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Ratio Analysis

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You are on page 1of 43

ANALYSIS OF FINANCIAL

STATEMENTS

PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA

Charles W. Caldwell, D.B.A., CMA

Jon A. Booker, Ph.D., CPA, CIA

Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

17 - 2

C1

BASICS OF ANALYSIS

Application

Application Involves

Involves

Reduces

Reduces of

of analytical

analytical transforming

transforming

uncertainty

uncertainty tools

tools data

data

Financial

Financial statement

statement analysis

analysis helps

helps users

users

make

make better

better decisions.

decisions.

Internal Users External Users

Managers Shareholders

Officers Lenders

Internal Auditors Customers

17 - 3

C1

Liquidity and

Solvency

efficiency

Market

Profitability

prospects

17 - 4

C1

1. Income Statement

2. Balance Sheet

3. Statement of Stockholders Equity

4. Statement of Cash Flows

5. Notes to the Financial Statements

17 - 5

C1

compare the results we obtained to other

standards or benchmarks.

Intracompany

Competitors

Industry

Guidelines

17 - 6

C2

TOOLS OF ANALYSIS

Horizontal Analysis

Comparing a companys financial condition and

performance across time.

Vertical Analysis

Comparing a companys financial condition and

performance to a base amount.

Ratio Analysis

Measurement of key relations between financial statement

items.

17 - 7

P1

HORIZONTAL ANALYSIS

17 - 8

P1

COMPARATIVE STATEMENTS

Calculate Change in Dollar Amount

Change = Amount Amount

change in dollar amounts, compare the

analysis

analysis period balance

balance to the

the base

base

period balance. The analysis period is

usually the current

current year while the base

period is usually the prior year.

17 - 9

P1

COMPARATIVE STATEMENTS

Calculate Change as a Percent

Change

=

Base Period Amount 100

When calculating

calculating the change

change as

as aa

percentage, divide the amount of of the

dollar change by the

the base period

period

amount, and then

then multiply

multiply by 100 to

convert to

to a percentage.

17 - 10

P1

HORIZONTAL ANALYSIS

$1,550,861

$1,550,861 $835,546

$835,546 == $715,315

$715,315

17 - 11

P1

HORIZONTAL ANALYSIS

$14,953,224

$14,953,224 $11,065,186

$11,065,186 == $3,888,038

$3,888,038

17 - 12

P1

TREND ANALYSIS

covering successive periods.

Percent

=

Base Period Amount 100

17 - 13

P1

TREND ANALYSIS

Research in Motion

Income Statement Information

Using 2006 as the base year we will get the following trend information :

Examples

Examples of of 2006-2008

2006-2008 Calculations

Calculations for

for Revenues:

Revenues:

2006

2006 is

is base

base year.

year. Set

Set to

to 100%

100%

2007:

2007: $3,037,103

$3,037,103 $2,065,845

$2,065,845 100

100 == 147.0%

147.0%

2008:

2008: $6,009,395

$6,009,395 $2,065,845

$2,065,845 100

100 == 290.9%

290.9%

17 - 14

P1

TREND ANALYSIS

graph so we can see the trend over time.

17 - 15

P2

VERTICAL ANALYSIS

Common-Size Statements

Percent

= Base Amount 100

Balance Sheet Total Assets

Income Statement Revenues

17 - 16

P2

($1,550,861

($1,550,861 $10,204,409)

$10,204,409) 100

100 == 15.2%

15.2%

($835,546

($835,546 $8,101,372)

$8,101,372) 100

100 == 10.3%

10.3%

17 - 17

P2

($8,368,958

($8,368,958 $14,953,224)

$14,953,224) 100

100 == 56.0%

56.0%

17 - 18

P2

COMMON-SIZE GRAPHICS

17 - 19

P3

RATIO ANALYSIS

Liquidity

and Solvency

efficiency

Market

Profitability

prospects

17 - 20

P3

Current

Current Inventory

Inventory

Ratio

Ratio Turnover

Turnover

Acid-test

Acid-test Days

Days Sales

Sales

Ratio

Ratio Uncollected

Uncollected

Accounts

Accounts Days

Days Sales

Sales

Receivable

Receivable in

in Inventory

Inventory

Turnover

Turnover

Total

Total Asset

Asset

Turnover

Turnover

17 - 21

P3

WORKING CAPITAL

Working capital represents current assets

financed from long-term capital sources that

do not require near-term repayment.

