analysis staments @ bec doms_chapter17[1]

8/3/2019 Analysis Staments @ Bec Doms_chapter17[1]

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CHAPTER 17

ANALYSIS ANDINTERPRETATION OF

FINANCIAL STATEMENTS


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Non-accounting majors, especially,shouldrelate welltothischapter

Itlooksataccountinginformationfrom users

perspective Relatesverycloselytotopicsyou willstudy

inyourfinance courseTherefore, we willuse asomewhat broaderbrush

onthischapter

Whatisfinancialstatementanalysis?Tearing apartthe financialstatementsandlookingatthe relationships

Financial Statement Analysis


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Whoanalyzesfinancialstatements?

Internalusers (i.e., management)

Externalusers (emphasisofchapter) Examples?

Investors,creditors,regulatoryagencies &

stockmarketanalystsand

auditors

Financial Statement Analysis625


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Whatdointernalusersuse itfor?

Planning, evaluatingandcontrollingcompany

operations

Whatdo externalusersuse itfor?

Assessingpastperformance andcurrentfinancial

positionand makingpredictionsaboutthe future

profitabilityandsolvencyofthe companyas wellas evaluatingthe effectivenessofmanagement

Firstsentence inchaptersays...



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Informationisavailable from

Publishedannualreports

(1) Financialstatements

(2) Notestofinancialstatements

(3) Letterstostockholders

(4) Auditorsreport (Independentaccountants)

(5) Managementsdiscussionandanalysis Reportsfiled withthe government

e.g.,Form 10-K,Form 10-QandForm 8-K

627 628



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Informationisavailable from

Othersources

(1) Newspapers (e.g.,Wall Street Journal)

(2) Periodicals (e.g.Forbes, Fortune)

(3) Financialinformationorganizationssuch

as:Moodys, Standard & Poors, Dun & Bradstreet,

Inc.,and RobertMorris Associates

(4) Otherbusinesspublications

627 628



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Horizontal Analysis

Vertical Analysis

Common-Size Statements

Trend Percentages

Ratio Analysis

Methodsof



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Horizontal Analysis

Using comparative financial

statements to calculate dollaror percentage changesin afinancial statement item from

one period to thenext


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Vertical Analysis

For a single financialstatement, each item

isexpressed as apercentage of asignificant total,

e.g., all incomestatement items areexpressed as a

percentage ofsales


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Common-Size Statements

Financial statements that showonly percentages and no

absolute dollar amounts


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Trend Percentages

Show changes over timeingiven financial statement items

(can help evaluate financialinformation ofseveral years)


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Ratio Analysis

Expression of logical relationshipsbetweenitemsin a financialstatement of a single period

(e.g., percentage relationshipbetween revenue and net income)


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Horizontal Analysis Example

The managementofCloverCompanyprovidesyou

withcomparative balance sheetsofthe years

ended December31, 1999 and 1998.

Managementasksyoutoprepare ahorizontal

analysisonthe information.


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CLOVER CORPORATION

Comparative BalanceSheets

December 31, 1999 and 1998

Incre

1999 1998 Amo

Assets

Current assets:

Cash 12,000$ 23,500$

Accounts receivable, net 60,000 40,000Inventory 80,000 100,000

Prepaid expenses 3,000 1,200

Total current assets 155,000 164,700

P

roperty 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$


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Calculating Change in DollarAmounts

DollarChange Current YearFigure Base YearFigure=



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Calculating Change in DollarAmounts

Since we are measuring the amount ofthe change between 1998 and 1999, the

dollar amounts for 1998 become thebase year figures.

DollarChange Current YearFigure Base YearFigure=



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Calculating Change asa Percentage

PercentageChange Dollar ChangeBase YearFigure 100%=



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CLOVER CORPORATION



Increase (Decrease)

1999 1998 Amount %

Assets

Current assets:

Cash 12,000$ 23,500$ (11,500)$

Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000



Property and equipment:Land 40,000 40,000



Total assets 315,000$ 289,700$

$12,000 $23,500 = $(11,500)



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CLOVER CORPORATION



Increase (Decrease)

1999 1998 Amount %

Assets

Current assets:

Cash 12,000$ 23,500$ (11,500)$ (48.9)


Inventory 80,000 100,000



Property and equipment:Land 40,000 40,000



Total assets 315,000$ 289,700$

($11,500

$23,500)

100% = 48.9%



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CLOVER CORPORATION



Increase (Decrease)

1999 1998 Amount %

Assets

Current assets:

Cash 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)

Property and equipment: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



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Lets apply thesameprocedures to the

liability and stockholdersequity sections of the

balancesheet.



