The document discusses techniques for analyzing financial statements, including horizontal analysis, vertical analysis, and ratio analysis. It provides examples of applying horizontal analysis to compare line items on Home Depot's balance sheet and income statement from 2006 to 2007. Vertical analysis is also demonstrated by expressing line items as a percentage of total assets or total sales. Key points shown include current assets increasing 33.2% and cost of merchandise sold increasing 16.7% based on the horizontal analysis examples.

1. 1 TOPIC 10: FINANCIAL STATEMENT ANALYSIS

2. 2 Introduction Interpretation is when users evaluate financial information to make judgements It is the key to any in-depth understanding of an organisation’s performance. Basically, the users evaluate an organisation’s performance and financial position using the information from INCOME STATEMENT and BALANCE SHEET. The value of the analysis is depends on the value of the financial statements.

3. 3 Techniques (types) of analysis: 1.HorizontalAnalysis Comparing key figures in financial statement Evaluates a series of financial statement over a period of time. 2. Vertical Analysis Evaluates financial statement by expressing each item in a financial statement as a percent of the base amount (key figure) Key-figure (such as sales in IS and total assets on BS) are set to 100% Other items are then expressed as percentage of 100

4. 4 Techniques (types) of analysis: (cont.) 3. Trend analysis Similar to horizontal analysis, except that the first set of account in the series is given a base of 100 4. Ratio Analysis It expresses the relationship among selected items of financial statement data.

5. 5 Horizontal Analysis It’s an analysis of the percentage increases and decreases of related items in comparative financial statements. What is horizontal analysis?

6. 6 14-7 HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent Assets Current assets $10,361 $ 7,777 $2,584 33.2% Property and equipment, net 15,375 13,068 2,307 17.7 Other assets 658 540 118 21.9 Total assets $26,394 $21,385 $5,009 23.4 Liabilities Current liabilities $ 6,501 $ 4,385 $2,116 48.3 Long-term debt, excluding current installment 1,250 1,545 (295) (19.1) Other long-term liabilities 372 256 116 45.3 Deferred income taxes 189 195 (6) (3.1) Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3) Total liabilities $ 8,312$ 6,381$1,931 30.3 The stockholders’ equity section is not displayed.

7. 7 Horizontal Analysis: Difference $2,584 Base year $7,777 = 33.2% 14-8 HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent Assets Current assets $10,361 $ 7,777 $2,584 33.2% Property and equipment, net 15,375 13,068 2,307 17.7 Other assets 658 540 118 21.9 Total assets $26,394 $21,385 $5,009 23.4 Liabilities Current liabilities $ 6,501 $ 4,385 $2,116 48.3 Long-term debt, excluding current installment 1,250 1,545 (295) (19.1) Other long-term liabilities 372 256 116 45.3 Deferred income taxes 189 195 (6) (3.1) Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3) Total liabilities $ 8,312$ 6,381$1,931 30.3 33.2%

8. 8 Horizontal Analysis: Difference $2,307 Base year $13,068 = 17.7% 14-9 HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Condensed Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent Assets Current assets $10,361 $ 7,777 $2,584 33.2% Property and equipment, net 15,375 13,068 2,307 17.7 Other assets 658 540 118 21.9 Total assets $26,394 $21,385 $5,009 23.4 Liabilities Current liabilities $ 6,501 $ 4,385 $2,116 48.3 Long-term debt, excluding current installment 1,250 1,545 (295) (19.1) Other long-term liabilities 372 256 116 45.3 Deferred income taxes 189 195 (6) (3.1) Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3) Total liabilities $ 8,312$ 6,381$1,931 30.3 33.2% 33.2% 17.7

9. 9 14-10 HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Condensed Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent Assets Current assets $10,361 $ 7,777 $2,584 33.2% Property and equipment, net 15,375 13,068 2,307 17.7 Other assets 658 540 11821.9 Total assets $26,394 $21,385 $5,009 23.4 Liabilities Current liabilities $ 6,501 $ 4,385 $2,116 48.3 Long-term debt, excluding current installment 1,250 1,545 (295) (19.1) Other long-term liabilities 372 256 116 45.3 Deferred income taxes 189 195 (6) (3.1) Total long-term liabilities $ 1,811$ 1,996$ (185) (9.3) Total liabilities $ 8,312$ 6,381$1,93130.3