Current assets

Current liabilities

= Working capital

More

More working

working capital

capital suggests

suggests aa strong

strong liquidity

liquidity

position

position and

and an

an ability

ability to

to meet

meet current

current obligations.

obligations.

17 - 22

P3

CURRENT RATIO

Current Assets

Current Ratio =

Current Liabilities

This

This ratio

ratio measures

measures thethe short-term

short-term debt-

debt-

paying

paying ability

ability of

of the

the company.

company. A A higher

higher current

current

ratio

ratio suggests

suggests aa strong

strong liquidity

liquidity position.

position.

17 - 23

P3

ACID-TEST RATIO

Acid-test ratio = receivables

Current Liabilities

Referred

Referred to

to as

as Quick

Quick Assets

Assets

This

This ratio

ratio is

is like

like the

the current

current ratio

ratio but

but excludes

excludes current

current assets

assets

such

such as

as inventories

inventories andand prepaid

prepaid expenses

expenses that

that may

may be

be

difficult

difficult to

to quickly

quickly convert

convert into

into cash.

cash.

17 - 24

P3

Net sales

Accounts receivable =

turnover Average accounts receivable,

net

(Beginning acct. rec. + Ending acct. rec.)

Average accounts receivable =

2

This

This ratio

ratio measures

measures howhow

many

many times

times aa company

company

converts

converts its

its receivables

receivables

into

into cash

cash each

each year.

year.

17 - 25

P3

INVENTORY TURNOVER

Cost of goods sold

Inventory turnover =

Average inventory

2

This

This ratio

ratio measures

measures the the

number

number ofof times

times

merchandise

merchandise is is sold

sold and

and

replaced

replaced during

during the

the year.

year.

17 - 26

P3

Day's sales =

365

uncollected

Net sales

Provides

Provides insight

insight into

into how

how frequently

frequently aa

company

company collects

collects its

its accounts

accounts receivable.

receivable.

17 - 27

P3

Ending inventory

Day's sales in =

365

Inventory

Cost of goods sold

This

This ratio

ratio is

is aa useful

useful measure

measure in in evaluating

evaluating

inventory

inventory liquidity.

liquidity. IfIf aa product

product isis demanded

demanded

by

by customers,

customers, this this formula

formula estimates

estimates how

how

long

long itit takes

takes to

to sell

sell the

the inventory.

inventory.

17 - 28

P3

Net sales

Total asset turnover =

Average total assets

Average assets =

2

This

This ratio

ratio reflects

reflects aa

companys

companys ability ability to

to use

use

its

its assets

assets to to generate

generate

sales.

sales. ItIt is

is an

an important

important

indication

indication of of operating

operating

efficiency.

efficiency.

17 - 29

P3

SOLVENCY

Debt

Debt

Ratio

Ratio

Equity

Equity

Ratio

Ratio

Pledged

Pledged Assets

Assets

to

to Secured

Secured

Liabilities

Liabilities

Times

Times

Interest

Interest

Earned

Earned

17 - 30

P3

Amount Ratio

Total liabilities $ 8,000,000 66.7% [Debt ratio]

Total equity 4,000,000 33.3% [Equity ratio]

Total liabilities and equity $ 12,000,000 100.0%

$8,000,000

$8,000,000 $12,000,000

$12,000,000 == 66.7%

66.7%

The

The debt

debt ratio

ratio expresses

expresses total

total liabilities

liabilities as

as aa percent

percent of

of

total

total assets.

assets. The

The equity

equity ratio

ratio provides

provides complementary

complementary

information

information byby expressing

expressing total

total equity

equity as as aa percent

percent of

of total

total

assets.

assets.

