Disclaimer:

These slides are taken from different internet sources, book and further edited to
increase the knowledge of business administration students according to their discipline.
There is not any intention for taking title of this material on author’s own name. These
lecture slides are prepared and will be delivered for educational purpose only. These are
tentative slides subject to addition or subtraction of material as per lecture requirements.
The instructor of current course acknowledge the work of  Van Horne,John M. Wachowicz
for providing easy to understand Financial Management book for beginners

Source: Fundamentals of Financial Management PowerPoints on the Web, 13th

Edition
J. Van Horne, Stanford University
Prof John M Wachowicz, The University of Tennessee
©2009 |Pearson
ANALYSIS of FINANCIAL
STATEMENT

2
 Purpose of Analysis
Financial statement analysis helps users
make better decisions.

Internal Users External Users

Managers Shareholders
Officers Lenders
Internal Auditors Customers 3
 Methods of
Financial Statement Analysis
• Horizontal Analysis
• Vertical Analysis
• Ratio Analysis

4
 Horizontal Analysis

Using comparative financial

statements to calculate dollar
or percentage changes in a
financial statement item from
one period to the next

5
 Vertical Analysis
For a single financial
statement, each item
is expressed as a
percentage of a
significant total,
e.g., all income
statement items are
expressed as a
percentage of sales
Financial Statement Base Amount
Balance Sheet Total Assets
6
Income Statement Revenues
 Ratio Analysis
Expression of logical relationships
between items in a financial
statement of a single period
(e.g., percentage relationship
between revenue and net income)

7
 Horizontal Analysis Example
The management of Clover Company provides you
with comparative balance sheets of the years
ended December 31, 2021 and 2020.
Management asks you to prepare a horizontal
analysis on the information.

8
9
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 2021 and 2020, the dollar
amounts for 2020 become the “base” year
figures.
10
 Horizontal Analysis Example
Calculating Change as a Percentage

Percentage Dollar Change

Change
=
Base Year Figure × 100%

11
Horizontal Analysis Example

12
Horizontal Analysis Example

$12,000 – $23,500 = $(11,500)

13
Horizontal Analysis Example

($11,500 ÷ $23,500) × 100% = 48.9%

14
Horizontal Analysis Example

15
Horizontal Analysis Example
Let’s apply the same
procedures to the
liability and stockholders’
equity sections of the
balance sheet.

16
 CLOVER CORPORATION
Comparative Balance Sheets
December 31, 2021 and 2020
Increase (Decrease)
2021 2020 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

17
Horizontal Analysis Example

Now, let’s apply the

procedures to the
income statement.

18
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December
Increase (Decrease)
2021 2020 Amount %
Net sales $ 520,000 $ 480,000
Cost of goods sold 360,000 315,000
Gross margin 160,000 165,000
Operating expenses 128,600 126,000
Net operating income 31,400 39,000
Interest expense 6,400 7,000
Net income before taxes 25,000 32,000
Less income taxes (30%) 7,500 9,600
Net income $ 17,500 $ 22,400

19
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December
Increase (Decrease)
2021 2020 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)

20
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December
Increase (Decrease)
2021 2020 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)

21
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31
Increase (Decrease)
2021 2020 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)

