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. 1TOPIC 10: FINANCIAL STATEMENT ANALYSIS

2. 2IntroductionInterpretation is when users evaluate financial information to make judgementsIt 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. 3Techniques (types) of analysis:1.HorizontalAnalysis Comparing key figures in financial statementEvaluates a series of financial statement over a period of time.2. Vertical AnalysisEvaluates 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. 4Techniques (types) of analysis: (cont.)3. Trend analysisSimilar to horizontal analysis, except that the first set of account in the series is given a base of 1004. Ratio AnalysisIt expresses the relationship among selected items of financial statement data.

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

6. 614-7HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Increase (Decrease)Dec 31, 2007Dec 31, 2006 Amount PercentAssets Current assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred 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 30.3The stockholders’ equity section is not displayed.

7. 7Horizontal Analysis: Difference $2,584 Base year $7,777= 33.2%14-8HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Increase (Decrease)Dec 31, 2007Dec 31, 2006 Amount PercentAssets Current assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred 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 30.333.2%

8. 8Horizontal Analysis: Difference $2,307 Base year $13,068= 17.7%14-9HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007CondensedIncrease (Decrease)Dec 31, 2007Dec 31, 2006 Amount PercentAssets Current assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred 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 30.333.2%33.2%17.7

9. 914-10HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007CondensedIncrease (Decrease)Dec 31, 2007Dec 31, 2006 Amount PercentAssets Current assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 11821.9Total assets $26,394 $21,385 $5,009 23.4 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred 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. 10Horizontal Analysis: Difference $7,815 Base year $45,738= 17.1%14-11HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006Increase (Decrease)Dec 31, 2007Dec 31, 2006 Amount Percent17.1%Sales (net) $53,553 $45,738 $7,815Cost of merchandise sold 37,406 32,057 5,349Gross profit $16,147$13,681$2,466Selling and store operating exp. 10,280 8,655 1,625General and administrative exp. 935 835 100Total operating expenses $11,215$ 9,490$1,725Income 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 277Net income $ 3,044 $ 2,581 $ 463

11. 11Horizontal Analysis: Difference $5,349 Base year $32,057= 16.714-12HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006Increase (Decrease)Dec 31, 2007Dec 31, 2006 Amount Percent17.1%Sales (net) $53,553 $45,738 $7,815Cost of merchandise sold 37,406 32,057 5,349Gross profit $16,147$13,681$2,466Selling and store operating exp. 10,280 8,655 1,625General and administrative exp. 935 835 100Total operating expenses $11,215$ 9,490$1,725Income 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 277Net income $ 3,044 $ 2,581 $ 463 16.7

12. 1217.1%16.7 14-13HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006Increase (Decrease)Dec 31, 2007Dec 31, 2006 Amount PercentSales (net) $53,553 $45,738 $7,815Cost of merchandise sold 37,406 32,057 5,349Gross profit $16,147$13,681$2,466Selling and store operating exp. 10,280 8,655 1,625General and administrative exp. 935 835 100Total operating expenses $11,215$ 9,490$1,725Income 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 277Net income $ 3,044 $ 2,581 $ 463 18.018.812.018.217.712.833.317.516.917.9

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

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

15. 1514-1814-18HOME DEPOTComparative Balance Sheets (in Millions) December 31, 2007 and December 31, 2006CondensedDecember 31, 2007 December 31, 2006 Amount Percent Amount PercentAssets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540Total assets $26,394 $21,385 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996Total liabilities $ 8,312$ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082$15,004Total liabilities and SE $26,394 $21,385 100.0%Total assets is 100.0%

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

17. 1714-20HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006CondensedDecember 31, 2007 December 31, 2006 Amount Percent Amount PercentAssets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540Total assets $26,394 $21,385 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996Total liabilities $ 8,312$ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082$15,004Total liabilities and SE $26,394 $21,385 39.3%58.2 2.5100.0%24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0%

