Ch.13Financial Statement

Analysis

Stockholders

Financial Statement Analysis

Creditors

Will I be paid?

How good is our investment?

F/S Analysis Requires Proper Comparisons Over time for the same company

Trend/horizontal analysis With other companies in the same industry

Ratio analysis With industry average

Trend Analysis

Return on Average Equity2004 2003 2002 2001 2000

24.7% 26.7% 28.7% 30.1% 29.0%

Wm. Wrigley Jr. Company

Tracking items over a series of years

Types of Analysis Liquidity Analysis Solvency Analysis Profitability Analysis

Part I: Liquidity Analysis

Nearness to cash Ability to pay short-term debts as they

become due

LO4

Working Capital

Excess of current assets over current liabilities Lacks meaningful comparisons for companies

of different size

–

Current Ratio

Measure of short-term financial health Consider composition of current assets

Rule of thumb2:1

Acid-Test (Quick) Ratio

Stricter test of ability to pay debts Excludes inventories and prepaid assets

Quick AssetsCurrent Liabilities

Cash Flow from Operations to Current Liabilities

Focuses on cash only Can be used to indicate the flow

of cash during the year to cover the debts due

Net Cash Provided by Operating ActivitiesAverage Current Liabilities

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

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ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

Accounts Receivable Turnover Ratio

Net Credit SalesAverage Accounts Receivable

Indicates how quickly a company is collecting (i.e., turning over) its receivables

Number of Days’ Sales in Receivables

Represents the average number of days an account is outstanding

Number of Days in the PeriodAccounts Receivable Turnover

Number of Days’ Sales in Receivables

360 days4.8 times

= 75 days

Example:

Inventory Turnover Ratio

Represents the number of times per period inventory is turned over (i.e., sold).

Cost of Goods SoldAverage Inventory

Number of Days’ Sales in Inventory

Represents the average number of days inventory is on hand before it’s sold

Number of Days in the PeriodInventory Turnover

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

Cash Operating Cycle

Time between the purchase of merchandise and the collection of the from the sale

Number of Days’ Sales in Inventory +

Number of Days’ Sales in Receivables

Part II: Solvency Analysis

Ability to stay in business over the long-term. That is, the ability to pay all the liabilities

LO5

Debt-to-Asset Ratio

Total Liabilities Total Assets

How much of the company’s

assets were borrowed?

Debt-to-Equity Ratio

Total Liabilities Total Assets = .60

60% of the company’s assets were borrowed,

and only 40% were provided by owners.

Times Interest Earned

Measures ability to meet current interest payments

The greater the coverage the better

Net Income + Interest Expense + Income Tax ExpenseInterest Expense

Part III: Profitability Analysis Rate of Return on Assets Return on Common Stockholders’ Equity Earnings per Share Price/Earnings Ratio Dividend Ratios

LO6

Return on Assets Ratio

Measures return to all providers of capital (creditors and owners)

Net Income + Interest Expense, Net of TaxAverage Total Assets

Return on Common Stockholders’ Equity

Net Income – Preferred DividendsAverage Common Stockholders’ Equity

The owners earned 15%on their investment

in ABC Co... Not bad!

Earnings per Share

Presents profits on a per-share basis

Net Income – Preferred DividendsWeighted Average Number of Common Shares Outstanding

Certificate of Stock

Price/Earnings Ratio

Relates earnings to the market price of the stock

Current Market PriceEarnings per Share

very high P/Every low P/E

possibly overpricedpossibly underpriced

Price/Earnings Ratio

Both companies have earnings of $2 per share. So why the different P/E

ratios?

P/E Ratios

Co. A = 10 to 1Co. B = 7 to 1

Dividend Payout Ratio

Common Dividends per ShareEarnings per Share

We need to decide what

percentage of the firm’s income we

can return to owners

LIFO FIFO

Limitations of Financial Statement Analysis

Use of different accounting methods Changes in accounting methods

LO1

Limitations of Financial Statement Analysis

Difficulty of making industry comparisons (i.e., conglomerates)

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Limitations of Financial Statement Analysis

Nonoperating items on income statement Effects of inflation

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