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  • Slide 4-1 Chapter 14 McGraw-Hill/Irwin FINANCIAL STATEMENT ANALYSIS © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-2 Purpose of Analysis Purpose of Analysis Financial statement analysis helps users Financial statement analysis helps users make better decisions. make better decisions. Internal Users Managers Officers Internal Auditors McGraw-Hill/Irwin External Users Shareholders Lenders Customers © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-3 Purpose of Analysis Purpose of Analysis F in a n c ia l m e a s u re s a re o fte n u s e d to ra n k c o rp o ra te p e rfo rm a n c e . E x a m p le m e a s u re s in c lu d e : G ro w th in s a le s R e tu rn to s to c k h o ld e r s P r o fit m a r g in s R e tu rn o n e q u ity D e te r m in e d b y a n a ly z in g th e fin a n c ia l s ta te m e n ts . McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-4 Financial Statements Are Designed Financial Statements Are Designed for Analysis for Analysis C la s s ifie d F in a n c ia l S ta te m e n ts C o m p a ra tiv e F in a n c ia l S ta te m e n ts C o n s o lid a te d F in a n c ia l S ta te m e n ts Ite m s w ith c e r ta in c h a r a c te r is tic s a r e g ro u p e d to g e th e r. A m o u n ts fro m s e v e ra l y e a rs a p p e a r s id e b y s id e . In fo r m a tio n fo r th e p a r e n t a n d s u b s id ia r y a re p re s e n te d . R e s u lts in s ta n d a r d iz e d , m e a n in g fu l s u b to ta ls . H e lp s id e n tify s ig n ific a n t changes and tre n d s . P r e s e n te d a s if th e tw o c o m p a n ie s a r e a s in g le b u s in e s s u n it. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-5 Tools of Analysis Tools of Analysis Dollar & Percentage Changes Component Percentages McGraw-Hill/Irwin Trend Percentages Ratios © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-6 Dollar and Percentage Changes Dollar and Percentage Changes Dollar Change: Dollar Change = Analysis Period Amount – Base Period Amount Percentage Change: % Percent Change McGraw-Hill/Irwin = Dollar Change ÷ Base Period Amount © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-7 Dollar and Percentage Changes Dollar and Percentage Changes E v a lu a tin g P e rc e n ta g e C h a n g e s in S a le s a n d E a rn in g s S a le s a n d e a r n in g s s h o u ld in c r e a s e a t m o r e th a t th e r a te o f in fla tio n . In m e a s u r in g q u a r te r ly c h a n g e s , c o m p a re to th e s a m e q u a r te r in th e p r e v io u s y e a r . P e rc e n ta g e s m a y b e m is le a d in g w h e n th e b a s e a m o u n t is s m a ll. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-8 Dollar and Percentage Changes Dollar and Percentage Changes Example Example Let’s look at the asset section Let’s look at the asset section of Clover Corporation’s of Clover Corporation’s comparative balance sheet and comparative balance sheet and income statement for 2003 and income statement for 2003 and 2002. 2002. Compute the dollar change and Compute the dollar change and the percentage for cash. the percentage for cash. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-9 CLOVER CORPORATION Comparative Balance Sheets December 31, 2003 Assets Current assets: Cash and equivalents $ 12,000 Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 Total assets $ 315,000 * Percent rounded to one decimal point. McGraw-Hill/Irwin Dollar Change 2002 $ 23,500 40,000 100,000 1,200 $ 164,700 Percent Change* ? ? 