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**Basics of Financial Statement Analysis
**

Analyzing financial statements involves:

Characteristics Liquidity Profitability Solvency Comparison Bases Intracompany Industry averages Intercompany Tools of Analysis Horizontal Vertical Ratio

Horizontal Analysis

Horizontal analysis, also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time. Its purpose is to determine the increase or decrease that has taken place. Horizontal analysis is commonly applied to the balance sheet, income statement, and statement of retained earnings.

800 Long-term liabilties 143.000 Instructions: Prepare a horizontal analysis of the balance sheet data for Ramsey Corporation using 2008 as a base.000 $ 200.000 99.200 Total liabilities & equity $ 200.000 2008 $ 80.000 40.000 90.000 Current assets PP&E Intangibles Total assets Current liabilities $ 40. 2009 $ 76.000 150.000 Stockholders' equity 16.000 12.000 $ 48.Horizontal Analysis Exercise: The comparative condensed balance sheets of Ramsey Corporation are presented below.000 $ 210. .000 25.000 $ 210.

. 2009 $ 76.000 $ 48.5% $ (10.200) (7.8% $ (7.0% (15.000 Stockholders' equity 16.000) -5.000) -15.800 Long-term liabilties 143.0% -4.Horizontal Analysis Exercise: The comparative condensed balance sheets of Ramsey Corporation are presented below.000 Increase Percentage (Decrease) Change $ (4.0% 9.200 $ (10.000 40.000 150.000 12.000 25.000) -37.000 99.000 $ 200.000 $ 210.000 90.000) -4.000 2008 $ 80.0% -4.000) 4.000 $ 210.000 Instructions: Prepare a horizontal analysis of the balance sheet data for Ramsey Corporation using 2008 as a base.000 10.8% Current assets PP&E Intangibles Total assets Current liabilities $ 40.200 Total liabilities & equity $ 200.7% 35.

. On an income statement. we might say that selling expenses are 16% of net sales.Vertical Analysis Vertical analysis. also called common-size analysis. is a technique that expresses each financial statement item as a percent of a base amount. Vertical analysis is commonly applied to the balance sheet and the income statement.

000 Net sales Cost of goods sold Gross profit Operating expense Net income Instructions: Prepare a vertical analysis of the income statement data for Hendi Corporation in columnar form for both years.200 $ 59.000 $ 36.000 44. .000 57.Vertical Analysis Exercise: The comparative condensed income statements of Hendi Corporation are shown below.000 420.000 483.000 80. 2009 Amount $ 600.800 2008 Amount $ 500.000 117.

0% 44.200 9.000 84.0% 2008 Amount Percent $ 500.Vertical Analysis Exercise: The comparative condensed income statements of Hendi Corporation are shown below.5% 117.0% 80.000 19. .5% 57.5% $ 59. 2009 Amount Percent $ 600.000 100.000 8.000 100.000 7.800 10.0% 420.000 80.8% $ 36.2% Net sales Cost of goods sold Gross profit Operating expense Net income Instructions: Prepare a vertical analysis of the income statement data for Hendi Corporation in columnar form for both years.0% 483.000 16.

Financial Ratio Classifications Liquidity Profitability Solvency Measures the ability of the company to survive over a long period of time.Ratio Analysis Ratio analysis expresses the relationship among selected items of financial statement data. . time. Measures short-term Measures the ability of the company income or to pay its maturing operating success obligations and to meet of a company for unexpected needs for a given period of cash.

. The discussion of ratios will include the following types of comparisons.Ratio Analysis A single ratio by itself is not very meaningful.

Ratio Analysis Liquidity Ratios Measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. the acid-test ratio. and inventory turnover. Ratios include the current ratio. receivables turnover. . Short-term creditors such as bankers and suppliers are particularly interested in assessing liquidity.

000 18.500 807.000 301.000 283.500 479.500 1.500 14.000 $ 2008 $ 1.000 199.000 184.Ratio Analysis Illustration Taylor Tool Company Income Statement For the Year Ended December 31 2009 Net sales Cost of goods sold Gross profit Selling and administrative expenses Income from operations Other expenses and losses: Interest expense Income before income taxes Income tax expense Net income $ $ 1.500 .500 77.000 84.000 754.818.000 506.750.000 261.500 996.000 275.011.

200 $ $ 64.200 50.500 332.800 2009 2008 .Ratio Analysis Taylor Tool Company Balance Sheets December 31 Assets Current assets Cash Short-term investments Accounts receivable (net) Inventory Total current assets Plant assets (net) Total assets $ $ 60.800 133.000 102.500 520.300 852.100 69.900 600.300 970.000 107.800 115.000 369.

000 387.400 465.700 970.500 203.000 43.Ratio Analysis Lia ilities a d Stockholders' E ity Current lia ilities Accounts paya le Income taxes paya le Total current lia ilities Bonds paya le Total lia ilities Stockholders' equity Common stock ($5 par) Retained earnings Total stockholders' equity Total lia ilities and equity $ 2009 160.200 $ 2008 145.500 280.000 187.700 566. 2009.000 on December 31. .400 852. and $3.400 300.800 $ $ All sales were on account.500 200. 2008.400 42.400 200.000 165. The allowance for doubtful accounts was $3.000 286.000 403.200 on December 31.

