Managerial Accountingby James Jiambalvo

Chapter 13:

Analyzing Financial Statements: A

managerial Perspective

Slides Prepared by:Scott PetersonNorthern State

University

Objectives

1. Explain why managers analyze financial statements.

2. Perform horizontal and vertical analysis of the balance sheet and the income statement.

3. Discuss earnings management and the importance of comparing net income to cash flow from operations.

4. Understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial performance.

Objectives (continued)

5. Calculate and interpret profitability ratios.

6. Calculate and interpret turnover ratios.

7. Calculate and interpret debt-related ratios.

Why Managers Analyze Financial Statements

1. To control operations.2. To asses the financial stability of vendors,

customers and partners.3. To assess how their companies appear to

investors and creditors.

Control of Operations

1. Examples include:a. Inventory turnover.b. Asset turnover.c. Receivables turnover…

2. Financial analyses help managers determine whether or not plans and decisions have been successful.

3. The numbers help tell the story.

Assessment of Vendors, Customers, and Other Business Partners

1. Management applies the same analyses to vendor, customer and other strategic partner financial statements as they do to their own.

2. Financial statement analysis used to find, qualify and monitor potential partners.

Assessment of Appearance To Investors and Creditors

1. Accrual income vs. cash flow.

2. Notes to financial statements.

Review of the Three Basic Financial Statements

1. Balance sheet.

2. Income statement.

3. Statement of cash flows.

The Balance Sheet

1. Snapshot at a given point in time.

2. Three categories:a. Assets

b. Liabilities

c. Equity

3. Basic equation:Assets = Liabilities + Shareholder Equity

4. Differentiate between current and noncurrent: 1-year threshold

The Income Statement

1. Statement of operations or a statement of (accrual) performance over a given period of time.

2. Revenues, expenses, gains and losses.

3. Basic relationship:Sales – COGS – Operating Expenses ±

Nonoperating Income (Expense) – Income Tax = Net Earnings

The Statement of Cash Flows

1. Explanation of the change in cash from the beginning to the end of an accounting time period.

2. Categories include:a. Operating (activities)

b. Investing (activities)

c. Financing (activities)

Horizontal and Vertical Analysis

1. Horizontal Analysis:a. Analysis of dollar value and percentage

changes.b. Over time (left to right).c. Sometimes called trend analysis.

2. Vertical Analysis:a. Analysis of dollar value amounts relative to a

common base.b. Top to bottom.c. Sometimes called Common Size Statement

Analysis.

Analysis of The Balance Sheet

1. Horizontal Analysis: how have assets, liabilities and equities changed over time?

2. Vertical Analysis: express all other accounts relative to total assets.

Analyzing the Income Statement

1. Horizontal Analysis: how have sales, expenses, COGS changed over time?

2. Vertical Analysis: express all other accounts relative to sales.

Earnings Management and The Need to Compare Earnings and Cash-Flow Information

1. A fine line between “earnings management and earnings manipulation.

2. It can and does happen.a. Cendantb. Enronc. Sunbeamd. Waste Management

3. You get what you measure, so if you reward management on earnings….

Other Sources of Information on Financial Performance

1. Other information is available from third-parties.

2. Credit reporting services such as Dunn & Bradstreet.

3. News articles.

4. On-line sources…

5. Edgar

Management Discussion and Analysis

1. Included in the annual financial reports of publicly traded companies.

2. Known as MD&A.

3. Provides other financial, statistical, qualitative and quantitative data along with explanations.

Credit Reports

1. Credit reports provide information about company credit history.

2. Many firms provide this service, for a fee.

3. Provides insights about how well a firm has paid its bills, debts, mortgages, etc…

4. Examples include Dunn & Bradstreet.

News Articles

1. Many free and fee-for-service sources.

2. Nexis-Lexis.

3. Yahoo! Finance.

4. Thestreet.com

Ratio Analysis

1. Profitability.

2. Turnover.

3. Debt-related.

Profitability Ratios

1. Earnings Per Share (EPS).

2. Price-earnings (PE).

3. Gross margin percentage.

4. Return on total assets.

5. Return on common stockholders’ equity.

Turnover Ratios

1. Asset turnover.

2. Accounts receivable turnover.

3. Days’ sales in receivables.

4. Inventory turnover.

5. Days’ sales in inventory.

Debt-Related Ratios

1. Current ratio.

2. Acid-test (Quick) ratio.

3. Debt-to-equity ratio.

4. Times interest earned.

A Managerial Perspective on The Analysis of HGW’s Financial Statements

1. Summary of financial statement analysis objectives:

a. Control operations.

b. Assess stability of vendors, customers and other business partners.

c. Assess appearance of firm investors and creditors.

Control of Operations

1. HGW pressed for discounts from suppliers.

2. Has that plan been effective?

3. No! Gross margins are still about 30%.

4. Gross margins should be lower from one period to the next if goods were obtained at a lower price.

Stability of Vendors, Customers, and Other Business Partners

1. HGW considered outsourcing the IT function to CosmosSolutions, Inc.

2. What steps should HGW take to investigate this potential partner?

3. Financial analysis of Cosmos, D&B report, news articles, etc…

Appearance To Investors and Creditors

1. What additional information can the CEO or HGW give to investors, creditors, analysts?

2. What questions should be anticipated by the CEO of HGW given the current financial analysis?

3. Day’s sales in inventory is more than 120 days.

4. The CEO should prepare some solid answers.

Summary of Analyses

1. Horizontal analysis.

2. Vertical analysis.

3. Profitability ratios.

4. Turnover ratios.

5. Debt related ratios.

Quick Review Question #1

1. Horizontal analyses

a. Compare one company with another.

b. Evaluate profitability.

c. Anticipate questions from creditors.

d. Allow a firm to compare balances from one year to another.

Quick Review Answer #1

1. Horizontal analyses

a. Compare one company with another.

b. Evaluate profitability.

c. Anticipate questions from creditors.

d. Allow a firm to compare its own balances from one year to another.

Quick Review Question #2

2. The difference between current ratio and quick ratio is

a. The current ratio includes depreciation expense.

b. The acid-test ratio uses only monthly data.

c. The acid-test ratio excludes inventory from the numerator of the ratio.

d. The current ratio is more current.

Quick Review Answer #2

2. The difference between current ratio and quick ratio is

a. The current ratio includes depreciation expense.

b. The acid-test ratio uses only monthly data.

c. The acid-test ratio excludes inventory from the numerator of the ratio.

d. The current ratio is more current.

Quick Review Question #3

3. MD&A consists of

a. Financial ratios.

b. Horizontal and vertical analyses.

c. Management discussion and analysis.

d. Monthly discounts and advertising.

Quick Review Answer #3

3. MD&A consists of

a. Financial ratios.

b. Horizontal and vertical analyses.

c. Management discussion and analysis.

d. Monthly discounts and advertising.

Quick Review Question #4

4. Beginning inventory is $42,000. Ending inventory is $30,000. COSG is $320,000. Inventory turnover is

a. 10 times.

b. 9.2 times.

c. 8.89 times.

d. 1.4 times.

Quick Review Answer #4

4. Beginning inventory is $42,000. Ending inventory is $30,000. COSG is $320,000. Inventory turnover is

a. 10 times.

b. 9.2 times.

c. 8.89 times.

d. 1.4 times.

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