40,000 85,000 $ 125,000 $ 289,700 © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-10 CLOVER CORPORATION Comparative Balance Sheets December 31, 2003 2002 Dollar Change Percent Change* Assets Current assets: Cash and equivalents $ 12,000 $ 23,500 $ (11,500) Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200 $12,000 – $23,500 = $(11,500) Total current assets $12,000 – $ 164,700 = $(11,500) $ 155,000 $23,500 Property and equipment: Land 40,000 40,000 Buildings and equipment, net 120,000 85,000 Total property and equipment $ 160,000 $ 125,000 Total assets $ 315,000 $ 289,700 * Percent rounded to one decimal point. McGraw-Hill/Irwin ? © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-11 CLOVER CORPORATION Comparative Balance Sheets December 31, 2003 2002 Dollar Change Percent Change* Assets Current assets: Cash and equivalents $ 12,000 $ 23,500 $ (11,500) -48.9% Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200 ($11,500 ÷ $23,500) × 100% = 48.94% Total current assets $ 155,000 $ 164,700 ($11,500 ÷ $23,500) × 100% = 48.94% Property and equipment: Land 40,000 40,000 Complete the Complete the Buildings and equipment, net 120,000 85,000 analysis for analysis for Total property and equipment $ 160,000 $ 125,000 the other the other Total assets $ 315,000 $ 289,700 assets. assets. * Percent rounded to one decimal point. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-12 CLOVER CORPORATION Comparative Balance Sheets December 31, 2003 Assets Current assets: Cash and equivalents $ 12,000 Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 Total assets $ 315,000 * Percent rounded to one decimal point. McGraw-Hill/Irwin Dollar Change 2002 Percent Change* $ 23,500 $ 40,000 100,000 1,200 $ 164,700 (11,500) 20,000 (20,000) 1,800 (9,700) -48.9% 50.0% -20.0% 150.0% -5.9% 40,000 85,000 $ 125,000 $ 289,700 $ 35,000 35,000 25,300 0.0% 41.2% 28.0% 8.7% © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-13 Trend Analysis Trend Analysis Trend analysis is used to reveal patterns in data Trend analysis is used to reveal patterns in data covering successive periods. covering successive periods. Trend Analysis Period Amount = Percent Base Period Amount McGraw-Hill/Irwin × 100% © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-14 Trend Analysis -- Example Trend Analysis Example Berry Products Income Information For the Years Ended December 31, Item Revenues Cost of sales Gross profit Item Revenues Cost of sales Gross profit 2003 $ 400,000 285,000 115,000 2002 $ 355,000 250,000 105,000 2001 $ 320,000 225,000 95,000 2000 $ 290,000 198,000 92,000 2003 2002 2001 2000 145% 129% 116% 1999 is the base period so 105% its 1999 is the base period so104% its 150% 132% 118% amounts will equal 100%. 135% 124% 112% 108% amounts will equal 100%. (290,000 ÷ 275,000) (198,000 ÷ 190,000) (92,000 ÷ 85,000) McGraw-Hill/Irwin × 100% = 105% × 100% = 104% × 100% = 108% 1999 $ 275,000 190,000 85,000 1999 100% 100% 100% © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-15 Component Percentages Component Percentages Examine the relative size of each item in the financial statements by computing component (or commonsized) percentages. Component Percent = Analysis Amount Base Amount Financial Statement Financial Statement Balance Sheet Balance Sheet Income Statement Income Statement McGraw-Hill/Irwin × 100% Base Amount Base Amount Total Assets Total Assets Revenues Revenues © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-16 CLOVER CORPORATION Comparative Balance Sheets December 31, Complete the common-size analysis for the other assets. 2003 2002 13-16 Common-size Percents* 2003 2002 Assets Current assets: Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1% Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200 ($12,000 ÷ $315,000) × 100% = 3.8% ($12,000 ÷ $315,000) × $ 164,700 3.8% Total current assets $ 155,000 100% = Property and equipment: ($23,50040,000 Land 40,000 ($23,500÷ $289,700) × 100% = 8.1% ÷ $289,700) × 100% = 8.1% Buildings and equipment, net 120,000 85,000 Total property and equipment $ 160,000 $ 125,000 Total assets $ 315,000 $ 289,700 100.0% 100.0% * Percent rounded to first decimal point. © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin
  • Slide 4-17 CLOVER CORPORATION Comparative Balance Sheets December 31, 2003 Assets Current assets: Cash and equivalents $ 12,000 Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 Total assets $ 315,000 * Percent rounded to first decimal point. McGraw-Hill/Irwin 2002 13-17 Common-size Percents* 2003 2002 $ 23,500 40,000 100,000 1,200 $ 164,700 3.8% 19.0% 25.4% 1.0% 49.2% 8.1% 13.8% 34.5% 0.4% 56.9% 40,000 85,000 $ 125,000 $ 289,700 12.7% 38.1% 50.8% 100.0% 13.8% 29.3% 43.1% 100.0% © The McGraw-Hill Companies, Inc., 2002
  • CLOVER CORPORATION 13-18 Comparative Balance Sheets December 31, Complete the common-size analysis for the liabilities and equity Common-size accounts. Percents* 2003 2002 2003 2002 Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 67,000 $ 44,000 21.3% 15.2% Notes payable 3,000 6,000 1.0% 2.1% Total current liabilities $ 70,000 $ 50,000 22.2% 17.3% Long-term liabilities: Bonds payable, 8% 75,000 80,000 23.8% 27.6% Total liabilities $ 145,000 $ 130,000 46.0% 44.9% Shareholders' equity: Preferred stock 20,000 20,000 6.3% 6.9% Common stock 60,000 60,000 19.0% 20.7% Additional paid-in capital 10,000 10,000 3.2% 3.5% Total paid-in capital $ 90,000 $ 90,000 28.6% 31.1% Retained earnings 80,000 69,700 25.4% 24.1% Total shareholders' equity $ 170,000 $ 159,700 54.0% 55.1% Total liabilities and shareholders' equity $ 315,000 $ 289,700 100.0% 100.0% © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin * Percent rounded to first decimal point. Slide 4-18
  • Slide 4-19 13-19 CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31, Compute the common-size percentages for Common-size revenues and expenses. Percents* 2003 2002 2003 2002 Revenues $ 520,000 $ 480,000 100.0% 100.0% Costs and expenses: Cost of sales 360,000 315,000 69.2% 65.6% Selling and admin. 128,600 126,000 24.7% 26.3% Interest expense 6,400 7,000 1.2% 1.5% Income before taxes $ 25,000 $ 32,000 4.8% 6.7% Income taxes (30%) 7,500 9,600 1.4% 2.0% Net income $ 17,500 $ 22,400 3.4% 4.7% Net income per share $ 0.79 $ 1.01 Avg. # common shares 22,200 22,200 * Rounded to first decimal point. © The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin
  • Slide 4-20 Ratios Ratios A r a tio is a s im p le m a th e m a tic a l e x p r e s s io n o f th e r e la tio n s h ip b e tw e e n o n e ite m a n d a n o th e r . A lo n g w ith d o lla r a n d p e r c e n ta g e c h a n g e s , tre n d p e r c e n ta g e s , a n d c o m p o n e n t p e r c e n ta g e s , r a tio s c a n b e u s e d to c o m p a r e : P a s t p e rfo rm a n c e to p re s e n t p e rfo rm a n c e . McGraw-Hill/Irwin O th e r c o m p a n ie s to your com pany. © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-21 Use this information to calculate the liquidity ratios for Norton Corporation. McGraw-Hill/Irwin NORTON CORPORATION 2003 Cash $ 30,000 Accounts receivable, net Beginning of year 17,000 End of year 20,000 Inventory Beginning of year 10,000 End of year 15,000 Total current assets 65,000 Total current liabilities 42,000 Total liabilities 103,917 Total assets Beginning of year 300,000 End of year 346,390 Revenues 494,000 © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-22 Working Capital Working Capital Working capital is the excess of current Working capital is the excess of current assets over current liabilities. assets over current liabilities. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-23 Current Ratio Current Ratio This ratio measures This ratio measures the short-term debtthe short-term debtpaying ability of the paying ability of the company. company. Current Current Assets = Ratio Current Liabilities Current = Ratio McGraw-Hill/Irwin $65,000 $42,000 = 1.55 : 1 © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-24 Quick Ratio Quick Ratio Quick Ratio = Quick Assets Current Liabilities Quick assets are cash, marketable securities, Quick assets are cash, marketable securities, and receivables. and receivables. This ratio is like the current This ratio is like the current ratio but excludes current assets ratio but excludes current assets such as inventories that may be such as inventories that may be difficult to quickly convert into cash. difficult to quickly convert into cash. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-25 Quick Ratio Quick Ratio Quick Ratio Quick Ratio Quick Assets Current Liabilities = = $50,000 $42,000 = 1.19 : 1 This ratio is like the current This ratio is like the current ratio but excludes current assets ratio but excludes current assets such as inventories that may be such as inventories that may be difficult to quickly convert into cash. difficult to quickly convert into cash. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-26 Debt Ratio Debt Ratio A measure of creditor’s long-term risk. A measure of creditor’s long-term risk. The smaller the percentage of assets that The smaller the percentage of assets that are financed by debt, the smaller the risk are financed by debt, the smaller the risk for creditors. for creditors. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-27 Uses and Limitations of Financial Uses and Limitations of Financial Ratios Ratios U ses L im it a t io n s R a tio s h e lp u s e r s u n d e rs ta n d fin a n c ia l r e la tio n s h ip s . M a n a g e m e n t m a y e n te r in to tr a n s a c tio n s m e r e ly to im p r o v e th e r a tio s . R a tio s p r o v id e fo r q u ic k c o m p a r is o n o f c o m p a n ie s . R a tio s d o n o t h e lp w ith a n a ly s is o f th e c o m p a n y 's p r o g re s s to w a rd n o n fin a n c ia l g o a ls . McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-28 Measures of Profitability Measures of Profitability An income statement can be prepared in either a An income statement can be prepared in either a multiple-step or single-step format. multiple-step or single-step format. The single-step format is simpler. The single-step format is simpler. The multiple-step format provides The multiple-step format provides more detailed information. more detailed information. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Income Statement (Multiple-Step) Income Statement (Multiple-Step) Example Example Slide 4-29 Proper Heading Gross Margin Operating Expenses Nonoperating Items { { { { Remember to Remember to compute EPS. compute EPS. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-30 Income Statement (Single-Step) Example Income Statement (Single-Step) Example { Proper Heading Revenues & Gains Expenses & Losses { { Remember to Remember to compute EPS. compute EPS. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-31 NORTON CORPORATION 2003 Use this information to calculate the profitability ratios for Norton Corporation. McGraw-Hill/Irwin Number of common shares outstanding all of 2003 Net income Shareholders' equity Beginning of year End of year Revenues Cost of sales Total assets Beginning of year End of year $ 27,400 53,690 180,000 234,390 494,000 140,000 300,000 346,390 © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-32 Return On Assets (ROA) Return On Assets (ROA) This ratio is generally considered This ratio is generally considered the best overall measure of a the best overall measure of a company’s profitability. company’s profitability. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-33 Return On Equity (ROE) Return On Equity (ROE) This measure indicates how well the This measure indicates how well the company employed the owners’ company employed the owners’ investments to earn income. investments to earn income. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-34 Sources of Financial Information Sources of Financial Information Annual and q u a r te r ly fin a n c ia l re p o rts . R e p o r ts file d w ith th e S E C b y p u b lic ly o w n e d c o m p a n ie s . In te r n e t a n d o th e r fr e e s o u rc e s . D e ta ile d a n a ly s e s b y fin a n c ia l a n a ly s ts . Can be a u d ite d o r u n a u d ite d . McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  • Slide 4-35 End of Chapter 14 No more ratios, please! McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002