10. 10 Horizontal Analysis: Difference $7,815 Base year $45,738 = 17.1% 14-11 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent 17.1% Sales (net) $53,553 $45,738 $7,815 Cost of merchandise sold 37,406 32,057 5,349 Gross profit $16,147$13,681$2,466 Selling and store operating exp. 10,280 8,655 1,625 General and administrative exp. 935 835 100 Total operating expenses $11,215$ 9,490$1,725 Income from operations $ 4,932 $ 4,191 $ 741 Other income and expenses: Interest and investment inc. 53 47 6 Interest expense (28) (21) (7) Income before income tax $ 4,957 $ 4,217 $ 740 Income taxes 1,913 1,636 277 Net income $ 3,044 $ 2,581 $ 463

11. 11 Horizontal Analysis: Difference $5,349 Base year $32,057 = 16.7 14-12 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent 17.1% Sales (net) $53,553 $45,738 $7,815 Cost of merchandise sold 37,406 32,057 5,349 Gross profit $16,147$13,681$2,466 Selling and store operating exp. 10,280 8,655 1,625 General and administrative exp. 935 835 100 Total operating expenses $11,215$ 9,490$1,725 Income from operations $ 4,932 $ 4,191 $ 741 Other income and expenses: Interest and investment inc. 53 47 6 Interest expense (28) (21) (7) Income before income tax $ 4,957 $ 4,217 $ 740 Income taxes 1,913 1,636 277 Net income $ 3,044 $ 2,581 $ 463 16.7

12. 12 17.1% 16.7 14-13 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 Increase (Decrease) Dec 31, 2007Dec 31, 2006 Amount Percent Sales (net) $53,553 $45,738 $7,815 Cost of merchandise sold 37,406 32,057 5,349 Gross profit $16,147$13,681$2,466 Selling and store operating exp. 10,280 8,655 1,625 General and administrative exp. 935 835 100 Total operating expenses $11,215$ 9,490$1,725 Income from operations $ 4,932 $ 4,191 $ 741 Other income and expenses: Interest and investment inc. 53 47 6 Interest expense (28) (21) (7) Income before income tax $ 4,957 $ 4,217 $ 740 Income taxes 1,913 1,636 277 Net income $ 3,044 $ 2,581 $ 463 18.0 18.8 12.0 18.2 17.7 12.8 33.3 17.5 16.9 17.9

13. 13 Vertical Analysis A percentage analysis can be used to show the relationship of each component to a total within a single statement.

14. 14 Vertical Analysis The total, or 100% item, on the balance sheet is “total assets.” The total, or 100% item, on the income statement is “total sales.”

15. 15 14-18 14-18 HOME DEPOTComparative Balance Sheets (in Millions) December 31, 2007 and December 31, 2006 Condensed December 31, 2007 December 31, 2006 Amount Percent Amount Percent Assets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540 Total assets $26,394 $21,385 Liabilities Current liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996 Total liabilities $ 8,312$ 6,381 Stockholders’ Equity Common stock/paid-in capital $ 5,529 $ 4,926 RE & accumulated comp. loss 12,553 10,078 Total stockholders’ equity $18,082$15,004 Total liabilities and SE $26,394 $21,385 100.0% Total assets is 100.0%

16. 16 Vertical Analysis: Current assets $10,361 Total assets $26,394 = 39.3% 14-19 HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006 Condensed December 31, 2007 December 31, 2006 Amount Percent Amount Percent Assets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540 Total assets $26,394 $21,385 Liabilities Current liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996 Total liabilities $ 8,312$ 6,381 Stockholders’ Equity Common stock/paid-in capital $ 5,529 $ 4,926 RE & accumulated comp. loss 12,553 10,078 Total stockholders’ equity $18,082$15,004 Total liabilities and SE $26,394 $21,385 39.3% 100.0%

17. 17 14-20 HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006 Condensed December 31, 2007 December 31, 2006 Amount Percent Amount Percent Assets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540 Total assets $26,394 $21,385 Liabilities Current liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996 Total liabilities $ 8,312$ 6,381 Stockholders’ Equity Common stock/paid-in capital $ 5,529 $ 4,926 RE & accumulated comp. loss 12,553 10,078 Total stockholders’ equity $18,082$15,004 Total liabilities and SE $26,394 $21,385 39.3% 58.2 2.5 100.0% 24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0%

18. 18 39.3% 58.2 2.5 100.0% 24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0% 14-21 HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006 Condensed December 31, 2007 December 31, 2006 Amount Percent Amount Percent Assets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540 Total assets $26,394 $21,385 Liabilities Current liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996 Total liabilities $ 8,312$ 6,381 Stockholders’ Equity Common stock/paid-in capital $ 5,529 $ 4,926 RE & accumulated comp. loss 12,553 10,078 Total stockholders’ equity $18,082$15,004 Total liabilities and SE $26,394 $21,385 100.0% Total assets is 100.0%

