Upload
aron-butler
View
212
Download
0
Embed Size (px)
Citation preview
11-215-2
Learning Objective 13-1
Describe the nature of the adjusting process.
Learning Objective 13-1
Describe the nature of the adjusting process.
Insert Chapter Objectives
Financial Statement Analysis
1 Describe basic financial statement analytical methods.
2 Use financial statement analysis to assess the solvency of a business.
After studying this chapter, you should be able to:
3 Use financial statement analysis to assess the profitability of a business.
4 Describe the contents of corporate annual reports.
15-2
11-415-4
Basic Analytical Methods
Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are as follows:1. Horizontal analysis
2. Vertical analysis
3. Common-sized statements
1
11-515-5
Horizontal Analysis
The percentage analysis of increases and decreases in related items using comparative financial statements is called horizontal analysis.
1
11-715-7
1
Horizontal Analysis: Horizontal Analysis:
Difference $17,000
Base year (2009) $533,000= 3.2%
Exhibit 1
Comparative Balance Sheet—Horizontal Analysis
11-915-9
Horizontal Analysis: Horizontal Analysis:
Difference $25,800
Base year (2009) $64,700= 39.9%
1Comparative Schedule of Current Assets—Horizontal AnalysisExhibit 2
11-1115-11
Horizontal Analysis:Horizontal Analysis:
Increase amount $296,500
Base year (2009) $1,234,000
= 24.0%
1Comparative Income Statement—Horizontal AnalysisExhibit 3
11-1215-12
Comparative Retained Earnings Statement—Horizontal Analysis
Horizontal Analysis:Horizontal Analysis:
Increase amount $37,500
Base year (2009) $100,000= 37.5%
1Exhibit 4
11-1315-13
1 Example Exercise 15-1
Horizontal AnalysisThe comparative cash and accounts receivable balances for a company are provided below.
2010 2009Cash $62,500 $50,000Accounts receivable (net) 74,400 80,000
Based on this information, what is the amount and percentage of increase or decrease that would be shown in a balance sheet with horizontal analysis?
15-13
For Practice: PE 15-1A, PE 15-1B
Follow My Example 6-1
Follow My Example 15-1
Cash $12,500 increase ($62,500 – $50,000), or 25%Accounts receivable $5,600 decrease ($74,400 – $80,000), or –7%
11-1415-14
Vertical Analysis
A percentage analysis used to show the relationship of each component to the total within a single statement is called vertical analysis.
1
11-1515-15
In a vertical analysis of the balance sheet, each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity.
Vertical Analysis of Balance Sheet
1
11-1715-17
Compar-ative Balance Sheet—Vertical Analysis
Vertical Analysis: Vertical Analysis:
Current assets $550,000
Total assets $1,139,500= 48.3%
1
Exhibit 5
11-1815-18
In a vertical analysis of the income statement, each item is stated as a percent of net sales.
Vertical Analysis of the Income Statement
1
11-2015-20
Vertical Analysis: Vertical Analysis:
Selling expenses $191,000
Net sales $1,498,000= 12.8%
1Comparative Income Statement—Vertical AnalysisExhibit 6
11-2115-21
Common-Size Statements
In a common-sized statements, all items are expressed as a percentage. Common-sized statements are useful in comparing the current period with prior periods, individual businesses, or one business with with industry percentages.
1
11-2315-23
Example Exercise 15-2
Common-Sized Financial Statements
1
Income statement information for Lee Corporation is provided below:
Sales
$100,000Cost of goods sold
65,000Gross profit
$ 35,000
Prepare a common-sized analysis of the income statement for Lee Corporation.
15-23
11-2415-24
Example Exercise 15-2 (continued) 1
Sales $100,000 100% ($100,000 ÷ $100,000)Cost of goods
sold 65,000 65 ($65,000 ÷ $100,000)Gross profit 35,000 35% ($35,000 ÷ $100,000)
Amount Percentage
15-24
For Practice: PE 15-2A, PE 15-2B
Follow My Example 15-2
11-2615-26
Solvency Analysis
All users of financial statements are interested in the ability of a company to do the following:1. Meet its financial obligations (debts), called
solvency.2. Earn income, called profitability.
