Chapter 13 Powerpoint

Learning Objective
1. Perform horizontal analysis
13-1
Copyright 2015 Pearson Education Inc. All rights reserved.
PERFORM HORIZONTAL ANALYSIS
Study of percentage changes from year-to-year
Two steps:
1. Compute dollar amount of change from one period
to the next
2. Divide dollar amount of change by base-period
amount
13-2
LO 1
Illustration: Amazon.com, Inc.

Amazon.coms net sales (in millions) increased by 27.1%
during 2012, computed as follows:
Step 1 Compute the dollar amount

of change from 2011 to 2012
Step 2 Percentage change for the period
13-3
LO 1

Exhibit 13-2 | Comparative Consolidated Statements of OperationsHorizontal
Analysis (partial exhibit)
13-4
LO 1

Exhibit 13-3 | Consolidated Balance SheetsHorizontal Analysis (partial exhibit)
13-5
LO 1
Illustration
Prepare a horizontal analysis of the comparative income
statements of Ama Music Co.
13-6
Advance slide in presentation mode to reveal $ Change and % Change

LO 1
Trend Percentages
Form of horizontal analysis
Base year selected and set equal to 100%
13-7
Amount of each following year stated as a percent of

base
LO 1
Trend Percentages
Amazon.com, Inc., showed income from operations as follows:
Trend percentages are computed by dividing each successive

years amount by the 2008 amount
13-8
LO 1
Learning Objective
2. Perform vertical analysis
13-9
PERFORM VERTICAL ANALYSIS
13-10
Shows relationship of a financial-statement item to its

base
Income statement, base is total revenue
Balance sheet, base is total assets
LO 2

Exhibit 13-4 | Comparative Consolidated Statements of OperationsVertical
Analysis (partial exhibit)
13-11
LO 2

Exhibit 13-5 | Consolidated Balance SheetsVertical Analysis (partial exhibit)
13-12
LO 2
Learning Objective
3. Prepare common-size financial statements
13-13
PERPARE COMMON-SIZE FINANCIAL

STATEMENTS
Report only percentages (no dollar amounts)
Assists in the comparison of different companies
13-14
Expresses financial results in terms of a common

denominator
LO 3
Calculate the common-size percentages for the following income statement:
Advance slide
in
presentation
mode to
reveal answer
13-16
Benchmarking
Compares company to a standard set by others
Facilitated by common-size statements
Has goal of improvement

Exhibit 13-6
13-16
LO 3
Learning Objective
4. Analyze the statement of cash flows
13-17
ANALYZE STATEMENT OF CASH FLOWS

Cash flow signs of a healthy company:
13-18
Net cash flow provided by operating activities

exceeds net income
Operations are the major source of cash
Investing activities include more purchases than sales

of long-term assets
Financing activities are not dominated by borrowing
LO 4
ANALYZE STATEMENT OF CASH FLOWS
13-19
LO 4
Learning Objective
5. Use ratios to make business decisions
13-20
USE RATIOS TO MAKE BUSINESS

DECISIONS
Measuring ability to pay current
liabilities
Measuring turnover and cash
conversion cycle
Measuring leverage
Measuring profitability
Analyzing stock as an investment
13-21
LO 5
Ability to Pay Current Liabilities
Working
Capital
Current
Ratio
Quick
(Acid-test)
Ratio
13-22
LO 5

Working Capital:
13-23
Measures ability to pay current liabilities with current

assets
Generally, the larger the working capital, the better

the ability to pay debts
Capital is total assets minus total liabilities
Like a current version of total capital

LO 5

Current Ratio:
13-24
Measures ability to pay current liabilities with current

assets
In general, a higher current ratio indicates a stronger

financial position
LO 5

Quick (Acid-test) Ratio:
13-25
Shows ability to pay all current liabilities if they come

due immediately (quickly)
Narrower base to measure liquidity than current ratio
Ratio of 0.90 to 1.00 is acceptable in most industries
LO 5
Turnover and Cash Conversion Cycle

Inventory
Turnover
Days Sales
Outstanding
13-26
Accounts
Receivable
Turnover
Accounts
Payable
Turnover
Cash
Conversion
Cycle
LO 5

