Advanced Analysis Supplement to Accompany

UNDERSTANDING CORPORATE
ANNUAL REPORTS
A Financial Analysis Project

William R. Pasewark
Texas Tech University
Comprehensive Income

Comprehensive income represents the change in equity (net assets) of a corporation during the year from
transactions other than those resulting from investments and distributions to owners. Comprehensive
income usually differs from net income as a result of:

• Changes in the value of certain investments and financial instruments

• Certain translation adjustments for foreign currency
• Certain transactions related to derivative securities

Record the items that explain the difference between net income and comprehensive income in the
current year. If the corporation does not have any items that make comprehensive income different from
net income, enter the same amount for net income and comprehensive income.

Net Income (loss) $ _______________________________

Items explaining the difference in

net income and comprehensive income:

________________________________________ $ _______________________________

________________________________________ $ _______________________________

________________________________________ $ _______________________________

________________________________________ $ _______________________________

Comprehensive income (loss) $ _______________________________

9A
Accounts Receivable (Advanced)

If material, corporations must disclose expenses related to uncollectible receivables. The bad debt
percentage is a common size ratio calculated by dividing bad debt expense by gross sales.
( Receivables worksheet)

Bad Debt Bad Debt Expense

=
Percentage Gross Sales

A higher ratio indicates corporate profitability is more susceptible to expenses related to uncollectibles.
Determine the bad debt percentage for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Was the impact of bad debt on profitability more or less significant in the current year compared to the
previous year? Was the change related more to bad debt expense (the numerator) or to gross sales (the
denominator)?

___________________________________________________________________________________

___________________________________________________________________________________

Turnover of receivables may also be expressed in days by dividing the number of days in a year by the
receivable turnover ratio. The result indicates the average number of days needed to collect a receivable.
Fewer days indicate receivables are being collected faster.

Number of Days of ________365_______

=
Receivables Receivable Turnover

Compute the number of days of receivables for the current and previous year.

Current Year Previous Year

__________365_________ __________365_________
= days = days

17A
Inventories (Advanced)

Inventory as a percent of total assets is s common size ratio that indicates the relative importance of
inventory to the corporation. For retail companies, inventories can be one of the most
significant assets. The ratio is calculated by dividing inventory by total assets. Higher
ratios may indicate over accumulation of inventory, while lower ratios may indicate the
potential for stock outs. ( Inventory worksheet)

Inventory __Inventory__
=
Percentage Total Assets

Determine the inventory percentage for the current and previous year:

Current Year Previous Year

_________________________ _________________________
= % = %

Was the impact of the inventory on total assets more or less in the current year compared to the previous
year? Was the change related more to inventory levels (the numerator) or to total assets (the
denominator?

___________________________________________________________________________________

___________________________________________________________________________________

Cost of goods sold is the primary expense related to inventories. Analysts calculate the cost of goods
sold as a percentage of sales to determine the degree to which acquired goods (for retailers) or
manufacturing costs affect profit. The ratio is calculated by dividing cost of goods sold by net sales.

Cost of Goods Cost of Goods Sold

=
Sold Percentage Net Sales

A higher ratio indicates that acquired goods or manufacturing costs are more likely to reduce profits.
Determine the cost of goods sold percentage for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Was the impact of purchasing or manufacturing inventory more or less significant to profitability in the
current year compared to the previous year? Was the change related more to the cost (the numerator) or
to net sales (the denominator)?

___________________________________________________________________________________

18A
___________________________________________________________________________________

18A
Turnover of inventory may also be expressed in days by dividing the number of days in a year by the
inventory turnover ratio. The result indicates the average period of time a unit is held in inventory.
Fewer days indicate that inventory is being sold faster.

Number of Days ______365_______

=
of Inventory Inventory Turnover

Compute the number of days of inventory for the current and previous year.

Current Year Previous Year

__________365_________ __________365_________
= days = days

The inventory yield (or inventory productivity ratio) indicates the return received on dollars invested in
inventory. The ratio is calculated by dividing the gross profit by the average inventory. Average inventory
is determined by dividing the sum of beginning and ending inventory by two.