22
Column1 2020 2021
Cash and Bank Balance 406 419
Accounts Receivable 344 457
Stock in trade 2,393 2,489
Other Current Assets 437 804
property plant & equipment 10,046 10,847
Longterm Investments 87 103
Intangibles and Other Assets 92 50
Total Non Current Assets 10,225 153
Total Assets 15,849 16,837
Accounts Payable 3,062 2,798
Short Term Borrowings 1,035 300
Short Term LIABILITIES 30 54
Other Current Liabilities 1,852 2,155
Longterm Debt / Borrowings 4,029 5,140
Common Equity 453 453
Additional Paid in Capital 250 250
Retained Earnings 3,408 3,685
23
Column1 2020 2021 $ CHANGE % CHANGE
Cash and Bank Balance 406 419 13 3.20%
Accounts Receivable 344 457 113 32.85%
Stock in trade 2,393 2,489 96 4.01%
Other Current Assets 437 804 367 83.98%
property plant & equipment 10,046 10,847 801 7.97%
Longterm Investments 87 103 16 18.39%
Intangibles and Other Assets 92 50 (42) -45.65%
Total Non Current Assets 10,225 153 (10,072) -98.50%
Total Assets 15,849 16,837 988 6.23%
Accounts Payable 3,062 2,798 (264) -8.62%
Short Term Borrowings 1,035 300 (735) -71.01%
Short Term LIABILITIES 30 54 24 80.00%
Other Current Liabilities 1,852 2,155 303 16.36%
Longterm Debt / Borrowings 4,029 5,140 1,111 27.58%
Common Equity 453 453 0 0.00%
Additional Paid in Capital 250 250 0 0.00%
Retained Earnings 3,408 3,685 277 8.13%

24
 Vertical Analysis Example
The management of Sample Company asks you to
prepare a vertical analysis for the comparative
balance sheets of the company.

25
Vertical Analysis Example

26
Vertical Analysis Example

$82,000 ÷ $483,000 = 17% rounded

$30,000 ÷ $387,000 = 8% rounded

27
Vertical Analysis Example

28
Vertical Analysis Example

$76,000 ÷ $483,000 = 16% rounded

29
 Vertical Analysis of Income Statement
CLOVER CORPORATION
Comparative Income Statements
December 31, 2021 and 2020

2021 2020 2021 2020

Net sales $ 520,000 $ 480,000 100.00% 100.00%
Cost of goods sold 360,000 315,000 69.23% 65.63%
Gross margin 160,000 165,000 30.77% 34.38%
Operating expenses 128,600 126,000 24.73% 26.25%
Net operating income 31,400 39,000 6.04% 8.13%
Interest expense 6,400 7,000 1.23% 1.46%
Net income before taxes 25,000 32,000 4.81% 6.67%
Less income taxes (30%) 7,500 9,600 1.44% 2.00%
Net income $ 17,500 $ 22,400 3.37% 4.67%
30
 Interpreting Horizontal and Vertical
Analyses
With 60 new stores opened,
Lowe’s had a 7.9% increase in
inventory, and a 6.4%
increase in Property and Lowe’s
2019 2018 Equipment. grew by
5.9% in
fiscal 2019.

13-31
 Interpreting Horizontal and Vertical
Analyses
The Company’s cash
position weakened There was a
significantly between 2019 2018 large
fiscal 2018 and 2019. increase in
the
inventory
carried by
the
company.
The
accumulatio
n of
inventory is
13-32
 Interpreting Horizontal and Vertical
Analyses

2019 2018

13-33
 Interpreting Horizontal and Vertical
Analyses
Cost of sales and operating
Much of the expenses are the most
decline in fiscal important determinant of the
2008 Net Income company’s profitability.
is explained by 2019 2018
the increase in
Cost of Sales and
Operating
Expenses.

13-34
 Interpreting Horizontal and Vertical
Lowe’s did not do a
good job of
Analyses
controlling its Lowe’s has experienced a 0.4%
operating expenses increase in its cost of goods sold
between 2007 and from fiscal 2007 to 2008.
2008. The company is Increasing cost of sales means
faced with lower lower gross profit.
2019 2018
gross profit and poor
operating expense
control.

13-35
 Ratio Computations
Ratio analysis compares the amounts for one or more
line items to the amounts for other line items in the
same year.
Ratios are classified into three categories .
. .
Solvency ratios
Profitability ratios examine a
examine a company’s company’s
ability to generate ability to pay
income. interest and repay
debt when due.
Liquidity ratios
help us determine if a
company has sufficient
current assets to repay
liabilities when due.

13-36
 Ratios You Must Know
Liquidity Ratios

1. Working Capital Ratio

2. Current ratio
3. Acid-test (quick) ratio
651

37
 Working Capital

Working capital is the excess amount of

current assets over current liabilities.