19. 19 39.3% 58.2 2.5 100.0% 24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0% Vertical Analysis: Current assets $7,777 Total assets $21,385 = 36.4% 14-22 HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006 Condensed December 31, 2007 December 31, 2006 Amount Percent Amount Percent Assets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540 Total assets $26,394 $21,385 Liabilities Current liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996 Total liabilities $ 8,312$ 6,381 Stockholders’ Equity Common stock/paid-in capital $ 5,529 $ 4,926 RE & accumulated comp. loss 12,553 10,078 Total stockholders’ equity $18,082$15,004 Total liabilities and SE $26,394 $21,385 36.4% 100.0%

20. 20 39.3% 58.2 2.5 100.0% 24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0% 14-23 HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006 Condensed December 31, 2007 December 31, 2006 Amount Percent Amount Percent Assets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540 Total assets $26,394 $21,385 Liabilities Current liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996 Total liabilities $ 8,312$ 6,381 Stockholders’ Equity Common stock/paid-in capital $ 5,529 $ 4,926 RE & accumulated comp. loss 12,553 10,078 Total stockholders’ equity $18,082$15,004 Total liabilities and SE $26,394 $21,385 36.4% 61.1 2.5 100.0% 20.5% 9.3 29.8% 23.0% 47.1 70.2% 100.0%

21. 21 14-24 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 2007 2006 Amount Percent Amount Percent Sales (net) $53,553 100.0% $45,738 100.0% Cost of merchandise sold 37,406 32,057 Gross profit $16,147$13,681 Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835 Total operating expenses $11,215$ 9,490 Income from operations $ 4,932 $ 4,191 Other income and expenses: Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217 Income taxes 1,913 1,636 Net income $ 3,044 $ 2,581 Net sales is 100.0% Net sales is 100.0%

22. 22 2006 Vertical Analysis: Cost of Merchandise Sold $32,057 Net Sales $45,738 = 70.1% 14-25 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 2007 2006 Amount Percent Amount Percent Sales (net) $53,553 100.0% $45,738 100.0% Cost of merchandise sold 37,406 32,057 Gross profit $16,147$13,681 Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835 Total operating expenses $11,215$ 9,490 Income from operations $ 4,932 $ 4,191 Other income and expenses: Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217 Income taxes 1,913 1,636 Net income $ 3,044 $ 2,581 70.1

23. 23 2007 Vertical Analysis: Cost of Merchandise Sold $37,406 Net Sales $53,553 = 69.9% 14-26 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 2007 2006 Amount Percent Amount Percent Sales (net) $53,553 100.0% $45,738 100.0% Cost of merchandise sold 37,406 32,057 Gross profit $16,147$13,681 Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835 Total operating expenses $11,215$ 9,490 Income from operations $ 4,932 $ 4,191 Other income and expenses: Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217 Income taxes 1,913 1,636 Net income $ 3,044 $ 2,581 69.9 70.1

24. 24 14-27 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 2007 2007 Amount Percent Amount Percent Sales (net) $53,553 100.0% $45,738 100.0% Cost of merchandise sold 37,406 32,057 Gross profit $16,147$13,681 Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835 Total operating expenses $11,215$ 9,490 Income from operations $ 4,932 $ 4,191 Other income and expenses: Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217 Income taxes 1,913 1,636 Net income $ 3,044 $ 2,581 69.9 70.1 29.9% 18.9% 1.8 20.7% 9.2% 0.1 (0.1) 9.2% 3.6 5.6%

25. 25 14-28 HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006 2007 2006 Amount Percent Amount Percent Sales (net) $53,553 100.0% $45,738 100.0% Cost of merchandise sold 37,406 32,057 Gross profit $16,147$13,681 Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835 Total operating expenses $11,215$ 9,490 Income from operations $ 4,932 $ 4,191 Other income and expenses: Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217 Income taxes 1,913 1,636 Net income $ 3,044 $ 2,581 70.1 30.1% 19.2% 1.7 20.9% 9.2% 0.1 (0.0) 9.3% 3.6 5.7% 69.9 29.9% 18.9% 1.8 20.7% 9.2% 0.1 (0.1) 9.2% 3.6 5.6%