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CLOVER CORPORATION



Increase (Decrease)

1999 1998 Amount %

Liabilities and Stockholders'Equity

Current liabilities:

Accounts payable 67,000$ 44,000$ 23,000$ 52.3

Notes payable 3,000 6,000 (3,000) (50.0)

Total current liabilitie s 70,000 50,000 20,000 40.0Long-term l iabilities:

Bonds payable, 8% 75,000 80,000 (5,000) (6.3)

Total liabilities 145,000 130,000 15,000 11.5

Stockholders'equity:

Preferred stock 20,000 20,000 - 0.0

Commonstock 60,000 60,000 - 0.0 Additional paid-in capital 10,000 10,000 - 0.0

Total paid-in capital 90,000 90,000 - 0.0

Retained earnings 80,000 69,700 10,300 14.8

Total stockholders'equity 170,000 159,700 10,300 6.4

Total liabilitie s and stockholders'equity 315,000$ 289,700$ 25,300$ 8.7


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Now, lets apply theprocedures to theincomestatement.



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CLOVER CORPORATION

ComparativeIncomeStatements

For the YearsEnded December 31, 1999 and 1998

Increase (Decrease)

1999 1998 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3

Cost ofgoodssold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)

Operatingexpenses 128,600 126,000 2,600 2.1

Net operatingincome 31,400 39,000 (7,600) (19.5)

Interest expense 6,400 7,000 (600) (8.6)

Net income before taxes 25,000 32,000 (7,000) (21.9)

Lessincome taxes (30%) 7,500 9,600 (2,100) (21.9)

Net income 17,500$ 22,400$ (4,900)$ (21.9)


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CLOVER CORPORATION



Increase (Decrease)

1999 1998 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3







Net income 17,500$ 22,400$ (4,900)$ (21.9)

Salesincreased by 8.3% whilenet

income decreased by 21.9%.


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CLOVER CORPORATION



Increase (Decrease)

1999 1998 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3







Net income 17,500$ 22,400$ (4,900)$ (21.9)

There wereincreasesin both cost ofgoodssold (14.3%) and operatingexpenses (2.1%).Theseincreased costs more than offset the

increaseinsales, yielding an overalldecreaseinnet income.


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Vertical Analysis Example

The managementofSample Companyasksyouto

prepare averticalanalysisforthe comparative

balance sheetsofthe company.


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Sample Company

BalanceSheet (Assets)

At December 31, 1999 and 1998

% ofTotal Assets

1999 1998 1999 1998Cash 82,000$ 30,000$ 17% 8%

Accts.Rec. 120,000 100,000 25% 26%

Inventory 87,000 82,000 18% 21%

Land 101,000 90,000 21% 23%Equipment 110,000 100,000 23% 26%

Accum. Depr. (17,000) (15,000) -4% -4%

Total 483,000$ 387,000$ 100% 100%



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Vertical Analysis ExampleSample Company

BalanceSheet (Assets)


% ofTotal Assets

1999 1998 1999 1998Cash 82,000$ 30,000$ 17% 8%

Accts.Rec. 120,000 100,000 25% 26%

Inventory 87,000 82,000 18% 21%

Land 101,000 90,000 21% 23%Equipment 110,000 100,000 23% 26%

Accum. Depr. (17,000) (15,000) -4% -4%

Total 483,000$ 387,000$ 100% 100%

$82,000 $483,000 = 17% rounded$30,000 $387,000 = 8% rounded


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Sample Company

BalanceSheet (Liabilities & Stockholders'Equity)


% ofTotal Assets

1999 1998 1999 1998

Acts.Payable 76,000$ 60,000$ 16% 16%

WagesPayable 33,000 17,000 7% 4%

NotesPayable 50,000 50,000 10% 13%

CommonS

tock 170,000 160,000 35% 41%Retained Earnings 154,000 100,000 32% 26%

Total 483,000$ 387,000$ 100% 100%


$76,000 $483,000 = 16% rounded


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Trend Percentages Example

Wheeler,Inc.providesyou withthe following

operatingdataandasksthatyouprepare atrend

analysis.

