Financial Statement Analysis

Chapter 17

© 2009 The McGraw-Hill Companies, Inc.

 Horizontal (Trend) Analysis
Horizontal analysis compares a
company’s financial condition
and performance over time.

A year-over-year percentage change expresses

the current year’s dollar change as a percentage
of the prior year’s total using this formula.

Percent × 100%
= Current Year’s Total ̶ Prior Year’s Total
Change
Prior Year’s Total

McGraw-Hill/Irwin Slide 2
 Horizontal Analysis of Lowe’s
Summarized Balance Sheets
LOWE'S
Comparative Balance Sheets (in millions)
Dollar Percent
2006 2005 Change Change*
Assets
Current assets:
Cash $ 364 $ 423 $ (59) (13.9)
Short-term investments 432 453 (21) (4.6)
Accounts receivable - - - -
Inventories 7,144 6,635 509 7.7
Other current assets 374 277 97 35.0
Total current assets 8,314 7,788 526 6.8
Property and equipment, net 18,971 16,354 2,617 16.0
Long-term investments 482 497 (15) (3.0)
Total assets $ 27,767 $ 24,639 $ 3,128 12.7
* Percent rounded to first decimal point.
McGraw-Hill/Irwin Slide 3
 Horizontal Analysis of Lowe’s
Summarized Balance Sheets

LOWE'S
Comparative Balance Sheets (in millions)
Dollar Percent
2006 2005 Change Change*
Liabilities and Stockholders' Equity
Current liabilities $ 6,539 $ 5,832 $ 707 12.1
Long-term liabilities 5,503 4,511 992 22.0
Total liabilities 12,042 10,343 1,699 16.4
Stockholders' equity 15,725 14,296 1,429 10.0
Total liabilities and stockholders' equity $ 27,767 $ 24,639 $ 3,128 12.7
* Percent rounded to first decimal point.

McGraw-Hill/Irwin Slide 4
 Horizontal Analysis of Lowe’s
Summarized Income Statements

LOWE'S
Comparative Income Statements (in millions)
Dollar Percent
2006 2005 Change Change*
Net sales revenue $ 46,927 $ 43,243 $ 3,684 8.5
Cost of revenues 30,729 28,453 2,276 8.0
Gross profit 16,198 14,790 1,408 9.5
Operating and other expenses 11,046 10,136 910 9.0
Interest expense 154 158 (4) (2.5)
Income tax expense 1,893 1,731 162 9.4
Net income $ 3,105 $ 2,765 $ 340 12.3

Earnings per share $ 2.02 $ 1.78 0.24 13.5

* Percent rounded to first decimal point.

McGraw-Hill/Irwin Slide 5
 Changes Revealed in Trend Analysis
Lowe’s grew significantly in 2006.

Total Net sales Gross Net

assets revenues profit income
rose by rose by rose by rose by
12.7 8.5 9.5 12.3
percent percent. percent percent.

The growth in net sales revenues more than offset the

growth in expenses resulting in net income growth in 2006
that was greater than the net sales revenues growth.

McGraw-Hill/Irwin Slide 6
 Vertical (Common Size) Analysis
Vertical analysis focuses on important relationships
within financial statements by expressing each
financial statement amount as a percentage of
another amount on that statement.

Common-size percentages for financial

statements are calculated using this formula.
Common-size Analysis Amount × 100%
=
Percent Base Amount

The base amount is total assets for the balance sheet

and sales revenue for the income statement.
McGraw-Hill/Irwin Slide 7
 Vertical Analysis of Lowe’s
Summarized Balance Sheets
LOWE'S
Comparative Balance Sheets (in millions)
2006 2005
Amount Percent* 2005 Percent*
Assets
Current assets:
Cash $ 364 1.3% $ 423 1.7%
Short-term investments 432 1.6% 453 1.8%
Inventories 7,144 25.7% 6,635 26.9%
Other current assets 374 1.3% 277 1.1%
Property and equipment, net 18,971 68.3% 16,354 66.4%
Long-term investments 482 1.7% 497 2.0%
Total assets $ 27,767 100.0% $ 24,639 100.0%

