Chapter 14

FINANCIAL STATEMENT
ANALYSIS

PowerPoint Authors:
Winston Kwok, Ph.D., MBA, CA
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

Copyright © 2016 by McGraw-Hill Education (Asia). All rights reserved.

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C1

BASICS OF ANALYSIS

Application Involves
Reduces
of analytical transforming
uncertainty
tools data

Financial statement analysis helps users

make better decisions.
Internal Users External Users
Managers Shareholders
Officers Lenders
Internal Auditors Customers
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BUILDING BLOCKS OF ANALYSIS

Liquidity and
Solvency
efficiency

Market
Profitability
prospects
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INFORMATION FOR ANALYSIS

1. Statement of Profit or Loss and

Other Comprehensive Income
(including the Income Statement)
2. Statement of Financial Position
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes to the Financial Statements
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C2

STANDARDS FOR COMPARISON

When we interpret our analysis, it is essential to
compare the results we obtained to other
standards or benchmarks.

Intracompany
Competitors
Industry
Guidelines
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TOOLS OF ANALYSIS
Horizontal Analysis
Comparing a company’s financial condition and
performance across time.

Vertical Analysis
Comparing a company’s financial condition and
performance to a base amount.

Ratio Analysis
Measurement of key relations between financial statement
items.
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HORIZONTAL ANALYSIS
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COMPARATIVE STATEMENTS
Calculate Change in Dollar Amount

Dollar Analysis Period Base Period

Change = Amount – Amount

When measuring the amount of the

change in dollar amounts, compare the
analysis period balance to the base
period balance. The analysis period is
usually the current year while the base
period is usually the prior year.
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P1

COMPARATIVE STATEMENTS
Calculate Change as a Percent

Percent Dollar Change

Change
=
Base Period Amount × 100

When calculating the change as a

percentage, divide the amount of the
dollar change by the base period
amount, and then multiply by 100 to
convert to a percentage.
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HORIZONTAL ANALYSIS

1,683
1,683 –– 1,587
1,587 == 96
96

96 ÷ 1,587 × 100 = 6.0%

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HORIZONTAL ANALYSIS

14,534
14,534 –– 14,203
14,203 == 331
331

331 ÷ 14,203 × 100 = 2.3%

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TREND ANALYSIS

Trend analysis is used to reveal patterns in data

covering successive periods.

Trend Analysis Period Amount

Percent
=
Base Period Amount × 100
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TREND ANALYSIS
Adidas
Income Statement Information

Examples
Examples of of 2014
2014 Calculations
Calculations for
for Net
Net Sales:
Sales:
2010
2010 is
is base
base year.
year. Set
Set to
to 100%
100%
2014:
2014: 14,534
14,534 ÷÷ 11,990
11,990 ×× 100
100 == 121.2%
121.2%
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TREND ANALYSIS

We can use the trend percentages to construct a

graph so we can see the trend over time.
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VERTICAL ANALYSIS
Common-Size Statements

Common-size Analysis Amount

Percent
= Base Amount × 100

Financial Statement Base Amount

Statement
Statement of
of Financial
Financial Position
Position Total Assets
Income Statement Revenues
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P2 COMMON-SIZE
STATEMENT OF FINANCIAL POSITION

(1,683
(1,683 ÷÷ 12,417)
12,417) ×× 100
100 == 13.6%
13.6%

(1,587
(1,587 ÷÷ 11,599)
11,599) ×× 100
100 == 13.7%
13.7%
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P2

COMMON-SIZE INCOME STATEMENT

(7,610
(7,610 ÷÷ 14,534)
14,534) ×× 100
100 == 52.4%
52.4%
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P2

COMMON-SIZE GRAPHICS
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RATIO ANALYSIS

Liquidity
and Solvency
efficiency

Market
Profitability
prospects
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LIQUIDITY AND EFFICIENCY

Current Days’ Sales

Ratio Uncollected

Acid-test Days’ Sales

Ratio in Inventory

Accounts Accounts Days’

Receivable Payable Purchases in
Turnover Turnover Accounts
Payable
Inventory Total Asset
Turnover Turnover
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WORKING CAPITAL
Working capital represents current assets
financed from long-term capital sources that
do not require near-term repayment.
2014 2013
  Current assets 7,347 6,857
– Current liabilities 4,378 4,732
= Working capital 2,969 2,125
   
More working capital suggests a strong liquidity
position and an ability to meet current obligations.
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CURRENT RATIO
Current Assets
Current Ratio =
Current Liabilities
2014 2013
7,347 6,857
4,378 4,732
= 1.7 to 1 = 1.4 to
1
This ratio measures the short-term debt-
paying ability of the company. A higher current
ratio suggests a strong liquidity position.
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P3

ACID-TEST RATIO

Cash + Short-term financial assets + Current

Acid-test ratio = receivables + Other current financial assets
Current Liabilities
Referred
Referred to
to as
as Quick
Quick Assets
Assets 2014 2013
1,683+5+1,946+398 1,587+41+1,809+183
4,378 4,732
= 0.9 to 1 = 0.8 to 1

This ratio is like the current ratio but excludes current assets
such as inventories and prepaid expenses that may be
difficult to quickly convert into cash.
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P3

ACCOUNTS RECEIVABLE TURNOVER

Net sales(credit sales)
Accounts receivable =
turnover Average accounts receivable,
net
(Beginning acct. rec. + Ending acct. rec.)
Average accounts receivable =
2
14,534
(1,946+1,809)/2