18. 1839.3%58.2 2.5100.0%24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0% 14-21HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006CondensedDecember 31, 2007 December 31, 2006 Amount Percent Amount PercentAssets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540Total assets $26,394 $21,385 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996Total liabilities $ 8,312$ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082$15,004Total liabilities and SE $26,394 $21,385 100.0%Total assets is 100.0%

19. 1939.3%58.2 2.5100.0%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%14-22HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006CondensedDecember 31, 2007 December 31, 2006 Amount Percent Amount PercentAssets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540Total assets $26,394 $21,385 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996Total liabilities $ 8,312$ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082$15,004Total liabilities and SE $26,394 $21,385 36.4%100.0%

20. 2039.3%58.2 2.5100.0%24.6% 6.9 31.5% 20.9% 47.6 68.5% 100.0% 14-23HOME DEPOTComparative Balance Sheets (in Millions)December 31, 2007 and December 31, 2006CondensedDecember 31, 2007 December 31, 2006 Amount Percent Amount PercentAssets Current assets $10,361 $ 7,777 Property and equipment, net 15,375 13,068 Other assets 58 540Total assets $26,394 $21,385 LiabilitiesCurrent liabilities $ 6,501 $ 4,385 Long-term liabilities 1,811 1,996Total liabilities $ 8,312$ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082$15,004Total liabilities and SE $26,394 $21,385 36.4%61.1 2.5100.0%20.5% 9.3 29.8% 23.0% 47.1 70.2% 100.0%

21. 2114-24HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 20062007 2006Amount Percent Amount PercentSales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147$13,681Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835Total operating expenses $11,215$ 9,490Income 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 1,636Net income $ 3,044 $ 2,581 Net sales is 100.0%Net sales is 100.0%

22. 222006Vertical Analysis: Cost of Merchandise Sold $32,057 Net Sales $45,738= 70.1%14-25HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 20062007 2006Amount Percent Amount PercentSales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147$13,681Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835Total operating expenses $11,215$ 9,490Income 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 1,636Net income $ 3,044 $ 2,581 70.1

23. 232007Vertical Analysis: Cost of Merchandise Sold $37,406 Net Sales $53,553= 69.9%14-26HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 20062007 2006Amount Percent Amount PercentSales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147$13,681Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835Total operating expenses $11,215$ 9,490Income 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 1,636Net income $ 3,044 $ 2,581 69.970.1

24. 2414-27HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 20062007 2007Amount Percent Amount PercentSales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147$13,681Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835Total operating expenses $11,215$ 9,490Income 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 1,636Net income $ 3,044 $ 2,581 69.970.129.9% 18.9% 1.8 20.7% 9.2% 0.1 (0.1) 9.2% 3.6 5.6%

25. 2514-28HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 20062007 2006Amount Percent Amount PercentSales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147$13,681Selling and store operating exp. 10,280 8,655 General and administrative exp. 935 835Total operating expenses $11,215$ 9,490Income 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 1,636Net income $ 3,044 $ 2,581 70.130.1% 19.2% 1.7 20.9% 9.2% 0.1 (0.0) 9.3% 3.6 5.7%69.929.9% 18.9% 1.8 20.7% 9.2% 0.1 (0.1) 9.2% 3.6 5.6%

26. 26Types of ratio analysisProfitability RatioEfficiency/activity/asset management RatioLiquidity RatioSolvency RatioCash flowInvestment

27. 271. Profitability 1. Return on capital employed 2. Gross profit ratio 3. Net profit ratio2. Liquidity 1. Current ratio 2. Quick ratio3. Efficiency 1. Debtors turnover 2. Debtors collection period 3. Stock turnover ratio 4. Asset turnover ratio4. Solvency/financial leverage management ratio 1. Debt to Equity ratio 2.Debt ratio

28. 28Continue………..6. Investment 1. Dividend yield 2. Dividend cover 3. Earnings per share 4. Price/earnings ratio 5. Interest cover5. Cash Flow 1. Cash flow ratio

29. 29Importance of RatiosQuick and easy snapshot of an organisation’s achievements

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

31. 30PROFITABILITY RATIOIt measures the income or operating effectiveness of an organisation for a given period of time.