Wheeler, Inc.

Operating Data

1999 1998 1997 1996 1995

Revenues 2,405$ 2,244$ 2,112$ 1,991$ 1,820$

Expenses 2,033 1,966 1,870 1,803 1,701Net income 372$ 278$ 242$ 188$ 119$


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Wheeler,Inc.providesyou withthe following

operatingdataandasksthatyouprepare atrend

analysis.

Wheeler, Inc.

Operating Data

1999 1998 1997 1996 1995

Revenues 2,405$ 2,244$ 2,112$ 1,991$ 1,820$

Expenses 2,033 1,966 1,870 1,803 1,701Net income 372$ 278$ 242$ 188$ 119$

$1,991 - $1,820 = $171


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Using 1995 asthe base year, we developthe

followingpercentage relationships.

Wheeler, Inc.

Operating Data

1999 1998 1997 1996 1995

Revenues 132% 123% 116% 109% 100%

Expenses 120% 116% 110% 106% 100%

Net income 313% 234% 203% 158% 100%

$1,991 - $1,820 = $171

$171 $1,820 = 9% rounded


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90

100

110

120

130

140

1995 1996 1997 1998 1999

Years

%

of100Base

Sales

Expenses

Trend lineforSales


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Ratioscan be expressedinthree different ways:

1. Ratio (e.g.,currentratioof2:1)

2. % (e.g.,profit marginof2%)

3. $ (e.g., EPS of$2.25)

CAUTION!

Usingratiosandpercentages withoutconsideringthe underlyingcauses may be hazardoustoyour

health!leadtoincorrectconclusions.

Ratios


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CategoriesofRatios

Liquidity RatiosIndicate acompanysshort-termdebt-payingability

Equity (Long-Term Solvency) RatiosShow relationship betweendebtand equityfinancinginacompany

Profitability TestsRelate income toothervariables

Market TestsHelpassessrelative meritsofstocksinthe

marketplace


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Liquidity Ratios Current (workingcapital)ratio

Acid-test (quick)ratio Cashflow liquidityratio

Accountsreceivable turnover

Numberofdayssalesinaccounts

receivable

Inventoryturnover

Totalassetsturnover

651

10 Ratios YouMustKnow


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Equity (Long-Term Solvency) Ratios

Equity (stockholders equity)ratio

Equitytodebt



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Profitability Tests

Returnonoperatingassets

Netincome tonetsales (returnonsalesorprofitmargin)

Returnonaverage common

stockholders equity (ROE)

Cashflow margin

Earningspershare

Timesinterest earned

Timespreferreddividends earned

$



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Market Tests

Earningsyieldoncommonstock

Price-earningsratio Payoutratiooncommonstock

Dividendyieldoncommonstock

Dividendyieldonpreferredstock

Cashflow pershare ofcommon

stock



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Now, lets look atNorton

Corporations 1999

and 1998 financialstatements.


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NORTON CORPORATION

BalanceSheets


1999 1998Assets

Current assets:

Cash 30,000$ 20,000$


Inventory 12,000 10,000



Property and equipment:

Land 165,000 123,000



Total assets 346,390$ 300,000$


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NORTON CORPORATION

BalanceShee ts


1999 1998

Liabilities and Stockholders'EquityCurrent liabilities:

Accounts payable 39,000$ 40,000$

Notes payable, short-term 3,000 2,000

Total current liabilities 42,000 42,000

Long-term liabilities:Notes payable, long-term 70,000 78,000

Total liabilities 112,000 120,000

Stockholders'equity:

Commonstock, $1 parvalue 27,400 17,000

Additional paid-in capital 158,100 113,000Total paid-in capital 185,500 130,000

Retained earnings 48,890 50,000

Total stockholders'equity 234,390 180,000

Total liabilities and stockholders'equity 346,390$ 300,000$


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NORTON CORPORATION

IncomeStatements

For the YearsEnded December 31, 1999 and 19981999 1998

Net sales 494,000$ 450,000$

Cost ofgoodssold 140,000 127,000

Gross margin 354,000 323,000Operatingexpenses 270,000 249,000

Net operatingincome 84,000 74,000

Interest expense 7,300 8,000

Net income before taxes 76,700 66,000

Lessincome taxes (30%) 23,010 19,800

Net income 53,690$ 46,200$


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Now, lets calculatethe 10 ratios based

on Nortons financial

statements.


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NORTON CORPORATION

1999

Cash 30,000$Accounts receivable, net

Beginning of year 17,000

End of year 20,000

Inventory


End of year 12,000

Total current assets 65,000Total current liabilities 42,000

Sales on account 494,000

Cost ofgoodssold 140,000

We will

use this

information

tocalculatethe liquidityratiosfor

Norton.


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Working Capital*

12/31/99

Current assets 65,000$

Current liabilities (42,000)

Working capital 23,000$

The excessofcurrentassetsovercurrent

liabilities.

*While thisisnot aratio,itdoesgive an

indicationofacompanysliquidity.


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Current (Working Capital) Ratio

CurrentRatio

$65,000$42,000

= = 1.55 : 1

Measures the abilityof the company to pay current

debts as they become due.

CurrentR

atio

Current Assets

Current Liabilities

=

#1


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Acid-Test (Quick) Ratio

Quick Assets

Current Liabilities

=Acid-TestR

atio

Quick assets are Cash,MarketableSecurities,

AccountsReceivable (net) and

current NotesReceivable.

#2


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Quick Assets

Current Liabilities

=Acid-TestR

atioNorton Corporationsquickassets consist of cash of

$30,000 and accounts

receivable of $20,000.


#2


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Quick Assets

Current Liabilities

=Acid-TestR

atio$50,000$42,000

= 1.19 : 1=Acid-TestRatio


#2


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Sales onAccountA

verageA

ccountsR

eceivable

AccountsReceivable

Turnover

=

Accounts Receivable Turnover

= 26.70 times$494,000

($17,000 + $20,000) 2

AccountsReceivableTurnover

=

This ratio measures how manytimes a company convertsits

receivablesinto cash each year.

#3 Average, net accountsreceivable

Net, credit sales

b f S l


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NumberofDays Sales

in Accounts Receivable

Measures, on average, how manydaysit takes to collect an

account receivable.

Days SalesinAccounts

Receivables

=365 Days


= 13.67 days=365 Days

26.70 Times

Days SalesinAccountsReceivables

#4

N b f D S l


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NumberofDays Sales

in Accounts Receivable

In practice, would 45 days be adesirablenumber of daysin

receivables?

#4Days SalesinAccounts

Receivables

=365 Days


= 13.67 days=365 Days

26.70 Times

Days SalesinAccountsReceivables


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Inventory Turnover

Cost of GoodsSoldAverageInventory

InventoryTurnover

=

Measures thenumber of timesinventory issold and

replaced during the year.

= 12.73 times$140,000

($10,000 + $12,000) 2InventoryTurnover

=

#5


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Inventory Turnover

Cost of GoodsSoldAverageInventory

InventoryTurnover

=

Would 5 be adesirablenumber of timesforinventory to turnover?

= 12.73 times$140,000

($10,000 + $12,000) 2InventoryTurnover

=

#5

E i L T


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Equity,orLongTerm

Solvency Ratios

Thisispartofthe

informationto

calculate the equity,or

long-term solvencyratiosofNorton

Corporation.

NORTON CORPORATION

1999

Net operatingincome 84,000$

Net sales 494,000

Interest expense 7,300

Total stockholders'equity 234,390

NORTON CORPORATION


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NORTON CORPORATION

1999

Commonshares outstanding

Beginning of year 17,000End of year 27,400

Net income 53,690$

Stockholders'equity

Beginning of year 180,000 End of year 234,390

Dividends pershare 2

Dec. 31 market price/share 20

Interest expense 7,300

Total assets


End of year 346,390

Hereis therest of the

informationwe will

use.