= 7.7 times
This ratio measures how
many times a company
converts its receivables
into cash each year.
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P3

INVENTORY TURNOVER
Cost of goods sold
Inventory turnover =
Average inventory

Average inventory = (Beginning inventory + Ending inventory)

2

7,610
(2,526+2,634)/2
= 2.9 times
This ratio measures the
number of times
merchandise is sold and
replaced during the year.
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P3

ACCOUNTS PAYABLE TURNOVER

Cost of goods sold
Accounts payable turnover =
Average accounts payable
(Beginning accounts payable +
Average accounts Ending accounts payable)
payable =
2
7,610
(1,652+1,825)/2

A short-term liquidity= 4.4 times

measure used to quantify
the rate at which a company
pays off its suppliers.
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P3

DAYS’ SALES UNCOLLECTED

Accounts receivable, net
Day's sales =
× 365
uncollected
Net sales
365
Day's sales =
uncollected
Accounts Receivable Turnover
1,946 x 365
14,534 365
= 48.9 days 7.7 times
= 47.4 days
Provides insight into
how frequently a
company collects its
accounts receivable.
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P3

DAYS’ SALES IN INVENTORY

Day's sales in = Ending inventory Textbook f
× 365
inventory
Cost of goods sold
Day's sales in = 365
inventory
Inventory Turnover
2,526 x 365 365
7,610 2.9 times
= 121.2 days = 125.8 days
This ratio is a useful measure in evaluating
inventory liquidity. If a product is demanded
by customers, this formula estimates how
long it takes to sell the inventory.
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P3
DAYS’ PURCHASES IN ACCOUNTS
PAYABLE

Days’ purchases in Accounts payable

× 365
accounts payable =
Cost of goods sold
Days’ purchases in 365
accounts payable =
Accounts Payable Turnover
1,652 x 365 365
7,610 4.4 times
= 79.2 days = 82.9 days
This ratio is a useful measure in evaluating
how long the business takes to pay its credit
suppliers.
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P3

CASH CONVERSION CYCLE

The sum of the days’ sales uncollected and the

days’ sales in inventory subtracting the days’
purchases in accounts payable. It represents
the number of days a firm’s cash remains tied
up within the operations of the business.

The lower the cash conversion cycle, the more

healthy a company generally is.
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TOTAL ASSET TURNOVER

Net sales
Total asset turnover =
Average total assets
(Beginning assets + Ending assets)
Average assets =
2

14,534
(12,417+11,599)/2
This ratio reflects a
= 1.2 times
company’s ability to use
its assets to generate
sales. It is an important
indication of operating
efficiency.
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P3

SOLVENCY
Debt
Ratio

Equity
Ratio

Debt-to-Equity
Ratio

Times
Interest
Earned
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DEBT AND EQUITY RATIOS

  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%  
         
= total assets

$8,000,000
$8,000,000 ÷÷ $12,000,000
$12,000,000 == 66.7%
66.7%

The debt ratio expresses total liabilities as a percent of

total assets. The equity ratio provides complementary
information by expressing total equity as a percent of total
assets.
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DEBT-TO-EQUITY RATIO
Total liabilities  
Debt-to-equity ratio =
Total equity  
4,378+2,422
5,617
= 1.2 times

This ratio measures what portion of a

company’s assets are contributed by creditors.
A larger debt-to-equity ratio implies less
opportunity to expand through use of debt
financing.
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P3

TIMES INTEREST EARNED

Profit before interest expense
Times interest earned and income taxes  
=
Interest expense  
  Net profit 564 902
+ Interest expense + 67
+ Income taxes +271 67
= Profit before interest expense and taxes 902
    = 13.5 times

This is the most common measure of the

ability of a company’s operations to provide
protection to long-term creditors.
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PROFITABILITY

Profit Return on
Margin Total Assets

Return on Ordinary
Shareholders’
Equity
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PROFIT MARGIN

Net profit  
Profit margin =
Net sales  

490
14,534
= 2.2%

This ratio describes a company’s ability to

earn net profit from each sales dollar.
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RETURN ON TOTAL ASSETS

Net profit  
Return on total asset =
Average total assets  

490
(12,417+11,599)/2
= 4.1%

Return on total assets measures how well

assets have been employed by the
company’s management.
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P3
RETURN ON ORDINARY SHAREHOLDERS'
EQUITY
Net profit - Preference dividends  
Return on ordinary shareholders'
Average ordinary shareholders'
equity =
equity  

490
(5,617+5,481)/2
= 8.8%

This measure indicates how well the

company employed the shareholders’
equity to earn net profit.
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MARKET PROSPECTS

Price-Earnings Dividend
Ratio Yield
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PRICE-EARNINGS RATIO
Market price per ordinary share  
Price-earnings ratio =
Earnings per share  

56.44
2.67
= 21.1

This measure is often used by investors as a

general guideline in gauging share values.
Generally, the higher the price-earnings ratio,
the more opportunity a company has for
growth.
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P3

DIVIDEND YIELD
Annual cash dividends per share  
Dividend yield =
Market price per share  

1.50
56.44
= 2.7%

This ratio identifies the return, in terms of

cash dividends, on the current market price
per share of the company’s ordinary shares.
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END OF CHAPTER 14