Inventory Gross Profit___

=
Yield Average Inventory

A higher ratio provides evidence that an inventory is productive, while a lower ratio may indicate the
inventory is less marketable or obsolete. Calculate the inventory yield for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Has the corporation improved its ability to manage inventory in the current year compared to the previous
year? What evidence suggests this is or is not the case?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

18B
Property and Depreciation (Advanced)

The tangibility ratio indicates the degree to which fixed assets are utilized in a corporation. The ratio is a
common size ratio determined by expressing net fixed assets as a percent of total assets. ( Fixed
Assets worksheet)

Tangibility Net Fixed Assets

=
Ratio Total Assets

Higher tangibility ratios indicate the corporation is more capital intensive. Calculate the tangibility ratio for
the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Compared to the previous year, has the corporation become more or less dependent on fixed assets?

___________________________________________________________________________________

___________________________________________________________________________________

Expressing deprecation as a percent of revenue will indicate the degree to which the use of fixed assets
reduces income. The ratio is determined by dividing depreciation expense by revenue. Because
depreciation can be a portion of cost of sales, selling expenses, or administrative expenses, the total
amount of depreciation expense is usually disclosed in the notes rather than on the income statement.

Depreciation Expense as a Depreciation Expense

=
Percent of Revenue Revenue

Determine the depreciation expense as a percent of revenue for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Did depreciation expense have more or less significance in determining profitability this year compared to
the previous year? What factors affected any changes in the way that fixed assets change profitability?

___________________________________________________________________________________

___________________________________________________________________________________

20A
The average fixed asset life indicates how long fixed assets are used in the corporation. The ratio is
determined by dividing gross depreciable assets by depreciation expense. Depreciable fixed assets do
not include land or construction in progress.

Average Fixed Gross Depreciable Assets

=
Asset Life Depreciation Expense

Higher average fixed asset lives indicate the corporation owns assets that last longer. Increases in the
ratio may result from the purchase of new fixed assets or the use of assets that are expected to have a
longer useful life. Decreases in the ratio may indicate the corporation has not made recent capital
expenditures. Calculate the average fixed asset life for the current and previous year.

Current Year Previous Year

______________________ ______________________
= years = years

Did the average fixed asset life change in the current year compared to the previous year? What factors
might explain the change?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

Investments Investments are classified as trading securities (intended to generate near-term profits),
held-to-maturity (debt investments that will be held for the investment life), securities available for sale (
SFAS 115) or equity investments ( APB 18). Does the corporation hold investments? If so, indicate the
value of these investments in each of the following categories for the current year. ( trading securities,
held-to-maturity, available for sale, equity investment)

Investment Category Current Investments Long-Term Investments

Trading Securities $ _______________________

Held-to-Maturity Securities $ _______________________ $ _______________________

Securities Available for Sale $ _______________________ $ _______________________

Equity Investments $ _______________________

20B
Leases (Advanced)

The operating lease utilization ratio indicates the degree to which operating leases are utilized in the
corporation. The ratio is determined by dividing the operating lease expense by revenue.

Operating Lease Operating Lease Expense

=
Utilization Ratio Revenue

Higher operating lease utilization ratios indicate the corporation is more likely to use operating leases to
gain access to fixed assets. Corporations that utilize operating leases tend to have lower assets and
lower debt. Lower assets potentially increase the return on assets (by lowering the denominator) and
lower debt potentially decreases the debt to equity ratio (by decreasing the numerator). (The potential
effect of operating lease utilization on these ratios may be determined by completing the lease worksheet,
 Inventory worksheet)

Determine the operating lease utilization ratio for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

The capital lease utilization ratio indicates the degree to which capital leases are utilized to gain access to
fixed assets. The ratio is determined by dividing the gross capital leases by total assets.

Capital Lease Gross Capital Leases

=
Utilization Ratio Total Assets

Higher capital lease utilization ratios indicate that the corporation may prefer capital leasing to purchasing
fixed assets. Determine the capital lease utilization ratio for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

21A
Pension Plan (Advanced)

Expressing the pension expense as a percent of revenue indicates the degree to which the pension plan
reduces income. The ratio is a common size ratio in which pension expense is divided by total revenue.

Pension Expense Pension Expense

=
to Revenue Total Revenue

A higher ratio indicates pension promises made by the corporation have a greater likelihood of reducing
income. Calculate pension expense as a percent of revenue for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Comparison of the projected benefit obligation to the total assets indicates the size of the pension plan in
relation to the corporation. The pension obligation ratio is determined by dividing the projected benefit
obligation of the pension plan by the total asset of the corporation.