17 - 31

P3

DEBT-TO-EQUITY RATIO

Total liabilities

Debt-to-equity ratio =

Total equity

This

This ratio

ratio measures

measures what

what portion

portion of

of aa companys

companys

assets

assets are

are contributed

contributed by by creditors.

creditors. A

A larger

larger debt-to-

debt-to-

equity

equity ratio

ratio implies

implies less

less opportunity

opportunity to to expand

expand

through

through use

use ofof debt

debt financing.

financing.

17 - 32

P3

Income before interest and

Times interest earned taxes

=

Interest expense

Net income

+ Interest expense

+ Income taxes

= Income before interest and taxes

This

This isis the

the most

most common

common measure

measure of of the

the

ability

ability of

of aa companys

companys operations

operations to

to provide

provide

protection

protection to

to long-term

long-term creditors.

creditors.

17 - 33

P3

PROFITABILITY

Profit

Profit Return

Return on

on

Margin

Margin Total

Total Assets

Assets

Return

Return on

on Common

Common

Stockholders

Stockholders Equity

Equity

17 - 34

P3

PROFIT MARGIN

Net income

Profit margin =

Net sales

This

This ratio

ratio describes

describes aa companys

companys ability

ability to

to

earn

earn net

net income

income from

from each

each sales

sales dollar.

dollar.

17 - 35

P3

Net income

Return on total asset =

Average total

assets

Return

Return on

on total

total assets

assets measures

measures how

how well

well

assets

assets have

have been

been employed

employed by

by the

the

companys

companys management.

management.

17 - 36

P3

RETURN ON COMMON STOCKHOLDERS

EQUITY

equity = Average common stockholders'

equity

This

This measure

measure indicates

indicates how

how well

well the

the

company

company employed

employed the

the stockholders

stockholders equity

equity

to

to earn

earn net

net income.

income.

17 - 37

P3

MARKET PROSPECTS

Price-Earnings

Price-Earnings Dividend

Dividend

Ratio

Ratio Yield

Yield

17 - 38

P3

PRICE-EARNINGS RATIO

Market price per common share

Price-earnings ratio =

Earnings per share

This

This measure

measure isis often

often used

used by

by investors

investors as

as aa

general

general guideline

guideline in

in gauging

gauging stock

stock values.

values.

Generally,

Generally, the

the higher

higher the

the price-earnings

price-earnings ratio,

ratio, the

the

more

more opportunity

opportunity aa company

company hashas for

for growth.

growth.

17 - 39

P3

DIVIDEND YIELD

Annual cash dividends per share

Dividend yield =

Market price per share

This

This ratio

ratio identifies

identifies the

the return,

return, in

in terms

terms of

of cash

cash

dividends,

dividends, onon the

the current

current market

market price

price per

per share

share

of

of the

the companys

companys common

common stock.

stock.

17 - 40

GLOBAL VIEW

Horizontal and vertical analyses help eliminate many differences between

U.S. GAAP and IFRS when analyzing and interpreting financial

statements. However, when fundamental differences in reporting regimes

impact financial statements, the user must exercise caution when drawing

conclusions.

Ratio Analysis

Ratio analysis of financial statement also helps eliminate differences

between U.S. GAAP and IFRS. Importantly, the use of ratio analysis is fine,

with some possible changes in interpretation depending on what is and

what is not included in certain accounting measures across U.S. GAAP and

IFRS. Care must be taken in drawing inferences from a comparison of ratios

across reporting regimes.

17 - 41

A1

ANALYSIS REPORTING

The purpose of financial statement analyses is to

reduce uncertainty in business decisions through a

rigorous and sound evaluation. A financial statement

analysis report directly addresses the building blocks of

analysis and documents the reasoning.

1. Executive Summary

2. Analysis Overview

3. Evidential Matter

4. Assumptions

5. Key Factors

6. Inferences

17 - 42

INCOME

Extraordinary

Extraordinary

Items

Items

Discontinued

Discontinued

Segments

Segments

Continuing

Continuing

Operations

Operations Net Income

17 - 43

END OF CHAPTER 17

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