Plain Background Power Point Slides Chapter 13 Financial Statement Analysis 87

Financial Statement
Analysis
Chapter 13
1
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Learning Objective 1
Perform a horizontal analysis of

comparative financial
statements.
2
Horizontal Analysis
Study of percentage changes in
comparative statements
1. Compute the dollar amount of the change
from the base period to the later period.
2. Divide the dollar amount of change
by the base-period amount.
3
Trend Percentages
Computed by selecting a base
year whose amounts are set
equal to 100%.
Trend % = Any year $ ÷ Base year $
4
Perform a vertical analysis of

financial statements.
5
Vertical Analysis
Reveals the relationship of each
statement item to a specified
base, which is the 100% figure.
Every other item on the
financial statement is then
reported as a percentage of that
base.
6
Prepare and use common-size

financial statements.
7
Common-Size Statements
 On a common-size income
statement, each item is expressed
as a percentage of net sales.
 In the balance sheet, the common
size is total assets.
 A common-size statement eases
the comparison of different
companies.
8
Benchmarking
Practice of comparing a
company to other companies
Common-size statements are
also used to compare the
company to a specific company
9
Use the statement of cash flows

for decisions.
10
Statement of Cash Flows
Cash-flow signs of a healthy
company:
 Operations are a major source of
cash.
 Investing activities include more
purchases than sales of long-term
assets.
 Financing activities are not
dominated by borrowing.
11
Compute the standard financial

ratios.
12
Ratio Classification
1. Measure ability to pay current liabilities
2. Measure ability to sell inventory and
collect receivables
3. Measure ability to pay long-term debt
4. Measure profitability
5. Analyze stock as an investment
13
Working Capital
Measures ability to pay current
liabilities with current assets
Current assets – Current liabilities
14
Current Ratio
Measures company’s ability to
pay current liabilities with
current assets
Current assets ÷ Current liabilities
15
Acid-Test Ratio
Shows the company’s ability to
pay all current liabilities if they
come due immediately.
(Cash + Short-term investments

+ Net current receivables)
÷ Current liabilities
16
Measuring Ability to Sell
Inventory
Inventory turnover – measure of
the number of times the
average level of inventory is
sold during a year
Cost of goods sold ÷ Average inventory
17
Measuring Ability to
Collect Receivables
Accounts receivable turnover
measures a company’s ability to
collect cash from credit
customers.
Net credit sales ÷ Average accounts receivable
18
Collect Receivables
Days’ sales in receivables ratio
measures how many day’s
sales remain in Accounts
Receivable.
One day’s sales = Net sales ÷ 365 days
Days’ sales in receivable =

Avg net accounts receivable ÷ One day’s sales
19
Pay Debt
The debt ratio indicates the
proportion of assets financed
with debt.
Total liabilities ÷ Total assets
20
Pay Debt
Times-interest-earned ratio
measures the number of times
operating income can cover
interest expense.
Income from operations ÷ Interest expense
21
Measuring Profitability
Rate of return on net sales
shows the percentage of each
sales dollar earned as net
income.
Net income ÷ Net sales
22
Rate of return on total assets
measures how profitably a
company uses its assets.
(Net income + Interest expense)
÷ Average total assets
23
Rate of Return on Common
Stockholders’ Equity:
Net income – Preferred dividends

÷ Average common stockholders’
equity
24
Earnings per share of common
stock
(Net income – Preferred dividends)

÷ Number of shares of common
stock outstanding
25
Objective 6
Use ratios in decision making
26
Analyzing Stock Investments
 Price/earning ratio - ratio of market
price per share to earnings per share
 Dividend yield - percentage of stock’s
market value returned as dividends to
stockholders each period
Dividend per share of common stock ÷
Market price per share of common stock
27
Analyzing Stock Investments
Book value per share of
common stock
(Total stockholders’ equity – Preferred equity)

÷ Number of shares of common
stock outstanding
28
Measure the economic value

added by operations.
29
Economic Value Added
Combines concepts of
accounting income and corporate
finance to measure whether the
company’s operations have
increased stockholder wealth.
EVA® =
Net income + Interest expense – Capital charge
30
Capital charge
=
Notes Loans Long-term Stockholders’
+ + +
payable payable debt equity
×
Cost of capital
 Capital charge - amount that
stockholders, lenders charge a
company for use of their money
 Cost of capital – weighted average
of the returns demanded by
company’s stockholders and
lenders.
 A positive EVA® amount indicates
an increase in stockholder wealth
32
End of Chapter 13
33

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Financial Statement

Perform a horizontal analysis of

Perform a vertical analysis of

Prepare and use common-size

Use the statement of cash flows

Compute the standard financial

Current assets – Current liabilities

Current assets ÷ Current liabilities

(Cash + Short-term investments

Cost of goods sold ÷ Average inventory

Net credit sales ÷ Average accounts receivable

Days’ sales in receivable =

Total liabilities ÷ Total assets

Income from operations ÷ Interest expense

Net income ÷ Net sales

Net income – Preferred dividends

(Net income – Preferred dividends)

Use ratios in decision making

(Total stockholders’ equity – Preferred equity)

Measure the economic value

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