Inventory Turnover:
13-27
Measures number of times a company sells its

average level of inventory during a year
Varies widely with nature of business
Compare ratio over time as well as with industry

averages or competitors
LO 5

Days Inventory Outstanding:
13-28
Converts inventory turnover ratio into days
LO 5

Accounts Receivable Turnover:
13-29
Measures ability to collect cash from credit customers
In general, higher the ratio, the better
Tells how many times during the year average

receivables were turned into cash
LO 5

Days Sales Outstanding:
13-30
How many days sales remain in accounts receivable
How may days it takes to collect the average level of

receivables
LO 5

Accounts Payable Turnover:
13-31
Measures number of times per year that entity pays

off its accounts payable
LO 5

Days Payable Outstanding:
13-32
How many days it takes a company to pay off

accounts payable
LO 5

Cash Conversion Cycle:
13-33
Shows overall liquidity by computing the total days it takes to

convert inventory to receivables and back to cash, less the
days to pay off its suppliers
LO 5
Leverage: Overall Ability to Pay Debts
Debt Ratio
13-34
TimesInterestEarned Ratio
LO 5

Debt Ratio:
13-35
Indicates percentage of assets financed with debt
Ratio of 1 reveals that debt has financed all the assets
Ratio of 0.50 means that debt finances half the assets
Higher the ratio, greater the pressure to pay interest and

principal
LO 5

Times-Interest-Earned Ratio:
13-36
Measures number of times operating income can cover

interest expense
Also called interest-coverage ratio
High ratio indicates ease in paying interest; a low value

suggests difficulty
LO 5
Illustration
Using the data on the next slide, calculate the following ratios
for 2014: (Round answers to two decimal places)
a. Working capital
b. Current ratio
c. Quick (acid-test) ratio
d. Debt ratio
e. Times-interest-earned ratio
13-37
LO 5
Illustration
Summary data:
13-38
LO 5
Illustration
a. Working
capital
$248,000
13-39
$455,000
$207,000
LO 5
Illustration
b. Current Ratio
2.20
13-40
$455,000
$207,000
LO 5
Illustration
c. Quick Ratio
.93
13-41
$193,000
$207,000
LO 5
Illustration
d. Debt Ratio
.60
13-42
$304,000
$510,000
LO 5
Illustration
e. TimesInterestEarned Ratio
7.34
13-43
$301,000
$41,000
LO 5
Measuring Profitability
Operating
Income
Percentage
DuPont
Analysis
Rate of
Return on
Sales
Asset
Turnover
Rate of
Return on
Total Assets
Leverage
Ratio
Rate of
Return on
Equity
Earnings Per
Share
Gross Margin
Percentage
13-44
LO 5
Gross (Profit) Margin Percentage:
13-45
Amount of profit that the entity makes from merely

selling a product before other operating costs are
subtracted
LO 5
Operating Income (Profit) Percentage:
13-46
Measures percentage of profit earned from each sales

dollar in a companys core business operations
Persistently high operating income compared to net

sales is an important determinant of earnings quality
LO 5
DuPont Analysis:
Return on assets
Rate of
return
on
sales
Net
income
13-47
Levera
ge
ratio
Return
on
equity
Levera
ge
ratio
Return on
equity
Net
sales
x
Net
sales
Asset
turnov
er
Averag
e total
assets
Detailed analysis of return on

assets (ROA) and return on
common stockholders equity (ROE)
Averag
e total
assets
Averag
e
commo
n
equity
Net
income
Average
common
equity
Rate of Return (Net Profit Margin Ratio) on Sales:
13-48
Shows percentage of each sales dollar earned as net

income
Higher the percentage, the more profit is being

generated by sales dollars
LO 5
Asset Turnover:
13-49
Measures amount of net sales generated for each dollar

invested in assets
Measure of how efficiently management is operating the

company
Companies with high asset turnover tend to be more

productive
LO 5
Rate of Return on Total Assets (ROA):
13-50
Measures how profitably a company uses its assets
LO 5
Leverage (Equity Multiplier) Ratio:
13-51
Measures
Impact of debt financing on profitability
Proportion of each dollar of assets financed with

stockholders equity
LO 5
Rate of Return on Common Stockholders Equity:
13-52
Shows relationship between net income and common

stockholders investment in the companyhow much
income is earned for every $1 invested
LO 5
Earnings per Share (EPS) of Common Stock:
EPS =
13-53
Net income Preferred Dividends