26. 26 Types of ratio analysis Profitability Ratio Efficiency/activity/asset management Ratio Liquidity Ratio Solvency Ratio Cash flow Investment

27. 27 1. Profitability 1. Return on capital employed 2. Gross profit ratio 3. Net profit ratio 2. Liquidity 1. Current ratio 2. Quick ratio 3. Efficiency 1. Debtors turnover 2. Debtors collection period 3. Stock turnover ratio 4. Asset turnover ratio 4. Solvency/financial leverage management ratio 1. Debt to Equity ratio 2.Debt ratio

28. 28 Continue……….. 6. Investment 1. Dividend yield 2. Dividend cover 3. Earnings per share 4. Price/earnings ratio 5. Interest cover 5. Cash Flow 1. Cash flow ratio

30. Aid for comparisonsRatio provide benchmark to compare on company with another (inter-firm comparison) or to compare the same company over period of time (intra-firm comparison).

33. It measures the profitability from the shareholder view point.

34. It shows how many ringgit of the net income were earned for each ringgit invested by the owner. = Profit or earning after tax x 100% Average capital employed

36. 32 LIQUIDITY RATIO It measure the short term ability of the organisation to pay debt and to meet unexpected need for cash. i. Current Ratio To measure the ability of current asset that the company have to pay back the short term debt. = Current Asset Current Liability

39. 35 Generally the higher the ratio, the greater the financial stability and the lower the risk for both creditors and owners. However, the ratio should not be too high because that may indicate that the business is not reinvesting in long-term assets to maintain future productivity. High current ratio can actually indicate problems if inventories are getting larger than they should be or collections of receivables are slowing down.

40. 36 EFFICIENCY RATIO Debtors turnover Measures how many times it takes customers to pay Credit sales Average debtors

41. 37 EFFICIENCY RATIO 1. Debtors collection period Measures how long it takes customers to pay = Average debtors x 365 days OR365 days Credit salesdebtors turnover This ratio indicates how many days it takes, on average to collect a day’s sale revenue. The quicker a business collects and bank the money, the better it is to the company Large numbers of days is a negative signal, raising questions about the company’s policies of granting credit such as; Unrestricted credit policies Longer credit limit Collection attempts is not very strength

42. 38 Efficiency Ratio 3. Stock turnover ratio measures how quickly stock moves through business This ratio means that the average length of time that the stocks are held before being sold. = Cost of goods sold Average stock It can also be calculated in days = Average stock x 365 days OR 365 days Cost of goods sold stock turnover

44. Measures how efficient the assets in generating sales= Sales x 100% Average total assets

45. 40 SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIO 1. Debt to Equity ratio = Total liabilities Total Equity 2. Debt ratio Also call debt to assets ratio = Total liabilities Total Asset

48. 43 Balance Sheet as at 31 Dec 2007

49. 44 1. Profitability Ratios a. Return on Capital Employed Profit after tax = 35 = 16.3% Average capital employed 215 b. Gross Profit Ratio Gross profit= 100 = 50% Sales 200 c. Net Profit Ratio Net profit after taxation = 35 = 17.5% sales 200

50. 45 2. Liquidity Ratios a. Current Ratio Current assets = 120 = 2:1 Current liabilities 60 b. Quick Ratio Current assets - stock = 120-60 = 1:1 Current liabilities 60

51. 46 3. Efficiency Ratios Debtors Collection Period Average debtors x 365 = 40 x 365 = 73 days Credit sales 200

52. 47 c. Stock Turnover COGS = 100 = 1.66 times Average stock 60 d. Asset Turnover Ratio Sales x 100% = 200 x 100% Average total assets 395 = 51%

53. 48 4. Financing ratio a) Debt to equity ratio Total liabilities = 180 = 0.837 Total equity 215 b) Debt ratio Total liabilities = 180 = 0.456 Total assets 395

54. 49 Limitations of the Accounting Information Estimates The financial statement contains numerous estimates. Eg. Provision for doubtful debt, depreciation and contingent loss. Cost The traditional financial statements are based on historical cost, it is not adjusted for price-level change. Eg. Inflation affects the sales growth. Alternative Accounting Method A comparison may be misleading as different companies use different accounting method. Eg. FIFO and LIFO. Diversification of firms This diversification of activities of companies limit the usefulness of financial analysis. (no specific industry).

56. Ratio analysis must be compared with past result or industry norms, not in isolation

57. Things to be taken into account in using ratio analysis:

58. size of the organisation

59. Method used in accounting treatment

60. Same industry

61. Same country