Working Capital=
Current Assets Current Liabilities

38
Now, let’s calculate
the ratios based on
Norton’s financial
statements.

39
 NORTON CORPORATION
• Working Capital for 2019
year 2019 = Cash $ 30,000
Current Assets - Accounts receivable, net 27,000
Current Liabilities Accounts Payables 14,500
outstanding salaries 23,900
• =89000-38400
Inventory 22,000
• =50600 Prepaid rent 10,000
Plant and Equipp 120,000

40
• Positive working capital means that the business is able to
pay off its short-term liabilities. Also, a high working capital
can be a signal that the company might be able to expand its
operations.

• Negative working capital means that the business currently is

unable to meet its short-term liabilities with its current assets.
Therefore, an immediate increase in sales or additional capital
into the company is necessary in order to continue its
operations.

41
 Current RatioNORTON CORPORATION
2019
Current Current Assets Cash $ 30,000
Ratio =
Accounts receivable, net 27,000
Current Liabilities Accounts Payables 14,500
outstanding salaries 23,900
Inventory 22,000
Current = $89000 = 2.318 Prepaid rent 10,000
Ratio $38400
Plant and Equipp 120,000

Measures the ability

of the company to pay current
debts as they become due.
42
 Interpretation
• Generally, companies would aim to maintain a
current ratio of at least 1 to ensure that the
value of their current assets cover at least the
amount of their short term obligations.
• A current ratio of 2 would mean that current
assets are sufficient to cover for twice the
amount of a company's short term liabilities
• Drawback

43
 Practice Question
2021
Total Assets 539.50
Fixed Assets 459.80
Current Assets 79.70
total liabilites 434.40
Current Liabilities 147.10
Long Term Liabilities 287.30
Shareholder's Equity 105.10

Current Ratio= 79.9 / 147.40

= 0.542 44
Quick ratio

45
 Acid-Test (Quick) Ratio
Quick Assets can be= Current Assets – Inventory/Stock

Acid-Test Quick Assets

=
Ratio Current Liabilities

46
 Acid-Test (Quick) Ratio
Quick Assets can be= Current Assets – Inventory/Stock
NORTON CORPORATION
Acid- Quick Assets 2019
=
Test Current Liabilities Cash $ 30,000
Ratio
Accounts receivable, net 27,000
Accounts Payables 14,500
89000-22000
= = 1.74 : 1 outstanding salaries 23,900
38400
Inventory 22,000
Prepaid rent 10,000
Plant and Equipp 120,000

47
 Interpretation
• Quick ratio shows the extent of cash and
other current assets that are readily
convertible into cash in comparison to the
short term obligations of an organization.

• A quick ratio of 0.5 would suggest that a

company is able to settle half of its current
liabilities instantaneously

48
 Practice Question
2021
Total Assets 539.50
Fixed Assets 352.51
Current Assets 113.35
inventory 73.65
total liabilites 434.40
Current Liabilities 147.10
Long Term Liabilities 287.30
Shareholder's Equity 105.10

• Calculate :
• Current ratio CR=0.77
• Quick Ratio QR=0.2699 49
 2021 2022 2023
Total Assets 539.50 8800.3 8720.8
Fixed Assets 141.00 21.80 5916.80
Current Assets 398.50 8778.5 2804
total liabilites 434.40 5563.3 5088.3
Current Liabilities 147.10 3024.3 3276
Long Term Liabilities 287.30 2539.00 1812.30
Shareholder's Equity 105.10 3237 3632.5
Inventory 318.8 7022.8 841.2
Current Ratio 2.709041468 2.902655 0.855922
Quick Ratio 0.541808294 0.580531 0.599145
50
 Equity, or Long–Term
Solvency Ratios
• Solvency refers to an enterprise's capacity to
meet its long-term financial commitments.

• This ratio indicates the 

degree of financial leverage being used by the
business and includes both short-term and
long-term debt.