2
11-2715-27
Current Position Analysis
Using measures to assess a business’s ability to pay its current liabilities is called current position analysis. Such analysis is of special interest to short-term creditors.
2
11-2815-28
Working Capital
The excess of current assets of a business over its current liabilities is called working capital. The working capital is often used in evaluating a company’s ability to pay current liabilities.
2
11-2915-29
Working Capital = Current Assets – Current Liabilities
2010 2009
Current assets $550,000 $533,000Current liabilities –210,000 –243,000Working capital $340,000$290,000
2
11-3015-30
Current Ratio
The current ratio, sometimes called the working capital ratio or bankers’ ratio measures a company’s ability to pay its current liabilities.
2
11-3115-31
2010 2009Current assets $550,000 $533,000Current liabilities $210,000 $243,000Current ratio 2.6 2.2
$550,000
$210,000
$533,000
$243,000
2
Current Ratio =Current Assets
Current Liabilities
11-3215-32
Quick Ratio
A ratio that measures the “instant” debt-paying ability of a company is called the quick ratio or acid-test ratio.
2
11-3315-33
2010 2009
Quick ratio (a ÷ b) 1.3 1.0
Quick assets:Cash $ 90,500 $ 64,700Temporary Investments 75,000 60,000Accounts receivable (net) 115,000 120,000 a. Total quick assets $280,500 $244,700
b. Current liabilities $210,000 $243,000
Quick assets are cash and other current assets
that can be quickly converted to cash.
2
11-3415-34
Example Exercise 15-3
Current Position Analysis
2
The following items are reported on a company’s balance sheet:
Cash
$300,000Temporary investments
100,000Accounts receivable (net)
200,000Inventory
200,000Accounts payable
400,000
Determine (a) the current ratio and (b) the quick ratio.
15-34
11-3515-35
Example Exercise 15-3 (continued) 2
15-35
For Practice: PE 15-3A, PE 15-3B
b. Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($300,000 + $100,000 + $200,000) ÷ $400,000
Quick Ratio = 1.5
a. Current Ratio = Current Assets/Current Liabilities
Current Ratio = ($300,000 + $100,000 + $200,000 + $200,000) ÷ $400,000
Current Ratio = 2.0
Follow My Example 15-3
11-3615-36
Accounts Receivable Turnover
The relationship between sales and accounts receivable may be stated as the accounts receivable turnover. Collecting accounts receivable as quickly as possible improves a company’s solvency.
2
11-3715-37
Accounts receivable turnover (a ÷ b) 12.7 9.2
a. Net sales $1,498,000$1,200,000
Accounts receivable (net):Beginning of year $ 120,000$ 140,000End of year 115,500 120,000
Total$ 235,000 $ 260,000
b. Average (Total ÷ 2) $ 117,500$ 130,000
2010 2009
Accounts Receivable Turnover =
Net Sales
Average Accounts Receivable
2
11-3815-38
Number of Days’ Sales in Receivables
The number of days’ sales in receivables is an estimate of the length
of time (in days) the accounts receivable have been outstanding.
Number of Days’ Sales in Receivables
Average Accounts Receivable
Average Daily Sales
=
Net Sales
365
2
11-3915-39
Number of days’ sales in receivables (a ÷ b) 28.6 39.5
a. Average accounts receivable(Total accounts receivable ÷ 2) $ 117,500
$ 130,000Net sales $1,498,000
$1,200,000b. Average daily sales
(Sales ÷ 365) $ 4,104$ 3,288
2010 2009
2
11-4015-40
Example Exercise 15-4
Accounts Receivable Analysis
2
A company reports the following:
Net sales
$960,000Average accounts receivable (net)
48,000
Determine (a) the accounts receivable turnover and (b) the number of days’ sales in receivables. Round to one decimal place.
