Accounts
Accounts Receivable
Receivable Turnover
Turnover
Net sales on account
Accounts receivable (net):
Beginning of year
End of year
Total
Average (Total ÷ 2)

2006
$1,498,000

2005
$1,200,000

$ 120,000
115,500
$ 235,000
$ 117,500

$ 140,000
120,000
$ 260,000
$ 130,000

Net
Net sales
sales on
on account
account
Average
Average accounts
accounts
receivable
receivable

Accounts Receivable Analysis
Accounts
Accounts Receivable
Receivable Turnover
Turnover
Net sales on account
Accounts receivable (net):
Beginning of year
End of year
Total
Average
Accounts receivable turnover

2006
$1,498,000

2005
$1,200,000

$ 120,000
115,500
$ 235,000
$ 117,500
12.7

$ 140,000
120,000
$ 260,000
$ 130,000
9.2

Use:
Use: To
To assess
assess the
the efficiency
efficiency in
in collecting
collecting
receivables
receivables and
and in
in the
the management
management of
of credit.
credit.

Accounts Receivable Analysis
Number
Number of
of Days’
Days’ Sales
Sales in
in Receivables
Receivables
2006
Accounts receivable (net),
end of year
Net sales on account
Average daily sales on
account (sales ÷ 365)

2005

$ 115,000
$1,498,000

$ 120,000
$1,200,000

$

$

4,104

Accounts
Accounts receivable,
receivable, end
end of
of year
year
Average
Average daily
daily sales
sales on
on account
account

3,288

Accounts Receivable Analysis
Number
Number of
of Days’
Days’ Sales
Sales in
in Receivables
Receivables
2006
Accounts receivable (net),
end of year
Net sales on account
Average daily sales on
account (sales ÷ 365)
Number of days’ sales in
receivables

2005

$ 115,000
$1,498,000

$ 120,000
$1,200,000

$

$

4,104
28.0

3,288
36.5

Use:
Use: To
To assess
assess the
the efficiency
efficiency in
in collecting
collecting
receivables
receivables and
and in
in the
the management
management of
of credit.
credit.

Inventory Analysis
Inventory
Inventory Turnover
Turnover
Cost of goods sold
Inventories:
Beginning of year
End of year
Total
Average (Total ÷ 2)

Inventory turnover =

2006
$1,043,000

2005
$ 820,000

$ 283,000
264,000
$ 547,000
$ 273,500

$ 311,000
283,000
$ 594,000
$ 297,000

Cost
Cost of
of goods
goods sold
sold
Average
Average inventory
inventory

Inventory Analysis
Inventory
Inventory Turnover
Turnover
Cost of goods sold
Inventories:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Inventory turnover

2006
$1,043,000

2005
$ 820,000

$ 283,000
264,000
$ 547,000
$ 273,500
3.8

$ 311,000
283,000
$ 594,000
$ 297,000
2.8

Use:
Use: To
To assess
assess the
the efficiency
efficiency in
in the
the
management
management of
of inventory.
inventory.

Inventory Analysis
Number
Numberof
ofDays’
Days’Sales
Salesin
inInventory
Inventory
Inventories, end of year
Cost of goods sold
Average daily cost of
goods sold
(COGS ÷ 365)

Number of
Days’ Sales =
in Inventory

2006
$ 264,000
$1,043,000

2005
$283,000
$820,000

$

$

2,858

2,247

Inventories,
Inventories, end
end of
of year
year
Average
Average daily
daily cost
cost of
of goods
goods sold
sold

Inventory Analysis
Number
Numberof
ofDays’
Days’Sales
Salesin
inInventory
Inventory
Inventories, end of year
Cost of goods sold
Average daily cost of
goods sold
(COGS ÷ 365)
Number of days’ sales
in inventory

2006
$ 264,000
$1,043,000

2005
$283,000
$820,000

$

$

2,858
92.4

Use:
Use:To
To assess
assess the
the efficiency
efficiency in
in the
the
management
management of
of inventory.
inventory.

2,247
125.9

Long-Term Creditors
Ratio
Ratioof
ofFixed
FixedAssets
Assetsto
toLong-Term
Long-TermLiabilities
Liabilities
Fixed assets (net)
Long-term liabilities
Ratio of fixed assets to
long-term liabilities

2006
$444,500
$100,000
4.4

2005
$470,000
$200,000
2.4

Use:
Use: To
To indicate
indicate the
the margin
margin of
of safety
safety
to
to long-term
long-term creditors.
creditors.

Long-Term Creditors
Ratio
Ratio of
of Liabilities
Liabilities to
to Stockholders’
Stockholders’ Equity
Equity
Total liabilities
Total stockholders’ equity
Ratio of liabilities to
stockholders’ equity

2006
$310,000
$829,500

2005
$443,000
$787,500

0.37

0.56

Use:
Use: To
To indicate
indicate the
the margin
margin of
of safety
safety to
to
creditors.
creditors.

Long-Term Creditors
Number
Number of
of Times
Times Interest
Interest Charges
Charges Earned
Earned
Income before income tax
Add interest expense
Amount available for interest

Number of
Times Interest =
Charges Earned

2006
2005
$ 900,000 $ 800,000
300,000
250,000
$1,200,000 $1,050,000

Income
Income before
before
income
income tax
tax ++ interest
interest expense
expense
Interest
Interest expense
expense

Long-Term Creditors
Number
Number of
of Times
Times Interest
Interest Charges
Charges Earned
Earned
Income before income tax
Add interest expense
Amount available for interest
Number of times earned

2006
2005
$ 900,000 $ 800,000
300,000
250,000
$1,200,000 $1,050,000
4.0

Use:
Use: To
To assess
assess the
the risk
risk to
to debtholders
debtholders
in
in terms
terms of
of number
number of
of times
times
interest
interest charges
charges were
were earned.
earned.

