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© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Slide
4-1
FINANCIAL STATEMENT
ANALYSIS
Chapter
14

Slide
4-2
Internal Users External Users
Financial statement analysis helps users
make better decisions.
Financial statement analysis helps users
make better decisions.
Managers
Officers
Internal Auditors
Shareholders
Lenders
Customers
Purpose of AnalysisPurpose of Analysis

Slide
4-3
G r o w t h
i n s a l e s
R e t u r n t o
s t o c k h o l d e r s
P r o f i t
m a r g i n s
R e t u r n o n
e q u i t y
D e t e r m i n e d b y
a n a l y z i n g t h e
f i n a n c i a l
s t a t e m e n t s .
F i n a n c i a l m e a s u r e s a r e o f t e n u s e d
t o r a n k c o r p o r a t e p e r f o r m a n c e .
E x a m p l e m e a s u r e s i n c l u d e :
Purpose of AnalysisPurpose of Analysis

Slide
4-4
R e s u l t s
i n s t a n d a r d i z e d ,
m e a n i n g f u l
s u b t o t a l s .
I t e m s w i t h c e r t a i n
c h a r a c t e r i s t i c s a r e
g r o u p e d t o g e t h e r .
C l a s s i f i e d
F i n a n c i a l
S t a t e m e n t s
H e l p s i d e n t i f y
s i g n i f i c a n t
c h a n g e s a n d
t r e n d s .
A m o u n t s f r o m
s e v e r a l y e a r s
a p p e a r s i d e b y s i d e .
C o m p a r a t i v e
F i n a n c i a l
S t a t e m e n t s
P r e s e n t e d a s i f
t h e t w o c o m p a n i e s
a r e a s i n g l e
b u s i n e s s u n i t .
I n f o r m a t i o n f o r t h e
p a r e n t a n d s u b s i d i a r y
a r e p r e s e n t e d .
C o n s o l i d a t e d
F i n a n c i a l
S t a t e m e n t s
Financial Statements Are Designed
for Analysis
Financial Statements Are Designed
for Analysis

Slide
4-5
Dollar &
Percentage
Changes
Trend
Percentages
Component
Percentages
Ratios
Tools of AnalysisTools of Analysis

Slide
4-6
Dollar Change:
Analysis Period
Amount
Base Period
Amount
Dollar
Change = –
Percentage Change:
Dollar Change
Base Period
Amount
Percent
Change = ÷%%
Dollar and Percentage ChangesDollar and Percentage Changes

Slide
4-7
S a l e s a n d e a r n i n g s
s h o u l d i n c r e a s e a t
m o r e t h a t t h e r a t e
o f i n f l a t i o n .
I n m e a s u r i n g q u a r t e r l y
c h a n g e s , c o m p a r e t o
t h e s a m e q u a r t e r i n
t h e p r e v i o u s y e a r .
P e r c e n t a g e s m a y b e
m i s l e a d i n g w h e n t h e
b a s e a m o u n t i s s m a l l .
E v a l u a t i n g P e r c e n t a g e C h a n g e s
i n S a l e s a n d E a r n i n g s
Dollar and Percentage ChangesDollar and Percentage Changes

Slide
4-8
Let’s look at the asset section
of Clover Corporation’s
comparative balance sheet and
income statement for 2003 and
2002.
Compute the dollar change and
the percentage for cash.
Let’s look at the asset section
of Clover Corporation’s
comparative balance sheet and
income statement for 2003 and
2002.
Compute the dollar change and
the percentage for cash.
Dollar and Percentage Changes
Example
Dollar and Percentage Changes
Example

Slide
4-9
CLOVER CORPORATION
Comparative Balance Sheets
December 31,
2003 2002
Dollar
Change
Percent
Change*
Assets
Current assets:
Cash and equivalents 12,000$ 23,500$ ? ?
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000$ 164,700$
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.

Slide
4-10
CLOVER CORPORATION
December 31,
2003 2002
Dollar
Change
Percent
Change*
Assets
Current assets:
Cash and equivalents 12,000$ 23,500$ (11,500)$ ?
Inventory 80,000 100,000
Land 40,000 40,000
Total assets 315,000$ 289,700$
$12,000 – $23,500 = $(11,500)$12,000 – $23,500 = $(11,500)

Slide
4-11
CLOVER CORPORATION
December 31,
2003 2002
Dollar
Change
Percent
Change*
Assets
Current assets:
Cash and equivalents 12,000$ 23,500$ (11,500)$ -48.9%
Inventory 80,000 100,000
Land 40,000 40,000
Total assets 315,000$ 289,700$
($11,500 ÷ $23,500) × 100% = 48.94%($11,500 ÷ $23,500) × 100% = 48.94%
Complete the
analysis for
the other
assets.
Complete the
analysis for
the other
assets.