15-40
11-4115-41
Example Exercise 15-4 (continued) 2
15-41
For Practice: PE 15-4A, PE 15-4B
a. Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $960,000 ÷ $48,000
Accounts Receivable Turnover = 20.0
b. Number of Days’ Sales in Receivables = Average Accounts Receivable ÷ Average Daily Sales
Number of Days’ Sales in Receivables = $48,000 ÷ ($960,000/365) $48,000 ÷ $2,630
Number of Days’ Sales in Receivables = 18.3 days=
Follow My Example 15-4
11-4215-42
Inventory Turnover
The relationship between the volume of goods (merchandise) sold and inventory may be stated as the inventory turnover. The purpose of this ratio is to assess the efficiency of the firm in managing its inventory.
2
11-4315-43
Inventory Turnover =
Cost of Goods Sold
Average Inventory
Inventory turnover (a ÷ b) 3.8 2.8
2010 2009
a. Cost of goods sold $1,043,000$ 820,000
Inventories:Beginning of year $ 283,000
$ 311,000End of year 264,000
283,000Total $ 547,000
$ 594,000
b. Average (Total ÷ 2) $ 273,500$ 297,000
2
11-4415-44
Number of Days’ Sales in Inventory
The number of days’ sales in inventory is a rough measure of the length of time it takes to purchase, sell, and replace the inventory.
2
11-4515-45
Number of Days’ Sales in Inventory
Average Inventory
Average Daily Cost of Goods Sold
=
Cost of Goods Sold
365
Number of days’ sales in inventory (a ÷ b) 95.7 132.2
a. Average inventory (Total ÷ 2) $ 273,500 $ 297,000Cost of goods sold $1,043,000 $ 820,000
b. Average daily cost of goodssold (COGS ÷ 365 days) $2,858 $2,247
2010 2009
2
11-4615-46
Example Exercise 15-5
Inventory Analysis
2
A company reports the following:
Cost of goods sold
$560,000Average inventory
112,000
Determine (a) the inventory turnover and (b) the number of days’ sales in inventory. Round to one decimal place.
15-46
11-4715-47
Example Exercise 15-5 (continued) 2
a. Inventory Turnover = Cost of Goods Sold ÷ Average InventoryInventory Turnover = $560,000 ÷ $112,000Inventory Turnover = 5.0
b. Number of Days’ Sales in Inventory = Average Inventory ÷ Average Daily Cost of Goods Sold Number of Days’ Sales in Inventory = $112,000 ÷ ($560,000/365) Number of Days’ Sales in Inventory = $112,000 ÷ $1,534 Number of Days’ Sales in Inventory = 73.0 days
15-47
For Practice: PE 15-5A, PE 15-5B
Follow My Example 15-5
11-4815-48
Ratio of Fixed Assets to Long-Term Liabilities
The ratio of fixed assets to long-term liabilities is a solvency measure that indicates the margin of safety of the noteholders or bondholders. It also indicates the ability of the business to borrow additional funds on a long-term basis.
2
11-4915-49
Ratio of Fixed Assets to Long-Term Liabilities
Fixed Assets (net)
Long-Term Liabilities
=
2010 2009
Ratio of fixed assets to long-term liabilities (a ÷ b) 4.4 2.4
a. Fixed assets (net) $444,500 $470,000b. Long-term liabilities $100,000 $200,000
2
11-5015-50
Ratio of Liabilities to Stockholders’ Equity
The relationship between the total claims of the creditors and owners—the ratio of liabilities to stockholders’ equity—is a solvency measure that indicates the margin of safety for creditors.
2
11-5115-51
Ratio of Liabilities to Stockholders’ Equity
Total Liabilities
Total Stockholders’
Equity
=
Ratio of liabilities to stockholders’ equity ( a÷ b) 0.4 0.6
a. Total liabilities $310,000 $443,000b. Total stockholders’ equity $829,500 $787,500
2010 2009
2
11-5215-52
Example Exercise 15-6
Long-Term Solvency Analysis
2
The following information was taken from Acme Company’s balance sheet:
Fixed assets (net)
$1,400,000Long-term liabilities
400,000Total liabilities
560,000Total stockholders’ equity
1,400,000
Determine the company’s (a) ratio of fixed assets to long-term liabilities and (b) ratio of liabilities to stockholders’ equity.