Liabilities and Stockholders' Equity

Current liabilities $ 6,539 23.5% $ 5,832 23.7%
Long-term liailities 5,503 19.8% 4,511 18.3%
Stockholders' equity 15,725 56.6% 14,296 58.0%
Total liabilities and stockholders' equity $
McGraw-Hill/Irwin 27,767 100.0% $ 24,639 100.0%
Slide 8
 Vertical Analysis of Lowe’s
Summarized Income Statements

LOWE'S
Comparative Income Statements (in millions)
2006 2005
Amount Percent Amount Percent
Net sales revenue $ 46,927 100.0% $ 43,243 100.0%
Cost of revenues 30,729 65.5% 28,453 65.8%
Gross profit 16,198 34.5% 14,790 34.2%
Operating and other expenses 11,046 23.5% 10,136 23.4%
Interest expense 154 0.3% 158 0.4%
Income tax expense 1,893 4.0% 1,731 4.0%
Net income $ 3,105 6.6% $ 2,765 6.4%

* Percent rounded to first decimal point.

McGraw-Hill/Irwin Slide 9
 Interpreting Common Size Statements
Lowe’s total assets grew in 2006 by more than
$3,000,000,000. Most of the growth was in
property and equipment which increased from
66.4 percent of total assets in 2005 to 68.3 of total
assets in 2006.

The growth in total assets was accompanied by

increases in all major categories of liabilities and
equities. However, only long-term liabilities
increased as a percent of total assets, from 18.3
percent of total assets in 2005 to 19.8 percent of
total assets in 2006.

McGraw-Hill/Irwin Slide 10
 Interpreting Common Size Statements

Lowe’s was able to increase its net income as a

percent of sales from 6.4 percent to 6.6 percent
by reducing cost of goods sold as a percent of
sales by 0.3 percent.

The percentage decrease in cost of goods sold

was partially offset by small increase in
operating and other expenses.

McGraw-Hill/Irwin Slide 11
 Profitability Ratios
Profitability ratios provide us with measures
of a company’s ability to generate
income in the current period.
Net profit Gross profit Fixed asset
margin percentage turnover

Asset Earnings per

turnover share (EPS)

Return on Price/earnings Return on

equity (ROE) (P/E) assets (ROA)
McGraw-Hill/Irwin Slide 12
 Liquidity Ratios
Liquidity ratios focus on a company’s ability
to convert its assets into cash in order to
pay current liabilities as they come due.

Receivables Inventory
turnover turnover

Current Quick
ratio ratio

McGraw-Hill/Irwin Slide 13
 Solvency Ratios
Solvency ratios focus on a company’s ability to
repay debt, pay interest, and finance replacement
and/or expansion of long-term assets.

Times
interest
earned

Debt-to- Free cash

assets flow
McGraw-Hill/Irwin Slide 14
 Accounting Decisions and Ratio
Analysis
Differences in accounting methods between
companies sometimes make comparisons difficult.

We use the LIFO method to We use the average cost

value inventory. method to value inventory.
McGraw-Hill/Irwin Slide 15
 Accounting Decisions and Ratio
Analysis
Ratios may be interpreted by comparison with ratios
of other companies or with industry average ratios.
Ratios may vary because of the company’s industry
characteristics, nature of operations, size, and
accounting policies. Consider the following
information from three home improvement retailers.

Builder's
Lowe's Home Depot FirstSource
Inventory FIFO FIFO Weighted Average

Depreciation Straight-line Straight-line Straight line

Buildings 10-40 years 10-45 years 20-40 years
Equipment 3-15 years 3-20 years 3-10 years

McGraw-Hill/Irwin Slide 16
End of Chapter 17

© 2009 The McGraw-Hill Companies, Inc.