ANALYSIS AND

INTERPRETATION OF
FINANCIAL
STATEMENTS

Mgr. Andrea Gažová, PhD.

Financial Statement Analysis
Who analyzes financial statements?
– Internal users (i.e., management)
– External users
– Examples:
• Investors, creditors, regulatory agencies
• stock market analysts
• auditors
Financial Statement Analysis
• What do internal users use it for?
Planning, evaluating and controlling company
operations
• What do external users use it for?
Assessing past performance and current
financial position and making predictions
about the future profitability and solvency of
the company as well as evaluating the
effectiveness of management
Financial Statement Analysis

Information is available from:

– Published annual reports
• (1) Financial statements
• (2) Notes to financial statements
• (3) Letters to stockholders
• (4) Auditor’s report (Independent accountants)
• (5) Management’s discussion and analysis
– Reports filed with the government
Financial Statement Analysis

Information is available from:

– Other sources
• (1) Newspapers (e.g., Wall Street Journal )
• (2) Periodicals (e.g. Forbes, Fortune)
• (3) Financial information organizations such

as: Moody’s, Standard & Poor’s, Dun

& Bradstreet, Inc., and Robert Morris Associates
• (4) Other business publications...
 Methods of
Financial Statement Analysis
• Horizontal Analysis
• Vertical Analysis
• Common-Size Statements
• Trend Percentages
• Ratio Analysis
 Horizontal Analysis

Using
Using comparative
comparative financial
financial
statements
statements to
to calculate
calculate €€
or
or percentage
percentage changes
changes in in aa
financial
financial statement
statement item
item from
from
one
one period
period to
to the
the next
next
Vertical Analysis
For
For aa single
single financial
financial
statement,
statement, each
each item
item

is
is expressed
expressed as as aa
percentage
percentage of of aa
significant
significant total,
total,
e.g.,
e.g., all
all income
income
statement
statement items items are
are
expressed
expressed as as aa
percentage
percentage of of sales
sales
Common-Size Statements
Financial
Financial statements
statements that
that show
show
only
only percentages
percentages and
and nono
absolute
absolute €€ amounts
amounts
 Trend Percentages

Show
Show changes
changes over
over
time
time in
in
given
given financial
financial
statement
statement items
items
(can
(can help
help evaluate
evaluate
financial
financial information
information
of
of several
several years)
years)
 Ratio Analysis
Expression
Expression of of logical
logical
relationships
relationships betweenbetween
items
items in in aa financial
financial
statement
statement of of aa single
single
period
period
(e.g.,
(e.g., percentage
percentage
relationship
relationship betweenbetween
revenue
revenue and and netnet income)
income)
Horizontal Analysis Example
The management of Clover Company provides you with
comparative balance sheets of the years ended December
31, 1999 and 1998.

Management asks you to prepare a horizontal analysis on

the information.
Horizontal Analysis Example

Dollar Current Year Base Year

= –
Change Figure Figure

Calculating Change in Dollar Amounts

Horizontal Analysis Example
Calculating Change in Dollar Amounts

Dollar Current Year Base Year

= –
Change Figure Figure

Since we are measuring the amount of

the change between 1998 and 1999, the
dollar amounts for 1998 become the
“base” year figures.
Horizontal Analysis Example

Percentage Dollar Change

Change
=
Base Year Figure × 100%

Calculating Change as a Percentage

Horizontal Analysis
Example

$12,000 – $23,500 = $(11,500)

Horizontal Analysis
Example

($11,500 ÷ $23,500) × 100% = 48.9%

Horizontal Analysis
Example
Horizontal Analysis Example

Let’s apply the same

procedures to the
liability and stockholders’
equity sections of the
balance sheet.
 CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 67,000 $ 44,000 $ 23,000 52.3
Notes payable 3,000 6,000 (3,000) (50.0)
Total current liabilities 70,000 50,000 20,000 40.0
Long-term liabilities:
Bonds payable, 8% 75,000 80,000 (5,000) (6.3)
Total liabilities 145,000 130,000 15,000 11.5
Stockholders' equity:
Preferred stock 20,000 20,000 - 0.0
Common stock 60,000 60,000 - 0.0
Additional paid-in capital 10,000 10,000 - 0.0
Total paid-in capital 90,000 90,000 - 0.0
Retained earnings 80,000 69,700 10,300 14.8
Total stockholders' equity 170,000 159,700 10,300 6.4
Total liabilities and stockholders' equity $ 315,000 $ 289,700 $ 25,300 8.7
Horizontal Analysis Example

Now, let’s apply the

procedures to the
income statement.
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Net sales $ 520,000 $ 480,000 $ 40,000 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Net sales $ 520,000 $ 480,000 $ 40,000 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Sales increased by 8.3% while net
Net income before taxes 25,000 32,000 (7,000) (21.9)
income decreased
Less income taxes (30%) 7,500
by 21.9%.
9,600 (2,100) (21.9)
Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
 There were increases in both cost of goods
sold (14.3%) and operating expenses (2.1%).
These increased costs
CLOVERmore than offset the
CORPORATION
increase inComparative
sales, yielding anStatements
Income overall
Fordecrease
the Years Ended
in netDecember
income. 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Net sales $ 520,000 $ 480,000 $ 40,000 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
 Vertical Analysis Example

The management of Sample Company asks

you to prepare a vertical analysis for the
comparative balance sheets of the company.
Vertical Analysis Example
Vertical Analysis Example

$82,000 ÷ $483,000 = 17% rounded

$30,000 ÷ $387,000 = 8% rounded
Vertical Analysis Example

$76,000 ÷ $483,000 = 16% rounded

Trend Percentages Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a
trend analysis.
Trend Percentages Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a
trend analysis.

$1,991 - $1,820 = $171

 Trend Percentages
Example
Using 1995 as the base year, we develop the
following percentage relationships.

$1,991 - $1,820 = $171

$171 ÷ $1,820 = 9% rounded
Trend line
for Sales