15-52
11-5315-53
Example Exercise 15-6 (continued) 2
a. Ratio of Fixed Assets to Long-Term Liabilities = Fixed Assets ÷ Long- Term
LiabilitiesRatio of Fixed Assets to Long-Term Liabilities = $1,400,000 ÷ $400,000Ratio of Fixed Assets to Long-Term Liabilities = 3.5
b. Ratio of Liabilities to Total Stockholders’ Equity = Total Liabilities ÷ Total
Stockholders’ EquityRatio of Liabilities to Total Stockholders’ Equity = $560,000 ÷ $1,400,000 Ratio of Liabilities to Total Stockholders’ Equity = 0.4
15-53
For Practice: PE 15-6A, PE 15-6B
Follow My Example 15-6
11-5415-54
Number of Times Interest Charges Earned
Corporations in some industries normally have high ratios of debt to stockholders’ equity. For such corporations, the relative risk of the debtholders is normally measured as the number of times interest charges are earned (during the year), sometimes called the fixed charge coverage ratio.
2
11-5515-55
Number of Times Interest Charges Earned
Income Before Income Tax + Interest Expense
Interest Expense=
2010 2009
Income before income tax $162,500$134,600
a. Add interest expense 6,000 12,000
b. Amount available to meetinterest charges $168,500
$146,600Number of times interest charges earned (b ÷ a) 28.1 12.2
2
11-5615-56
Number of Times Preferred Dividends Are Earned
The number of times interest charges are earned can be adapted for use with
dividends on preferred stock.
Number of Times Preferred Dividends
Are Earned
Net Income
Preferred Dividends=
2
11-5715-57
15-57
2 Example Exercise 15-7
For Practice: PE 15-7A, PE 15-7B
Times Interest Charges are Earned
A company reports the following:Income before income tax
$250,000Interest expense
100,000
Determine the number of times interest charges are earned.
Follow My Example 15-7
Number of Times Interest Charges are Earned = (Income Before Income Tax + Interest Expense) ÷ Interest Expense
Number of Times Interest Charges are Earned = ($250,000 + $100,000) ÷ $100,000
Number of Times Interest Charges are Earned = 3.5
11-5915-59
Profitability Analysis
Profitability analysis focuses primarily on the relationship between operating results and the resources available to a business.
3
11-6015-60
Ratio of Net Sales to Assets
The ratio of net sales to assets is a profitability measure that shows how effectively a company utilizes its assets.
3
11-6115-61
Ratio of Net Sales to Assets Net Sales
Average Total Assets
=
2010 2009
a. Net sales $1,498,000 $1,200,000Total assets:
Beginning of year $1,053,000 $1,010,000End of year 1,044,500 1,053,000Total $2,097,500 $2,063,000
b. Average (Total ÷ 2) $1,048,750 $1,031,500
Excludes long-term investments
3
11-6215-62
Ratio of Net Sales to Assets Net Sales
Average Total Assets
=
2010 2009
a. Net sales $1,498,000 $1,200,000Total assets:
Beginning of year $1,053,000 $1,010,000End of year 1,044,500 1,053,000Total $2,097,500 $2,063,000
b. Average (Total ÷ 2) $1,048,750 $1,031,500
Ratio of net sales to assets (a ÷ b) 1.4 1.2
3
11-6315-63
15-63
3 Example Exercise 15-8
For Practice: PE 15-8A, PE 15-8B
Net Sales to AssetsA company reports the following:
Net sales
$2,250,000Average total assets
1,500,000
Determine the ratio of net sales to assets.
Follow My Example 15-8
Ratio of Net Sales to Total Assets = Net Sales ÷ Average Total Assets
Ratio of Net Sales to Total Assets = $2,250,000 ÷ $1,500,000
Ratio of Net Sales to Total Assets = 1.5
11-6415-64
Rate Earned on Total Assets
The rate earned on total assets measures the profitability of total assets, without considering how the assets are financed.