32. A low value of this ratio will affect the company ‘s ability to obtain debt, equity financing and the ability to grow or expand.i Return on capital employed (ROCE)measures effective use of capital

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

35. 31Continue…ii. Gross Profit MarginIt measures the percentage of one ringgit of sales that results in gross income.=Sales – Cost of Goods Sold x 100% Sales = Gross Profit x 100%Salesiii. Net Profit MarginIt measures the percentage of one ringgit of sales that results in net income. = Profit or earning after tax x 100% Sales

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

37. 33Continue…ii. Quick Ratio It measures the company’s immediate short term liquidity.Current Asset – Stock – Prepayment Current LiabilityThis ratio indicates whether current liabilities could be paid without having to sell the inventory

38. This ratio is useful for companies which cannot convert inventory into cash quickly if necessary. 34Cont….This ratio indicates whether the business has enough short-term assets to cover its short-term liabilities.A ratio above 1 indicates that working capital is positive (Current assets exceed current liabilities)A ratio below 1 indicates that working capital is negative.Many large companies regularly operate with current ratio closer to 1 and 2

39. 35Generally 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. 36EFFICIENCY RATIODebtors turnoverMeasures how many times it takes customers to payCredit sales Average debtors

41. 37EFFICIENCY RATIO1. Debtors collection periodMeasures how long it takes customers to pay= Average debtors x 365 days OR365 days Credit salesdebtors turnoverThis 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 companyLarge numbers of days is a negative signal, raising questions about the company’s policies of granting credit such as;Unrestricted credit policiesLonger credit limitCollection attempts is not very strength

42. 38Efficiency Ratio3. Stock turnover ratiomeasures how quickly stock moves through businessThis ratio means that the average length of time that the stocks are held before being sold.= Cost of goods sold Average stockIt can also be calculated in days= Average stock x 365 days OR 365 days Cost of goods sold stock turnover

43. 39Efficiency RatioAsset turnover ratiocompares sales to total assets employed

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

45. 40SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIO1. Debt to Equity ratio= Total liabilitiesTotal Equity 2. Debt ratioAlso call debt to assets ratio = Total liabilitiesTotal Asset

46. 41SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIOThis is to measure the ability of the company to survive over a long period of time

47. The ability to pay interest as it come due/mature42Income Statement for the year ended 31 Dec 2007Sales 200Less: Cost of goods sold (100)Gross profits 100Less expensesGeneral 40 Interest 10(50)Profit before tax 50Less: Taxation(15)Profits after tax 35Less: Dividends(15)Retained profits 20

48. 43Balance Sheet as at 31 Dec 2007

49. 441. Profitability Ratiosa. Return on Capital Employed Profit after tax = 35 = 16.3% Average capital employed 215b. Gross Profit RatioGross profit= 100 = 50% Sales 200c. Net Profit RatioNet profit after taxation = 35 = 17.5% sales 200

50. 452. Liquidity Ratiosa. Current RatioCurrent assets = 120 = 2:1 Current liabilities 60b. Quick RatioCurrent assets - stock = 120-60 = 1:1 Current liabilities 60

51. 463. Efficiency RatiosDebtors Collection Period Average debtors x 365 = 40 x 365 = 73 days Credit sales 200

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

53. 484. Financing ratioa) Debt to equity ratioTotal liabilities = 180 = 0.837 Total equity 215b) Debt ratioTotal liabilities = 180 = 0.456 Total assets 395

54. 49Limitations of the Accounting InformationEstimatesThe 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).

55. 50CONCLUSIONRatio analysis is a good way to overview an organisation’s activities

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