Average number of shares of common
stock outstanding
Amount of net income earned for each share of

outstanding common stock
Most widely quoted of all financial statistics
Only ratio that appears on the income statement

LO 5
Analyzing Stock Investments
Price/Earnings
Ratio
Dividend
Yield
Book Value per

Share of
Common Stock
13-54
LO 5

Price-Earnings Ratio (Multiple):
13-55
Shows market price of $1 of earnings
Ratio, abbreviated P/E, appears in the Wall Street

Journal stock listings and online
LO 5

Dividend Yield:
13-56
Measures percentage of a stocks market value

returned annually to stockholders as dividends
LO 5

Book Value per Share of Common Stock:
13-57
Indicates recorded accounting amount for each share of

common stock outstanding
LO 5
Limitations of Ratio Analysis
13-58
To be useful, ratios should be analyzed over a period of

years to consider all relevant factors
Any one year, or even any two years, may not represent
the companys performance over the long term
LO 5
Learning Objective
6. Use other measures to make investment
decisions
13-59
Economic Value Added (EVA)
Combines accounting and finance data
Measures if operations have increased stockholder

wealth
Positive EVA suggests increase in wealth
EVA = Net income before taxes + Interest expense

Capital charge
13-60
LO 6
Economic Value Added (EVA)

Capital charge =
13-61
LO 6
Red Flags in Financial Statement

Analysis
Earnings problems
13-62
Decreased cash flow
Too much debt
Inability to collect receivables
Buildup of inventories
Trends of sales, inventory and receivables
LO 6
Efficient Markets
13-63
Market prices fully reflect all information
Managers cannot fool market with accounting

manipulations
Market sets fair price for stock
Appropriate investment strategy:
Manage risk
Diversify investments
Minimize transaction costs
LO 6
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Chapter 13 Powerpoint

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Learning Objective

1. Perform horizontal analysis

Copyright 2015 Pearson Education Inc. All rights reserved.

PERFORM HORIZONTAL ANALYSIS

Study of percentage changes from year-to-year

Copyright 2015 Pearson Education Inc. All rights reserved.

Illustration: Amazon.com, Inc.

Step 1 Compute the dollar amount

Copyright 2015 Pearson Education Inc. All rights reserved.

Illustration: Amazon.com, Inc.

Copyright 2015 Pearson Education Inc. All rights reserved.

Illustration: Amazon.com, Inc.

Copyright 2015 Pearson Education Inc. All rights reserved.

Advance slide in presentation mode to reveal $ Change and % Change

Form of horizontal analysis

Base year selected and set equal to 100%

Amount of each following year stated as a percent of

Copyright 2015 Pearson Education Inc. All rights reserved.

Trend percentages are computed by dividing each successive

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

PERFORM VERTICAL ANALYSIS

Shows relationship of a financial-statement item to its

Income statement, base is total revenue

Balance sheet, base is total assets

Copyright 2015 Pearson Education Inc. All rights reserved.

Illustration: Amazon.com, Inc.

Copyright 2015 Pearson Education Inc. All rights reserved.

Illustration: Amazon.com, Inc.

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

PERPARE COMMON-SIZE FINANCIAL

Report only percentages (no dollar amounts)

Assists in the comparison of different companies

Expresses financial results in terms of a common

Copyright 2015 Pearson Education Inc. All rights reserved.

Calculate the common-size percentages for the following income statement:

Copyright 2015 Pearson Education Inc. All rights reserved.

Compares company to a standard set by others

Facilitated by common-size statements

Has goal of improvement

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE STATEMENT OF CASH FLOWS

Net cash flow provided by operating activities

Operations are the major source of cash

Investing activities include more purchases than sales

Financing activities are not dominated by borrowing

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE STATEMENT OF CASH FLOWS

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

USE RATIOS TO MAKE BUSINESS

Copyright 2015 Pearson Education Inc. All rights reserved.

Ability to Pay Current Liabilities

Copyright 2015 Pearson Education Inc. All rights reserved.

Ability to Pay Current Liabilities

Measures ability to pay current liabilities with current

Generally, the larger the working capital, the better

Capital is total assets minus total liabilities

Like a current version of total capital

Ability to Pay Current Liabilities

Measures ability to pay current liabilities with current

In general, a higher current ratio indicates a stronger