= 1.500 The ratio of 1. the company has $1.82:1 means that for every dollar of current liabilities.Ratio Analysis Liquidity Ratios Compute the Current Ratio for 2009. Current Assets Current Liabilities $369.82 of current assets.82 : 1 = Current Ratio .900 $203.

800 $203.500 = 1.000 + $107. .Ratio Analysis Liquidity Ratios Compute the Acid-Test Ratio for 2009.16 : 1 The acid-test ratio measures immediate liquidity.100 + $69. Cash + Short-Term Investments + Receivables (Net) Current Liabilities = Acid-Test Ratio $60.

500 ($107.800 + $102. Net Credit Sales Average Net Receivables $1. on average.3 times . = Receivables Turnover = 17. the company collects receivables during the period.818.800) / 2 It measures the number of times.Ratio Analysis Liquidity Ratios Compute the Receivables Turnover ratio for 2009.

800 + $102.800) / 2 A variant of the receivables turnover ratio is to convert it to an average collection period in terms of days. 365 days / 17.1 days This means that receivables are collected on average every 21 days. .Ratio Analysis $1.818.3 times ($107.3 times = every 21.500 Liquidity Ratios Receivables Turnover = 17.

1 times . Cost of Good Sold Average Inventory $1.000 + $115.500) / 2 Inventory turnover measures the number of times.500 ($133. on average. the inventory is sold during the period.011. = Inventory Turnover = 8.Ratio Analysis Liquidity Ratios Compute the Inventory Turnover ratio for 2009.

1 days Inventory turnover ratios vary considerably among industries.500 Liquidity Ratios Inventory Turnover = 8.000 + $115.500) / 2 A variant of inventory turnover is the days in inventory.1 times = every 45.1 times ($133.011.Ratio Analysis $1. 365 days / 8. .

liquidity position. and payout ratio. or the lack of it. . Income. earnings per share. and the ability to grow. asset turnover. affects the company·s ability to obtain debt and equity financing. return on assets. Ratios include the profit margin. price-earnings.Ratio Analysis Profitability Ratios Measure the income or operating success of a company for a given period of time. return on common stockholders· equity.

500 Measures the percentage of each dollar of sales that results in net income.818.000 $1. Net Income Net Sales $199.9% . = Profit Margin = 10.Ratio Analysis Profitability Ratios Compute the Profit Margin ratio for 2009.

= Asset Turnover = 2.800) / 2 Measures how efficiently a company uses its assets to generate sales.500 ($970.Ratio Analysis Profitability Ratios Compute the Asset Turnover ratio for 2009.818. Net Sales Average Assets $1.0 times .200 + $852.

800) / 2 An overall measure of profitability.8% .Ratio Analysis Profitability Ratios Compute the Return on Assets ratio for 2009.000 ($970. = Return on Assets = 21. Net Income Average Assets $199.200 + $852.

6% Shows how many dollars of net income the company earned for each dollar invested by the owners.000 .700 + $465.Ratio Analysis Profitability Ratios Compute the Return on Common Stockholders· Equity ratio for 2009. Return on Net Income ² Preferred Dividends Common = Stockholders· Average Common Stockholders· Equity Equity $199.400) / 2 = 38.$0 ($566. .

49 per share .000 57. = Earnings Per Share = $3.Ratio Analysis Profitability Ratios Compute the Earnings Per Share for 2009.000 (given) A measure of the net income earned on each share of common stock. Net Income Weighted Average Common Shares Outstanding $199.

49 The price-earnings (PE) ratio reflects investors· assessments of a company·s future earnings. Market Price per Share of Stock Earnings Per Share $25 (given) $3. = Price Earnings Ratio = 7.Ratio Analysis Profitability Ratios Compute the Price Earnings Ratio for 2009.16 times .

Ratio Analysis Profitability Ratios Compute the Payout Ratio for 2009.000 = Payout Ratio = 39% Measures the percentage of earnings distributed in the form of cash dividends. .700 * $199. Cash Dividends Net Income $77. * From analysis of retained earnings.

Debt to total assets and times interest earned are two ratios that provide information about debt-paying ability. .Ratio Analysis Solvency Ratios Solvency ratios measure the ability of a company to survive over a long period of time.

.200 Debt to = Total Assets Ratio = 41.500 $970. Total Debt Total Assets $403.Ratio Analysis Solvency Ratios Compute the Debt to Total Assets Ratio for 2009.6% Measures the percentage of the total assets that creditors provide.

000 + $18.000 + $84.000 $18. .000 Times Interest Earned = = 16.Ratio Analysis Solvency Ratios Compute the Times Interest Earned ratio for 2009. Income before Income Taxes and Interest Expense Interest Expense $199.7 times Provides an indication of the company·s ability to meet interest payments as they come due.

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