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18 - 1 ©2002 Prentice Hall, Inc. Business Publishing ...
 

18 - 1 ©2002 Prentice Hall, Inc. Business Publishing ...

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    18 - 1 ©2002 Prentice Hall, Inc. Business Publishing ... 18 - 1 ©2002 Prentice Hall, Inc. Business Publishing ... Presentation Transcript

    • Financial Statement Analysis Chapter 18
    • 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 auditor’s report.
      • comparative financial data for 5 to 10 years.
    • Objective 1
      • Perform a horizontal analysis
      • of financial statements.
    • Horizontal Analysis Increase/(Decrease) 2002 2001 Amount Percent Sales $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%
    • Horizontal Analysis 2002 2001 Difference Sales $41,500 $37,850 $3,650 $3,650 ÷ $37,850 = .0964, or 9.6%
    • Trend Percentages...
      • are computed by selecting a base year whose amounts are set equal to 100%.
      • The amounts of each following year are expressed as a percentage of the base amount.
      Trend % = Any year $ ÷ Base year $
      • 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.
      Trend Percentages What are the 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 by dividing 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 is then reported as a percentage of that base.
    • Vertical Analysis 1999 % Revenues $38,303 100.0 Cost of sales 19,688 51.4 Gross profit $18,615 48.6 Total operating expenses 13,209 34.5 Operating income $ 5,406 14.1 Other income 2,187 5.7 Income 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 4.7 Receivables net 10,438 26.9 Inventories 6,151 15.9 Prepaid expenses 3,526 9.1 Total current assets $21,931 56.6 Plant and equipment, net 6,847 17.7 Other assets 9,997 25.7 Total assets $38,775 100.0
    • Objective 3
      • Prepare common-size
      • financial 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 is the total on each side of the accounting equation.
      • Common-size statements are used to compare one company to other companies, and to the industry average.
    • Benchmarking Percent of Net Sales MCI Lucent Technologies  Cost of goods sold  Operating expenses  Income tax  Net income
    • Objective 4
      • Compute the standard
      • financial ratios.
    • Ratio Classification
      • Measuring ability to pay current liabilities
      • Measuring ability to sell inventory and collect receivables
      • Measuring ability to pay short-term and long-term debt
      • Measuring profitability
      • Analyzing stock as an investment
    • Palisades Furniture Example Net sales ( Year 2002 ) $858,000 Cost of goods sold 513,000 Gross profit $345,000 Total 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
    • Palisades Furniture Example Assets 20x2 20x1 Current assets: Cash $ 29,000 $ 32,000 Receivables net 114,000 85,000 Inventories 113,000 111,000 Prepaid expenses 6,000 8,000 Total current assets $262,000 $236,000 Long-term investments 18,000 9,000 Plant and equipment, net 507,000 399,000 Total assets $787,000 $644,000
    • Palisades Furniture Example Liabilities 20x2 20x1 Current liabilities: Notes payable $ 42,000 $ 27,000 Accounts 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
    • Palisades Furniture Example Stockholders’ Equity 20x2 20x1 Common stock, no par $186,000 $186,000 Retained earnings 170,000 134,000 Total stockholders’ equity $356,000 $320,000 Total liabilities and stockholders’ equity $787,000 $644,000
    • Measuring Ability to Pay Current Liabilities Current ratio = Total current assets ÷ Total current liabilities The current ratio measures the company’s ability to pay current liabilities with current assets.
    • Measuring Ability to Pay Current Liabilities
      • 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.
    • Measuring Ability to Pay Current Liabilities Acid-test ratio = (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities The acid-test ratio shows the company’s ability to pay all current liabilities if they come due immediately.
    • Measuring Ability to Pay Current Liabilities
      • 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 company’s acid-test ratio improved considerably during 20x2.
    • Measuring Ability to Sell Inventory 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.
    • Measuring Ability to Sell Inventory
      • Palisades’ inventory turnover:
      • 20x2: $513,000 ÷ $112,000 = 4.58
      • The industry average is 2.70.
      • A high number indicates an ability to quickly sell inventory.
    • Measuring Ability to Collect Receivables Accounts receivable turnover = Net credit sales ÷ Average accounts receivable Accounts receivable turnover measures a company’s ability to collect cash from credit customers.
