fin st analysis

8/3/2019 Fin St Analysis

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18 - 12002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber

Financial Statement Analysis

Chapter 18


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The Annual Report

Usually Contains ...

financial statements.

notes to the financial statements.

a summary of accounting methods used. management discussion and analysis of the

financial statements.

an auditors report. comparative financial data for 5 to 10 years.


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Objective 1

Perform a horizontal analysis

of financial statements.


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Horizontal Analysis

Increase/(Decrease)

2002 2001 Amount PercentSales $41,500 $37,850 $3,650 9.6%

Expenses 40,000 36,900 3,100 8.4%

Net income 1,500 950 550 57.9%


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2002 2001 Difference

Sales $41,500 $37,850 $3,650

$3,650 $37,850 = .0964, or 9.6%

Horizontal Analysis


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Trend Percentages...

are computed by selecting a base year

whose amounts are set equal to 100%.

The amounts of each following year areexpressed as a percentage of the base

amount.

Trend % = Any year $ Base year $


7/5318 - 72002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber

Year 2000 1999 1998

Revenues $27,611 $24,215 $21,718

Cost of sales 15,318 14,709 13,049

Gross profit $12,293 $ 9,506 $ 8,669

1998 is the base year.

What are the trend percentages?

Trend Percentages



Year 2000 1999 1998

Revenues 127% 111% 100%

Cost of sales 117% 113% 100%

Gross profit 142% 110% 100%

Trend Percentages

These percentages were calculated bydividing each item by the base year.



Objective 2

Perform a vertical analysis

of financial statements.



Vertical Analysis...

compares each item in a financial statement

to a base number set to 100%.

Every item on the financial statement isthen reported as a percentage of that base.



Vertical Analysis

1999 %

Revenues $38,303 100.0

Cost of sales 19,688 51.4Gross profit $18,615 48.6

Total operating expenses 13,209 34.5

Operating income $ 5,406 14.1

Other income 2,187 5.7Income before taxes $ 7,593 19.8

Income taxes 2,827 7.4

Net income $ 4,766 12.4



Vertical Analysis

Assets 1999 %

Current assets:

Cash $ 1,816 4.7Receivables net 10,438 26.9

Inventories 6,151 15.9

Prepaid expenses 3,526 9.1

Total current assets $21,931 56.6Plant and equipment, net 6,847 17.7

Other assets 9,997 25.7

Total assets $38,775 100.0



Objective 3

Prepare common-sizefinancial statements.



Common-size Statements

On the income statement, each item is

expressed as a percentage of net sales.

On the balance sheet, the common size isthe total on each side of the accounting

equation.

Common-size statements are used tocompare one company to other companies,

and to the industry average.



Benchmarking

43.0%

38.2%

8.0%

10.8%

51.4%

28.8%

7.4%

12.4%

Percent of Net Sales

MCILucent Technologies

Cost of goods sold Operating expensesIncome tax Net income



Objective 4

Compute the standard

financial ratios.


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Ratio Classification

1 Measuring ability to pay current liabilities

2 Measuring ability to sell inventory and

collect receivables

3 Measuring ability to pay short-term and

long-term debt

4 Measuring profitability

5 Analyzing stock as an investment


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Palisades Furniture Example

Net sales (Year 2002) $858,000

Cost of goods sold 513,000

Gross profit $345,000Total operating expenses 244,000

Operating income $101,000

Interest revenue 4,000

Interest expense (24,000)Income before taxes $ 81,000

Income taxes 33,000

Net income $ 48,000


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Assets 20x2 20x1

Current assets:

Cash $ 29,000 $ 32,000Receivables net 114,000 85,000

Inventories 113,000 111,000

Prepaid expenses 6,000 8,000

Total current assets $262,000 $236,000Long-term investments 18,000 9,000

Plant and equipment, net 507,000 399,000

Total assets $787,000 $644,000


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Liabilities 20x2 20x1

Current liabilities:

Notes payable $ 42,000 $ 27,000Accounts payable 73,000 68,000

Accrued liabilities 27,000 31,000

Total current liabilities $142,000 $126,000

Long-term debt 289,000 198,000

Total liabilities $431,000 $324,000


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Stockholders Equity 20x2 20x1

Common stock, no par $186,000 $186,000

Retained earnings 170,000 134,000Total stockholders equity $356,000 $320,000

Total liabilities and

stockholders equity $787,000 $644,000



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Current ratio =

Total current assets Total current liabilities

The current ratio measures

the companys ability to pay

current liabilities with current assets.

Measuring Ability to

Pay Current Liabilities


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Palisades current ratio:

20x1: $236,000 $126,000 = 1.87

20x2: $262,000 $142,000 = 1.85

The industry average is 1.80.

The current ratio decreased slightly

during 20x2.


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Acid-test ratio =

(Cash + Short-term investments+ Net current receivables)

Total current liabilities



The acid-test ratio shows the companys

ability to pay all current liabilities

if they come due immediately.