Slide
4-12
CLOVER CORPORATION
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 20,000 50.0%
Inventory 80,000 100,000 (20,000) -20.0%
Prepaid expenses 3,000 1,200 1,800 150.0%
Total current assets 155,000$ 164,700$ (9,700) -5.9%
Land 40,000 40,000 - 0.0%
Buildings and equipment, net 120,000 85,000 35,000 41.2%
Total property and equipment 160,000$ 125,000$ 35,000 28.0%
Total assets 315,000$ 289,700$ 25,300$ 8.7%

Slide
4-13
Trend analysis is used to reveal patterns in data
covering successive periods.
Trend analysis is used to reveal patterns in data
covering successive periods.
Trend
Percent
Analysis Period Amount
Base Period Amount
100%= ×
Trend AnalysisTrend Analysis

Slide
4-14
1999 is the base period so its
amounts will equal 100%.
1999 is the base period so its
amounts will equal 100%.
Berry Products
Income Information
For the Years Ended December 31,
Item 2003 2002 2001 2000 1999
Revenues 400,000$ 355,000$ 320,000$ 290,000$ 275,000$
Cost of sales 285,000 250,000 225,000 198,000 190,000
Gross profit 115,000 105,000 95,000 92,000 85,000
Item 2003 2002 2001 2000 1999
Revenues 105% 100%
Cost of sales 104% 100%
Gross profit 108% 100%
Item 2003 2002 2001 2000 1999
Revenues 145% 129% 116% 105% 100%
Cost of sales 150% 132% 118% 104% 100%
Gross profit 135% 124% 112% 108% 100%
(290,000 ÷ 275,000) × 100% = 105%
(198,000 ÷ 190,000) × 100% = 104%
(92,000 ÷ 85,000) × 100% = 108%
Trend Analysis - ExampleTrend Analysis - Example

Slide
4-15
Examine the relative size of each item in the financial
statements by computing component (or common-
sized) percentages.
Component
Percent
100%
Analysis Amount
Base Amount
= ×
Financial Statement Base Amount
Balance Sheet Total Assets
Income Statement Revenues
Financial Statement Base Amount
Balance Sheet Total Assets
Income Statement Revenues
Component PercentagesComponent Percentages

Slide
4-16 CLOVER CORPORATION
December 31,
Common-size
Percents*
2003 2002 2003 2002
Assets
Current assets:
Cash and equivalents 12,000$ 23,500$ 3.8% 8.1%
Inventory 80,000 100,000
Land 40,000 40,000
Total assets 315,000$ 289,700$ 100.0% 100.0%
* Percent rounded to first decimal point.
Complete the common-size analysis for the other
assets.
($12,000 ÷ $315,000) × 100% = 3.8%($12,000 ÷ $315,000) × 100% = 3.8%
($23,500 ÷ $289,700) × 100% = 8.1%($23,500 ÷ $289,700) × 100% = 8.1%
13-16

Slide
December 31,
Common-size
Percents*
2003 2002 2003 2002
Assets
Current assets:
Cash and equivalents 12,000$ 23,500$ 3.8% 8.1%
Accounts receivable, net 60,000 40,000 19.0% 13.8%
Inventory 80,000 100,000 25.4% 34.5%
Prepaid expenses 3,000 1,200 1.0% 0.4%
Total current assets 155,000$ 164,700$ 49.2% 56.9%
Land 40,000 40,000 12.7% 13.8%
Buildings and equipment, net 120,000 85,000 38.1% 29.3%
Total property and equipment 160,000$ 125,000$ 50.8% 43.1%
Total assets 315,000$ 289,700$ 100.0% 100.0%
13-17

Slide
4-18
CLOVER CORPORATION
December 31,
Common-size
Percents*
2003 2002 2003 2002
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable 67,000$ 44,000$
Notes payable 3,000 6,000
Total current liabilities 70,000$ 50,000$
Long-term liabilities:
Bonds payable, 8% 75,000 80,000
Total liabilities 145,000$ 130,000$
Shareholders' equity:
Preferred stock 20,000 20,000
Common stock 60,000 60,000
Additional paid-in capital 10,000 10,000
Total paid-in capital 90,000$ 90,000$
Retained earnings 80,000 69,700
Total shareholders' equity 170,000$ 159,700$
Total liabilities and shareholders' equity 315,000$ 289,700$
Complete the common-size analysis for the liabilities and equity
accounts.
CLOVER CORPORATION
December 31,
Common-size
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%
13-18

Slide
Comparative Income Statements
Common-size
Percents*
2003 2002 2003 2002
Revenues 520,000$ 480,000$
Costs and expenses:
Cost of sales 360,000 315,000
Selling and admin. 128,600 126,000
Interest expense 6,400 7,000
Income before taxes 25,000$ 32,000$
Income taxes (30%) 7,500 9,600
Net income 17,500$ 22,400$
Net income per share 0.79$ 1.01$
Avg. # common shares 22,200 22,200
* Rounded to first decimal point.
Compute the common-size percentages for
revenues and expenses.
CLOVER CORPORATION
Comparative Income Statements
Common-size
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.
13-19

Slide
4-20
P a s t p e r f o r m a n c e t o
p r e s e n t p e r f o r m a n c e .
O t h e r c o m p a n i e s t o
y o u r c o m p a n y .
A l o n g w i t h d o l l a r a n d p e r c e n t a g e c h a n g e s ,
t r e n d p e r c e n t a g e s , a n d c o m p o n e n t p e r c e n t a g e s ,
r a t i o s c a n b e u s e d t o c o m p a r e :
A r a t i o i s a s i m p l e m a t h e m a t i c a l e x p r e s s i o n
o f t h e r e l a t i o n s h i p b e t w e e n o n e i t e m a n d a n o t h e r .
RatiosRatios

Slide
4-21
NORTON CORPORATION
2003
Cash 30,000$
Accounts receivable, net
Beginning of year 17,000
End of year 20,000
Inventory
End of year 15,000
Total current assets 65,000
Total current liabilities 42,000
Total liabilities 103,917
Total assets
End of year 346,390
Revenues 494,000
Use this
information to
calculate the
liquidity ratios
for Norton
Corporation.