51
 Solvency Ratios

Solvency ratios are used to analyze a

company’s long-term debt-paying
ability and its financing structure.
1. Debt to Asset ratio
2. Debt to Equity ratio
3. Number of times interest earned
4. Plant assets to long-term liabilities

52
13-52
 Debt to Assets Ratio

Debt to
Total Liabilities
Assets =
Ratio Total Assets

This ratio measures the percentage of a

company’s assets that are financed by debt.

53
 Debt to Equity Ratio
Debt to
Total Liabilities
Equity =
Ratio Stockholders’ Equity

This ratio indicates the relative proportions

of debt to equity on a company’s balance
sheet.

Stockholders like a Creditors prefer less

lot of debt if the debt and more
company can take equity because
advantage of positive equity represents a
financial leverage. buffer of protection.
54
 Debt to Assets and Debt to Equity Ratios
2020 2021

Debt to Assets
Total Liabilities
Ratio =
Total Assets

Debt to Equity
Total Liabilities
Ratio =
Stockholders’ Equity
Debt to Assets and Debt to Equity Ratios

2020 2021

56
Number of Times Interest Earned Ratio

Earnings before Interest Expense

Times
Interest = and Income Taxes
Earned Interest Expense

This is the most common

measure of a company’s ability
to provide protection for its
long-term creditors.

57
 Number of Times Interest Earned Ratio

2020 2021

Earnings before Interest Expense

Times Interest =
and Income Taxes
Earned
Interest Expense

58
Number of Times Interest Earned Ratio

2020 2021

59
Income statement
Sales 1000
Costs of goods sold -500
GROSS PROFIT 500
OPERATING EXPENSE -32 PROFIT
INTEREST ON DEBT -6.4 BEFORE
Depreciation -100 TAX+INTEREST
Profit before tax 361.6 ON DEBT=EBIT
Taxes @40% 144.6 =361.6+6.4
Profit after tax 217 =368/6.4
=??
Times Interest Earned?
60
Plant Assets to Long-Term Liabilities

Plant Assets
Net Plant Assets
to Long-Term =
Liabilities Long-Term Liabilities

Companies often pledge plant

assets as collateral for long-term
liabilities. This ratio suggests how
well long-term debt is managed to
finance long-term assets.

61
Plant Assets to Long-Term Liabilities

2020 2021

62
 Profitability Ratios
Profitability ratios measure a
company’s ability to generate
earnings.
1. Net Margin (or Return on Sales)
2. Asset Turnover Ratio
3. Return on Investment
4. Return on Equity
5. Gross profit margin

63
Net Margin (Return on Sales)
Net Net Income
=
Margin Net Sales

This measure describes the percent

remaining of each sales dollar after
subtracting other expenses as well as
cost of goods sold.

64
 Net Margin
• Determine the operating margin ratio of
Company α given that its sales are $928,300
and its operating income is $113,200 for the
month.

• Net margin ratio = $113,200 / $928,300

• ≈ 0.12 = 12%

65
• Net margin ratio of 12% means that a net
profit of $0.12 is made on each dollar of sales.
Thus a higher value of operating margin ratio
is favorable which indicates that more
proportion of sales is converted to net income

66
 Asset Turnover Ratio
Asset Net Sales
=
Turnover Average Total Assets

This ratio measures how many sales

dollars were generated for each
dollar of assets invested.

67
 Asset Turnover Ratio
2020 2021 2022
Total Assets 539.50 8800.3 8720.8
Fixed Assets 392.40 6958.39 6664.50
Current Assets 147.10 1841.91 2056.3
total liabilites 434.40 5563.3 5088.3
Current Liabilities 147.10 3024.3 3276
Long Term Liabilities 287.30 2539.00 1812.30
Shareholder's Equity 105.10 3237 3632.5
Sales 67.4 86.21 93.5
cost of goods sold 12.3 33.5 64.3