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Palisades acid-test ratio:

20x1: ($32,000 + $85,000) $126,000 = .93

20x2: ($29,000 + $114,000) $142,000 = 1.01

The industry average is .60.

The companys acid-test ratio improved

considerably during 20x2.


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Inventory turnover = Cost of goods sold

Average inventory

Inventory turnover is a measure

of the number of times the average

level of inventory is sold during a year.


Sell Inventory


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Sell Inventory

Palisades inventory turnover:

20x2: $513,000 $112,000 = 4.58


A high number indicates an ability to

quickly sell inventory.


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Accounts receivable turnover =

Net credit sales Average accounts receivable

Accounts receivable turnover measures a companys

ability to collect cash from credit customers.


Collect Receivables


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Collect Receivables

Palisades accounts receivable turnover:

20x2: $858,000 $99,500 = 8.62 times

The industry average is 22.2 times.

Palisades receivable turnover is much

lower than the industry average.

The company is a home-town store that

sells to local people who tend to pay their

bills over a lengthy period of time.


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One days sales = Net sales 365 days

Days sales in Accounts Receivable =

Average net Accounts Receivable One days sales


Collect Receivables

Days sales in receivable ratio measures how

many days sales remain in Accounts Receivable.


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Collect Receivables

Palisades days sales in Accounts

Receivable for 20x2:

One days sales:

$858,000 365 = $2,351

Days sales in Accounts Receivable:

$99,500 $2,351 = 42 days

The industry average is 16 days.


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Total liabilities Total assets


Pay Debt

The debt ratio indicates the proportion

of assets financed with debt.


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Pay Debt

Palisades debt ratio:

20x1: $324,000 $644,000 = 0.50

20x2: $431,000 $787,000 = 0.55


Palisades Furniture expanded operations

during 20x2 by financing through

borrowing.


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Times-interest-earned

= Income from operations Interest expense


Pay Debt

Times-interest-earned ratio

measures the number of times

operating income can cover interest expense.


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Pay Debt

Palisades times-interest-earned ratio:

20x1: $ 57,000 $14,000 = 4.07

20x2: $101,000 $24,000 = 4.21


The companys times-interest-earned ratio

increased in 20x2.

This is a favorable sign.


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Rate of return on net sales =

Net income Net sales

Measuring Profitability

Rate of return on net sales shows the percentage

of each sales dollar earned as net income.


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Palisades rate of return on sales:

20x1: $26,000 $803,000 = 0.032

20x2: $48,000 $858,000 = 0.056


The increase is significant in itself and also

because it is much better than the industry

average.


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Rate of return on total assets = (Net income

+ interest expense) Average total assets


Rate of return on total assets measures

how profitably a company uses its assets.


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Palisades rate of return on total assets

for 20x2:

($48,000 + $24,000) $715,500 = 0.101


How does Palisades compare to the

industry?

Very favorably.


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Rate of return on common stockholders equity

= (Net incomepreferred dividends) Average common stockholders equity


Common equity includes additional

paid-in capital on common

stock and retained earnings.


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Palisades rate of return on common

stockholders equity for 20x2:

($48,000$0) $338,000 = 0.142


Why is this ratio larger than the return on

total assets (.101)?

Because Palisades uses leverage.


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Earnings per share of common stock

= (Net incomePreferred dividends) Number of shares of common stock outstanding


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Palisades earnings per share:

20x1: ($26,000$0) 10,000 = $2.60

20x2: ($48,000$0) 10,000 = $4.80

This large increase in EPS is considered

very unusual.


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Analyzing Stock as an Investment

Price/earning ratio is the ratio of market

price per share to earnings per share.

20x1: $35 $2.60 = 13.5

20x2: $50 $4.80 = 10.4

Given Palisades Furnitures 20x2 P/E ratio

of 10.4, we would say that the companysstock is selling at 10.4 times earnings.


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Dividend per share of common

(or preferred) stock Market price per shareof common (or preferred) stock


Dividend yield shows the percentage

of a stocks market value returned as

dividends to stockholders each period.


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Dividend yield on Palisades common stock:

20x1: $1.00 $35.00 = .029 (2.9%)

20x2: $1.20 $50.00 = .024 (2.4%)

An investor who buys Palisades Furniture

common stock for $50 can expect to receive

2.4% of the investment annually in the formof cash dividends.


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Book value per share of common stock

= (Total stockholders equity Preferred equity) Number of shares of common stock outstanding


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Book value per share of palisades common

stock:

20x1: ($320,000$0) 10,000 = $32.00 20x2: ($356,000$0) 10,000 = $35.60

Book value bears no relationship to market

value.


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Objective 5

Use ratios in decision making.


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Limitations of Financial Analysis

Business decisions are made in a world of

uncertainty.

No single ratio or one-year figure should berelied upon to provide an assessment of a

companys performance.


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Objective 6

Measure economic value added.


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Economic Value Added (EVA)

Economic value added (EVA) combines

accounting income and corporate finance to

measure whether the companys operationshave increased stockholder wealth.

EVA = Net income + Interest expense

Capital charge


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End of Chapter 18

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