3
11-6515-65
Rate Earned on Total Assets
Net Income + Interest Expense
Average Total Assets=
Rate earned on total assets (a ÷ b) 8.2% 7.3%
2010 2009
Net income $ 91,000 $ 76,500Plus interest expense 6,000 12,000a. Total $ 97,000 $ 88,500Total assets:
Beginning of year $1,230,500 $1,187,500End of year 1,139,500 1,230,500Total $2,370,000 $2,418,000
b. Average (Total ÷ 2) $1,185,000 $1,209,000
3
11-6615-66
15-66
3 Example Exercise 15-9
For Practice: PE 15-9A, PE 15-9B
Rate Earned on Total AssetsA company reports the following income statement and balance sheet information for the current year:
Net income
$ 125,000Interest expense
25,000Average total assets
2,000,000
Follow My Example 15-9
Rate Earned on Total Assets = (Net Income + Interest Expense) ÷ Average Total AssetsRate Earned on Total Assets = ($125,000 + 25,000) ÷ $2,000,000Rate Earned on Total Assets = 7.5%
Determine the rate earned on total assets.
11-6715-67
Rate Earned on Stockholders’ Equity
The rate earned on stockholders’ equity measure emphasizes the rate of income earned on the amount invested by the stockholders.
3
11-6815-68
Rate Earned on Stockholders’ Equity
Net Income
Average Total Stockholders’ Equity
=
Rate earned on stockholders’equity (a ÷ b) 11.3% 10.0%
a. Net income $ 91,000 $ 76,500Stockholders’ equity:
Beginning of year $ 787,500 $ 750,000End of year 829,500 787,500Total $1,617,000 $1,537,500
b. Average (Total ÷ 2) $ 808,500 $ 768,750
2010 2009
3
11-6915-69
The difference in the rate earned on stockholders’ equity and the rate earned on total assets is called leverage.
Leverage
3
11-7115-71
The rate earned on common stockholders’ equity focuses only on the rate of profits earned on the amount invested by the common stockholders.
Rate Earned on Common Stockholders’ Equity
3
11-7215-72
Rate Earned on Common Stockholders’ Equity
Net Income – Preferred Dividends
Average Common Stockholders’ Equity
=
Rate earned on common stockholders’ equity (a ÷ b) 12.5% 10.9%
2010 2009
Net income $ 91,000 $ 76,500Less preferred dividends 9,000 9,000
a. Remainder—common stock $ 82,000 $ 67,500Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000End of year 679,500 637,500Total $1,317,000 $1,237,500
b. Average (Total ÷ 2) $ 658,500 $ 618,750
3
11-7315-73
Example Exercise 15-10
Common Stockholders’ Profitability Analysis
3
A company reports the following:
Net income $ 125,000Preferred dividends 5,000Average stockholders’ equity 1,000,000Average common stockholders’ equity 800,000
Determine (a) the rate earned on stockholders’ equity and (b) the rate earned on common stockholders’ equity.
15-73
11-7415-74
Example Exercise 15-10 (continued) 3
15-74
For Practice: PE 15-10A, PE 15-10B
a. Rate Earned on Stockholders’ Equity = Net Income ÷ Average Stockholders’ Equity
Rate Earned on Stockholders’ Equity = $125,000 ÷ $1,000,000Rate Earned on Stockholders’ Equity = 12.5%
b. Rate Earned on Common Stockholders’ Equity = (Net Income – Preferred Dividends) ÷
Average Common Stockholders’ EquityRate Earned on Common Stockholders’ Equity = ($125,000 – $5,000) ÷ $800,000Rate Earned on Common
Stockholders’ Equity = 15%
Follow My Example 15-10
11-7515-75
Earnings per Share on Common Stock
Earning per share (EPS) on common stock measures the share of profits that are earned by share of common stock. GAAP require the reporting of earnings per share in the income statement.