    • Measuring Ability to 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.
    • Measuring Ability to Collect Receivables One day’s sales = Net sales ÷ 365 days Days’ sales in Accounts Receivable = Average net Accounts Receivable ÷ One day’s sales Days’ sales in receivable ratio measures how many day’s sales remain in Accounts Receivable.
    • Measuring Ability to Collect Receivables
      • Palisades’ days’ sales in Accounts Receivable for 20x2:
      • One day’s sales:
      • $858,000 ÷ 365 = $2,351
      • Days’ sales in Accounts Receivable:
      • $99,500 ÷ $2,351 = 42 days
      • The industry average is 16 days.
    • Measuring Ability to Pay Debt Total liabilities ÷ Total assets The debt ratio indicates the proportion of assets financed with debt.
    • Measuring Ability to Pay Debt
      • Palisades’ debt ratio:
      • 20x1: $324,000 ÷ $644,000 = 0.50
      • 20x2: $431,000 ÷ $787,000 = 0.55
      • The industry average is 0.61.
      • Palisades Furniture expanded operations during 20x2 by financing through borrowing.
    • Measuring Ability to Pay Debt Times-interest-earned = Income from operations ÷ Interest expense Times-interest-earned ratio measures the number of times operating income can cover interest expense.
    • Measuring Ability to Pay Debt
      • Palisades’ times-interest-earned ratio:
      • 20x1: $ 57,000 ÷ $14,000 = 4.07
      • 20x2: $101,000 ÷ $24,000 = 4.21
      • The industry average is 2.00.
      • The company’s times-interest-earned ratio increased in 20x2.
      • This is a favorable sign.
    • Measuring Profitability Rate of return on net sales = Net income ÷ Net sales Rate of return on net sales shows the percentage of each sales dollar earned as net income.
    • Measuring Profitability
      • Palisades’ rate of return on sales:
      • 20x1: $26,000 ÷ $803,000 = 0.032
      • 20x2: $48,000 ÷ $858,000 = 0.056
      • The industry average is 0.008.
      • The increase is significant in itself and also because it is much better than the industry average.
    • Measuring Profitability 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.
    • Measuring Profitability
      • Palisades’ rate of return on total assets for 20x2:
      • ($48,000 + $24,000) ÷ $715,500 = 0.101
      • The industry average is 0.049.
      • How does Palisades compare to the industry?
      • Very favorably.
    • Measuring Profitability Rate of return on common stockholders’ equity = (Net income – preferred dividends) ÷ Average common stockholders’ equity Common equity includes additional paid-in capital on common stock and retained earnings.
    • Measuring Profitability
      • Palisades’ rate of return on common stockholders’ equity for 20x2:
      • ($48,000 – $0) ÷ $338,000 = 0.142
      • The industry average is 0.093.
      • Why is this ratio larger than the return on total assets (.101)?
      • Because Palisades uses leverage.
    • Measuring Profitability Earnings per share of common stock = (Net income – Preferred dividends) ÷ Number of shares of common stock outstanding
    • Measuring Profitability
      • 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.
    • 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 Furniture’s 20x2 P/E ratio of 10.4, we would say that the company’s stock is selling at 10.4 times earnings.
    • Analyzing Stock as an Investment Dividend per share of common (or preferred) stock ÷ Market price per share of common (or preferred) stock Dividend yield shows the percentage of a stock’s market value returned as dividends to stockholders each period.
    • Analyzing Stock as an Investment
      • 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 form of cash dividends.
    • Analyzing Stock as an Investment Book value per share of common stock = (Total stockholders’ equity – Preferred equity) ÷ Number of shares of common stock outstanding
    • Analyzing Stock as an Investment
      • 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.
    • Objective 5
      • Use ratios in decision making.
    • Limitations of Financial Analysis
      • Business decisions are made in a world of uncertainty.
      • No single ratio or one-year figure should be relied upon to provide an assessment of a company’s performance.
    • Objective 6
      • Measure economic value added.
    • Economic Value Added (EVA®)
      • Economic value added (EVA®) combines accounting income and corporate finance to measure whether the company’s operations have increased stockholder wealth.
      • EVA® = Net income + Interest expense – Capital charge
    • End of Chapter 18