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Equity Ratio

Equity

Ratio=

Stockholders Equity

Total Assets

EquityRatio

=$234,390$346,390

67.7%=

Measures the proportionof total assets provided by

stockholders.

#6


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NetIncome toNet SalesA/K/A Returnon SalesorProfitMargin

Net Incometo

Net Sales

=Net Income

Net Sales

Net Incometo

Net Sales=

$53,690$494,000

= 10.9%

Measures the proportion of thesales dollarwhich is retained as profit.

#7


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NetIncome toNet SalesA/K/A Returnon SalesorProfitMargin

Net Incometo

Net Sales

=Net Income

NetS

ales

Net Incometo

Net Sales=

$53,690$494,000

= 10.9%

Would a 1% return onsales begood?

#7

R t A C


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Returnon Average Common

Stockholders Equity (ROE)

Return onStockholders

Equity=

Net IncomeAverage Common

Stockholders Equity

=

$53,690

($180,000 + $234,390) 2 = 25.9%

Return onS

tockholdersEquity

Important measure of theincome-producing ability

of a company.

#8


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Earnings

perShare

EarningsAvailable to CommonStockholders

Weighted-A

verage Number of CommonShares Outstanding=

EarningsperShare

$53,690(17,000 + 27,400) 2

= = $2.42

The financial press regularly publishesactual and forecasted EPS amounts.

#9

Earnings PerShare


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Whatsnew from Chap. 15?

Weighted-average calculation

EPS of commonstock = _______________________

Earnings available to

commonstockholdersWeighted-average number ofcommonshares outstanding

644

l Three alternatives for calculating

weighted-averagenumber ofshares

Earnings PerShare


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EPS of commonstock = _______________________

Earnings available to

commonstockholdersWeighted-average number ofcommonshares outstanding

645

Alternate #1

Earnings PerShare

Whatsnew from Chap. 15?

Weighted-average calculation


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Alternate #3

Alternate #2

645

Earnings PerShare


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EPS and StockDividendsorSplits

Whyrestate allpriorcalculationsofEPS?

Comparability- i.e.,noadditionalcapital was

generated bythe dividendorsplit

646

Earnings PerShare

Primary EPS andFully Diluted EPSAPB Opinion No. 15

I mentionedthis 17-page pronouncement that

requireda 100-page explanationinthe lecture

P i E i R i


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Price-Earnings RatioA/K/A P/E Multiple

Price-Earnings

Ratio

Market PricePerShare

EPS

=

Price-EarningsRatio

=$20.00$ 2.42

= 8.3 : 1

#10

Providessome measure of whether thestock is under or overpriced.


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Important Considerations

Needforcomparable data

Dataisprovided by Dun &

Bradstreet, Standard & Poors etc.

Mustcompare byindustry

Is EPS comparable?

Influence ofexternalfactors

General businessconditions

Seasonalnature ofbusinessoperations

Impactofinflation


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Question

The currentratioisa measure ofliquiditythatis

computed bydividingtotalassets bytotal

liabilities.

a. True

b. False


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The current ratio is a measure ofliquidity that is computed by dividing

total assets by total liabilities.

a. True

b. False

Question

The current ratio is a measure ofliquidity, but is computed by

dividing current assets bycurrent liabilities


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Question

Quickassetsare definedas Cash,Marketable

Securitiesandnetreceivables.

a. True

b. False


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Quick assets are defined as Cash,MarketableSecurities and net

receivables.

a. True

b. False

Question


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No more ratios, please!


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About Test#1

Will be challenging because the material

coveredischallenging

All questionsare T/ForM/C

Questionsare 5-pt., 3-pt. & 1-pt.

Notrickssuchaspatternsinanswers

Orderofanswersisrandom

Coverage is evenoverthe 4 chapters

Time allowed: 75 minutes


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About Test#1

Best waytostudy

Notesfirst

Studyguide and/orHermansontutorials

Calculators will be provided

Must waitoutside classroom

Have yourquestionsreadyfornextactual

class

See course home page foroffice hours

analysis staments @ bec doms_chapter17[1]

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