3
11-7615-76
Earnings per Share (EPS) on Common Stock
Net Income – Preferred Dividends
Shares of Common Stock Outstanding
=
Earnings per share on common stock (a ÷ b) $1.64 $1.35
2010 2009
Net income $91,000$76,500
Preferred dividends 9,000 9,000
a. Remainder—identified with common stock $82,000$67,500
b. Shares of common stock 50,00050,000
3
11-7715-77
Price-Earnings Ratio
Another profitability measure quoted by the financial press is the price-earnings (P/E) ratio on common stock. The price-earnings ratio on common stock measures a company’s future earnings prospects.
3
11-7815-78
Price-earnings (P/E) ratio
Market Price per Share of Common Stock
Earnings per Share on Common Stock
=
Price-earnings ratio on common stock 25 20
2010 2009
Market price per share of common stock $41.00 $27.00
Earnings per share on commonstock ÷ 1.64 ÷ 1.35
3
11-7915-79
Example Exercise 15-11
Earnings per Share and Price-Earnings
3
A company reports the following:
Net income$250,000
Preferred dividends$15,000
Shares of common stock
outstanding20,000
Market price per share of common stock
$35
a. Determine the company’s earnings per share on common stock.
b. Determine the company’s price-earnings ratio. Round to one decimal place.
15-79
11-8015-80
Example Exercise 15-11 (continued) 3
15-80
For Practice: PE 15-11A, PE 15-11B
b. Price-Earnings Ratio = Market Price per Share of Common Stock ÷ Earnings per Share on Common Stock
Price-Earnings Ratio = $35.00 ÷ $11.75
Price-Earnings Ratio = 3.0
a. Earnings per Shareon Common Stock = (Net Income – Preferred Dividends) ÷
Shares of Common Stock Outstanding
Earnings per Share = ($250,000 – $15,000) ÷ 20,000
Earnings per Share = $11.75
Follow My Example 15-11
11-8115-81
Dividends per Share
Dividends per share can be reported with earnings per share to indicate the relationship between dividends and earnings. Comparing these two per share amounts measures the extent to which earnings are being distributed to common shareholders.
3
11-8215-82
Dividends per Share Dividends
Shares of Common Stock Outstanding
=
Dividends per share of common stock (a ÷ b) $0.80 $0.60
2010 2009
a. Dividends $40,000 $30,000b. Shares of common stock outstanding 50,000 50,000
3
11-8415-84
The dividend yield on common stock measures the rate of return to common stockholders from cash dividends.
Dividend Yield
3
11-8515-85
Dividend Yield
Dividends per Share of Common Stock
Market Price per Share of Common Stock
=
Dividend yield on common stock 2.0% 2.2%
2010 2009
a. Dividends per share of common stock $ 0.80$ 0.60
b. Market price per share of common stock 41.0027.00
3
11-8915-89
Corporate Annual Reports
In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections:• Management discussion and analysis
• Report on adequacy of internal control
• Report on fairness of financial statements
4
11-9015-90
The Management Discussion and Analysis (MD&A) includes an analysis of the results of operations and discusses management’s opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition.
Management Discussion and Analysis
4
11-9115-91
The Sarbanes-Oxley Act of 2002 requires a report stating management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report.
Report on Internal Control
4
11-9215-92
All publicly held corporations are required to have an independent audit (examination) of their financial statements. The CPA firm that conducts the audit renders an opinion on the fairness of the statements.
Report on Fairness of Financial Statements
4
11-9415-94
Unusual Items Affecting the Current Period’s Income Statement
Unusual items affecting the current period’s income statement include the following:• Discontinued operations• Extraordinary items
11-9515-95
Discontinued Operations
A company may discontinue a segment of its operations by selling or abandoning the operations. A note accompanying the income statement should describe the operations sold including such details as the date operations were discontinued, the assets sold, and the effect (if any) on current and future operations.
11-9615-96
Extraordinary Items
An extraordinary item is defined as an event or transaction with the following characteristics:• Unusual in nature• Infrequent in occurrence