Asset Turnover Ratio=

(93.5)/((8720.8+8800.3)/2)
68
 Basket Wonders’ Balance Sheet
(Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2019a
Cash $ 90 Acct. Rec.c Notes Payable $ 290
394 Inventories 696 Acct. Payablec 94
Prepaid Exp d 5 Accrued Taxes d 16
Accum Tax Prepay 10 Other Accrued Liab. 100
Current Liab. e $ 500
Current Assetse $1,195 Fixed Assets Long-Term Debt f 530 Shareholders’
(@Cost)f 1030 Equity Com. Stock ($1
Less: Acc. Depr. g
(329) Net par) g
200 Add Pd in Capital g

Fix. Assets $ 701 Investment, LT 729 Retained Earnings h

210
50 Other Assets, LT Total Equity $1,139
223 Total Assets Total Liab/Equitya,b $2,169
b
$2,169
 Basket Wonders’ Income
Statement
Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2019a
Net Sales $ 2,211
Cost of Goods Sold b 1,599
Gross Profit $ 612
SG&A Expenses c 402
EBITd 210
Interest Expensee 59
EBT f $ 151
Income Taxes 60
EATg $ 91
Cash Dividends 38
Increase in RE $ 53
 Activity Ratios
Receivable Turnover
(Assume all sales are credit sales.)

Annual Net Credit Sales

Receivables
Activity Ratios $2,211
= 5.61
Indicates quality of $394
Collects
receivables and how receivables
successful the firm is in its about 5.61
collections.
times a year 
 Activity Ratios
Avg Collection Period

Days in the Year

Income Statement/ Receivable Turnover
Balance Sheet
Ratios For Basket Wonders
December 31, 2019
365 = 65 days rece.
Activity Ratios
5.61 are outstanding
Average number of days that
receivables are outstanding. Receivables x Days in the
Year
(or RT in days)
Annual Credit Sales
 Activity Ratios
Income Statement/ Payable Turnover (PT)
(Assume annual credit
Balance Sheet purchases = $1,551.)
Ratios
Annual Credit Purchases
Accounts Payable
Activity Ratios

Indicates the promptness of For Basket Wonders

payment to suppliers by the December 31, 2019
firm. $1551 = 16.5
times a
$94
year
 Activity Ratios
Income Statement/ PT in Days
Balance Sheet
Days in the Year
Ratios
Payable Turnover
Activity Ratios
For Basket Wonders
December 31, 2019
Average number of days
that payables are 365
outstanding. = 22.1 days
16.5
 Activity Ratios
Income Statement/ Inventory Turnover
Balance Sheet
Cost of Goods Sold
Ratios
Inventory
Activity Ratios
For Basket Wonders
Indicates the effectiveness December 31, 2019
of the inventory
management practices of $1,599 = 2.30 times
the firm. $696 inventory turn
into sales
Return on Investment (ROI)
Return on Net Income
=
Investment Average Total Assets

This is the ratio of wealth generated

(net income) to the amount invested
(average total assets).

76
 ROI
2020 2021 2022
Total Assets 539.50 8800.3 8720.8
Fixed Assets 392.40 6958.39 6664.50
Current Assets 147.10 1841.91 2056.3
total liabilites 434.40 5563.3 5088.3
Current Liabilities 147.10 3024.3 3276
Long Term Liabilities 287.30 2539.00 1812.30
Shareholder's Equity 105.10 3237 3632.5
Sales 67.4 86.21 93.5
cost of goods sold 12.3 33.5 64.3

Asset Turnover Ratio=

(93.5-64.3)/((8720.8+8800.3)/2)
77
 Return on Equity
Return on = Net Income
Equity Average Total Stockholders’
Equity

This measure is often used to measure

the profitability of the stockholders’
investment.

78
Return on Equity

2020 2021

79
Return on Equity

2020 2021

80
Uses and Limitations of Financial
Ratios

U ses L im ita tio ns

Ratios help users M anagem ent m ay enter

understand into transactions m erely
financial relationships. to im prove the ratios.

Ratios provide for Ratios do not help w ith

quick com parison analysis of the com pany's
of com panies. progress tow ard
nonfinancial goals.
81
 End of Chapter
No more
ratios,
please!

82