4.2

Profitability
Profitability Analysis
Analysis
 Profitability is the ability of an entity to earn profits.
 This ability to earn profits depends on the effectiveness
and efficiency of operations as well as resources
available.
 Profitability analysis focuses primarily on the
relationship between operating results reported in the
income statement and resources reported in the balance
sheet.

The Common Stockholder
Ratio
Ratio of
of Net
Net Sales
Sales to
to Assets
Assets
Net sales
Total assets:
Beginning of year
End of year
Total
Average (Total ÷ 2)

2006
$1,498,000

2005
$1,200,000

$1,053,000
1,044,500
$2,097,500
$1,048,750

$1,010,000
1,053,000
$2,063,000
$1,031,500

Excludes
Excludes long-term
long-term investments
investments

The Common Stockholder
Ratio
Ratio of
of Net
Net Sales
Sales to
to Assets
Assets
Net sales
Total assets:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Ratio of net sales to assets

2006
$1,498,000

2005
$1,200,000

$1,053,000
1,044,500
$2,097,500
$1,048,750

$1,010,000
1,053,000
$2,063,000
$1,031,500

1.4

Use:
Use: To
To assess
assess the
the effectiveness
effectiveness of
of
the
the use
use of
of assets.
assets.

1.2

The Common Stockholder
Rate
RateEarned
Earned on
on Total
Total Assets
Assets
Net income
Plus interest expense
Total
Total assets:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Rate earned on total assets

2006
$ 91,000
6,000
$ 97,000

2005
$ 76,500
12,000
$ 88,500

$1,230,500
1,139,500
$2,370,000
$1,185,000
8.2%

$1,187,500
1,230,500
$2,418,000
$1,209,000
7.3%

Use:
Use: To
To assess
assess the
the profitability
profitability of
of the
the assets.
assets.

The Common Stockholder
Rate
Rate Earned
Earned on
on Stockholders’
Stockholders’ Equity
Equity
Net income
Stockholders’ equity:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Rate earned on stockholders’
equity

2006
$ 91,000

2005
$ 76,500

$ 787,500
829,500
$1,617,000
$ 808,500

$ 750,000
787,500
$1,537,500
$ 768,750

11.3%

10.0%

Use:
Use: To
To assess
assess the
the profitability
profitability of
of
the
the investment
investment by
by stockholders.
stockholders.

The Common Stockholder
Rate
Rate Earned
Earned on
on Common
Common Stockholders’
Stockholders’ Equity
Equity
Net income
Less preferred dividends
Remainder—common stock
Common stockholders’ equity:
Beginning of year
End of year
Total
Average (Total ÷ 2)

$
$

2006
91,000
9,000
82,000

$ 637,500
679,500
$1,317,000
$ 658,500

$
$

2005
76,500
9,000
67,500

$ 600,000
637,500
$1,237,500
$ 618,750

The Common Stockholder
Rate
Rate Earned
Earned on
on Common
Common Stockholders’
Stockholders’ Equity
Equity
Net income
Less preferred dividends
Remainder—common stock
Common stockholders’ equity:
Beginning of year
End of year
Total
Average (Total ÷ 2)
Rate earned on common
stockholders’ equity

$
$

2006
91,000
9,000
82,000

$
$

2005
76,500
9,000
67,500

$ 637,500 $ 600,000
679,500
637,500
$1,317,000 $1,237,500
$ 658,500 $ 618,750
12.5%

10.9%

Use:
Use: To
To assess
assess the
the profitability
profitability of
of the
the
investment
investment by
by common
common stockholders.
stockholders.

The Common Stockholder
Earnings
Earnings Per
Per Share
Share on
on Common
Common Stock
Stock
Net income
Less preferred dividends
Remainder—common stock
Shares of common stock

2006
$ 91,000
9,000
$ 82,000
50,000

Earnings per share on common stock

$1.64

2005
$ 76,500
9,000
$ 67,500
50,000
$1.35

Use:
Use: To
To assess
assess the
the profitability
profitability of
of the
the
investment
investment by
by common
common stockholders.
stockholders.

The Common Stockholder
Price-Earnings
Price-Earnings Ratio
Ratio
2006
Market price per share of common
$41.00
Earnings per share on common
÷ 1.64
Price-earnings ratio on common stock
25

2005
$27.00
÷ 1.35
20

Use:
Use: To
To indicate
indicate future
future earnings
earnings
prospects,
prospects, based
based on
on the
the relationship
relationship
between
between market
market value
value of
of common
common
stock
stock and
and earnings.
earnings.

The Common Stockholder
Dividend
Dividend Yield
Yield on
on Common
Common Stock
Stock
Dividends per share of common
Market price per share of common
Dividend yield on common stock

2006
$ 0.80
÷ 41.00

2005
$ 0.60
÷ 27.00

1.95%

2.22%

Use:
Use: To
To indicate
indicate the
the rate
rate of
of return
return to
to common
common
stockholders
stockholders in
in terms
terms of
of dividends.
dividends.

Corporate
Corporate Annual
Annual Reports
Reports
In addition to financial statements, the annual
report includes a management discussion analysis
(MDA) and an independent auditors’ report.
The MDA includes an analysis of the results
of operations and discusses management’s
opinion about future performance. It
compares the prior year’s income statement
with the current year’s. It also contains an
analysis of the firm’s financial condition.

Corporate
Corporate Annual
Annual Reports
Reports
In addition to financial statements, the annual
report includes a management discussion analysis
(MDA) and an independent auditors’ report.
Before issuing annual statements, all
publicly held corporations are required
to have an independent audit of their
financial statements. The CPAs who
conduct the audit render an opinion as
to the fairness of the statements.

Chapter 17
The
The End
End

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