Slide
4-22
Working capitalWorking capital is the excess of current
assets over current liabilities.
Working capitalWorking capital is the excess of current
assets over current liabilities.
Working CapitalWorking Capital

Slide
4-23
Current
Ratio
Current Assets
Current Liabilities
=
Current
Ratio
$65,000
$42,000
= = 1.55 : 1
This ratio measures
the short-term debt-
paying ability of the
company.
This ratio measures
the short-term debt-
paying ability of the
company.
Current RatioCurrent Ratio

Slide
4-24
Quick assets are cash, marketable securities,
and receivables.
Quick assets are cash, marketable securities,
and receivables.
This ratio is like the current
ratio but excludes current assets
such as inventories that may be
difficult to quickly convert into cash.
Quick Assets
Current Liabilities
=Quick
Ratio
Quick RatioQuick Ratio

Slide
4-25
Quick Assets
Current Liabilities
=Quick
Ratio
$50,000
$42,000
= 1.19 : 1=Quick
Ratio
Quick RatioQuick Ratio

Slide
4-26
A measure of creditor’s long-term risk.A measure of creditor’s long-term risk.
The smaller the percentage of assets that
are financed by debt, the smaller the risk
for creditors.
A measure of creditor’s long-term risk.A measure of creditor’s long-term risk.
The smaller the percentage of assets that
are financed by debt, the smaller the risk
for creditors.
Debt RatioDebt Ratio

Slide
4-27
R a t i o s h e l p u s e r s
u n d e r s t a n d
f i n a n c i a l r e l a t i o n s h i p s .
R a t i o s p r o v i d e f o r
q u i c k c o m p a r i s o n
o f c o m p a n i e s .
U s e s
M a n a g e m e n t m a y e n t e r
i n t o t r a n s a c t i o n s m e r e l y
t o i m p r o v e t h e r a t i o s .
R a t i o s d o n o t h e l p w i t h
a n a l y s i s o f t h e c o m p a n y 's
p r o g r e s s t o w a r d
n o n f i n a n c i a l g o a l s .
L im it a t io n s
Uses and Limitations of Financial
Ratios
Uses and Limitations of Financial
Ratios

Slide
4-28
An income statement can be prepared in either a
multiple-step or single-step format.
An income statement can be prepared in either a
multiple-step or single-step format.
The single-step format is simpler.
The multiple-step format provides
more detailed information.
The single-step format is simpler.
The multiple-step format provides
more detailed information.
Measures of ProfitabilityMeasures of Profitability

Slide
4-29
Proper Heading {
Gross
Margin {
Operating
Expenses {
{
Non-
operating
Items
Income Statement (Multiple-Step)
Example
Income Statement (Multiple-Step)
Example
Remember to
compute EPS.
Remember to
compute EPS.

Slide
4-30
Proper Heading
{
Income Statement (Single-Step) ExampleIncome Statement (Single-Step) Example
Expenses
& Losses
{
Revenues
& Gains {
Remember to
compute EPS.
Remember to
compute EPS.

Slide
4-31
Use this
information to
calculate the
profitability
ratios for
Norton
Corporation.
NORTON CORPORATION
2003
Number of common
shares outstanding all of
2003 27,400
Net income 53,690$
Shareholders' equity
End of year 234,390
Revenues 494,000
Cost of sales 140,000
Total assets
End of year 346,390

Slide
4-32
This ratio is generally considered
the best overall measure of a
company’s profitability.
This ratio is generally considered
the best overall measure of a
company’s profitability.
Return On Assets (ROA)Return On Assets (ROA)

Slide
4-33
This measure indicates how well the
company employed the owners’
investments to earn income.
This measure indicates how well the
company employed the owners’
investments to earn income.
Return On Equity (ROE)Return On Equity (ROE)

Slide
4-34
C a n b e
a u d i t e d o r
u n a u d i t e d .
A n n u a l a n d
q u a r t e r ly
f i n a n c ia l
r e p o r t s .
R e p o r t s f i le d
w i t h t h e S E C b y
p u b l i c l y o w n e d
c o m p a n ie s .
I n t e r n e t a n d
o t h e r f r e e
s o u r c e s .
D e t a i l e d
a n a l y s e s b y
f in a n c i a l
a n a ly s t s .
Sources of Financial InformationSources of Financial Information

Slide
4-35
End of Chapter 14
No more
ratios, please!

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