Chapter 13 Financial Statement Analysis

Learning Objectives Perform a horizontal analysis of comparative financial statements Perform a vertical analysis of financial statements Prepare and use common-size financial statements Use the statement of cash flows for decisions Compute the standard financial ratios Use ratios in decision making Measure the economic value added by operations

Perform a horizontal analysis of comparative financial statements

Perform a vertical analysis of financial statements

Prepare and use common-size financial statements

Use the statement of cash flows for decisions

Compute the standard financial ratios

Use ratios in decision making

Measure the economic value added by operations

Types of Analysis Horizontal Analysis Study of percentage changes in comparative financial statements Considers changes over time. Compute the dollar amount of the change from the base period to the later period Divide the dollar amount of the change by the base period amount

Horizontal Analysis

Study of percentage changes in comparative financial statements

Considers changes over time.

Compute the dollar amount of the change from the base period to the later period

Divide the dollar amount of the change by the base period amount

Horizontal Analysis Compute the dollar amount of change from 2002 to 2003 $8,380 - $7,757 = $623 Divide the dollar amount of the change by the base period amount to get the percentage change. $623 / $7,757 = 8.0%

Horizontal Analysis

Trend Percentages Horizontal analysis over a period of several years. Indicates the direction a business is taking.

Horizontal analysis over a period of several years.

Indicates the direction a business is taking.

Vertical Analysis Shows the relationship of a financial statement item to its base. Income Statement base is usually Total Revenue Balance Sheet base is usually Total Assets

Shows the relationship of a financial statement item to its base.

Income Statement base is usually Total Revenue

Balance Sheet base is usually Total Assets

Vertical Analysis

Other Financial Analysis Tools Common-size statements similar to vertical analysis except no dollar amounts are shown allows one to compare companies of different sizes Benchmarking comparison of a company to a standard set by others

Common-size statements

similar to vertical analysis except no dollar amounts are shown

allows one to compare companies of different sizes

Benchmarking

comparison of a company to a standard set by others

Ratio Analysis A ratio expresses the relationship of one number to another Common types of ratios Ability to pay current liabilities Ability to sell inventory and collect receivables Ability to pay long-term debt Profitability Analyze stock as an investment

A ratio expresses the relationship of one number to another

Common types of ratios

Ability to pay current liabilities

Ability to sell inventory and collect receivables

Ability to pay long-term debt

Profitability

Analyze stock as an investment

Ability to Pay Current Liabilities Working Capital = Current assets – Current liabilities Current Ratio = Current assets / Current liabilities Acid-Test Ratio = Cash + Short-term investments + Net current receivables Current liabilities

Ability to Sell Inventory and Collect Receivables One day’s sales = Net sales / 365 Inventory Turnover = Cost of Goods Sold Average Inventory Accounts Receivable Turnover Net Sales Average net accounts receivable = Days’ sales in average accounts receivable = Average net accounts receivable One day’s sales

Ability to Pay Long-Term Debt Debt Ratio = Total Liabilities Total Assets Times Interest Earned Operating Income Interest Expense =

Measure Profitability Return on Sales = Net Income Net Sales Rate of Return on Total Assets Net Income + Interest Expense Average total assets = Rate of Return on Common Stockholders’ Equity = Average Common Stockholders’ Equity Preferred Dividends Net Income -

Measure Profitability Earnings per share of common stock = Number of shares of common stock outstanding Preferred Dividends Net Income -

Analyzing Stock Investments Price/Earnings Ratio = Market price per share of common stock Earnings per Share Dividend yield on common stock = Market price per share of common stock Dividend per share of common stock

Analyzing Stock Investments Book value per share of common stock = Number of shares of common stock outstanding Preferred equity Total stockholders’ equity -

Other Measures EVA ® = Net income + Interest expense – Capital charge Capital charge = x Cost of Capital Notes payable Current maturities of long-term debt Stockholders’ equity + +

Efficient Markets A capital market in which market prices fully reflect all information available to the public.

A capital market in which market prices fully reflect all information available to the public.

End of Chapter 13