Pension Pension Projected Benefit Obligation

=
Obligation Ratio Total Assets

A higher pension obligation ratio indicates the pension plan has a greater potential for imposing on
corporate resources. Determine the pension obligation ratio for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

Did the pension plan have more or less impact on the financial position and profitability corporation in the
current year compared to the previous year? What factors affected this change?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

23A
The pension funding ratio indicates whether there are sufficient assets in the pension plan to meet the
future obligations to retired employees. The ratio is determined by dividing the fair market value of
pension assets by the projected benefit obligation of the pension plan.

Pension Fair Market Value of Pension Assets______

=
Funding Ratio Projected Benefit Obligation of the Pension Plan

A pension funding ratio of greater than one indicates the corporation can meet future pension obligations
given current expectations of growth. If the ratio is less than one, the pension plan does not currently
contain sufficient assets to meet future expected obligations to retired employees. Calculate the pension
funding ratio for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

The actual rate of return on pension assets may be determined by dividing the actual earnings of pension
assets by the beginning fair market value of pension assets (some analysts prefer to use average fair
market value of pension assets instead).

Actual Return on _____Actual Earnings of Pension Assets_____

=
Pension Assets Beginning Fair Market Value of Pension Assets

A higher rate of return indicates the corporation is more successful in investing the assets related to the
pension plan. What was the actual rate of return the corporation earned on pension fund investments?

Current Year Previous Year

_________________________ _________________________
= % = %

How does the actual rate of return compare to the expected rate of return for pension assets?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

Note: Similar ratios may be calculated for post-retirement benefits other than pensions and for retirement
benefits as a whole. (see  Inventory worksheet)

23B
Analysis of Profitability (Advanced)

1. Total Stockholder Return (TSR)

The total stockholder return ratio indicates change in stockholder wealth during a period. The ratio is
determined by adding the stock price appreciation for the period to the dividends paid, then dividing the
sum by the stock price at the beginning of the year. Share price appreciation is determined by subtracting
the beginning of the year share price from the end of the year share price. If the share price decreased
during the year, share price appreciation will be negative.

Total Stockholder (Share Price Appreciation + Dividends Paid)

=
Return Beginning of Period Share Price

Higher total stockholder returns indicate greater accumulation of wealth for the stockholder. Determine
the total stockholder return for the current and previous year.

Current Year Previous Year

_________________________ _________________________
= % = %

2. Sales Multiple (Price / Sales Ratio)

The sales multiple indicates the relationship between the market price of a share of common stock and
the revenue per share. Some prefer the sales multiple to the P/E ratio for analyzing newer corporations
because newer corporations may have either losses or erratic earnings. The sales multiple is determined
by dividing the market price per share by the revenue per share. Revenue per share is determined by
dividing the revenue by the number of shares outstanding.

Sales Market Price per Share

=
Multiple Revenue per Share

Calculate the sales multiple for the current and previous year. If end of the year market prices of common
shares are not available, use an average of the high and low price during the last quarter of the year.

Current Year Previous Year

______________________ ______________________
= times = times

36A
3. Price to Book Ratio

The price to book ratio indicates the relationship between the market value of common stock and book
value per share. The book value per share is determined by dividing stockholders’ equity by the number
of shares outstanding.

Price to Market Price per Share

=
Book Ratio Book Value per Share

Some analysts believe a higher ratio indicates that the market value of the stock may be overpriced.
Others believe large differences between market and book values are evidence that values determined by
accounting standards are ineffective at pricing equity in the market. Calculate the price to book ratio for
the current and previous year.

Current Year Previous Year

______________________ ______________________
= times = times

36B
Competitor Analysis (Advanced)

1. Which corporation is more profitable? What factors contributed to greater profitability?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

2. Which corporation is more leveraged? What ratio provides evidence to support this conclusion?

___________________________________________________________________________________

___________________________________________________________________________________

3. Which corporation is best at using borrowed money to earn profits? Would you say that the
corporation is at greater risk?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

4. Debt serviceability refers to the corporation’s ability to pay periodic interest associated with their debt.
Which corporation is best able to service debt?

___________________________________________________________________________________

___________________________________________________________________________________

___________________________________________________________________________________

5. Which corporation collects receivables more effectively? What ratio provides evidence to support this
conclusion?

___________________________________________________________________________________

___________________________________________________________________________________

6. Which corporation is more effective at managing inventory? What ratio provides evidence to support
this conclusion?

___________________________________________________________________________________

___________________________________________________________________________________

43A