12-1

Discontinued OperationsParts of a company’s operations that

are eliminatedA one-time occurrence

Income/loss from discontinued operations separately reportedNet of taxes

Gain/loss from disposal of discontinued operations separately reportedNet of taxes

12-2

Extraordinary ItemsEvents that are

Unusual in natureAbnormal

Infrequent in occurrenceNot reasonably expected to occur again in

the foreseeable futureMuch judgment required to determine if

an event is an extraordinary item

12-3

Reporting Taxes

Income taxes shown as separate line item

Last item before income from continuing operations

Does not include tax expense/savings from extraordinary items or discontinued operations

12-4

Horizontal AnalysisEvaluating financial statements

across timeExpress change in a financial statement

item in percentages instead of dollarsCurrent year amount – Base year amount

Base year amountReported as a percentage

Two ways to compute Choose a single year as base period for all years analyzed

Use the prior year as base period

12-5

Horizontal Analysis

Compute the change in accounts receivable using2010 as the base yearThe prior year as the base year

2010 2011 2012 2013Accts Rec $5.5M $6.7M $6.1M $7.0M

12-6

Vertical AnalysisCompares items w/in single fin stmt

All items expressed as a percent of a common amountAlso called common-sizing financial

statementsIncome statement items

Percent of salesBalance sheet

Percent of total assets

12-7

Vertical Analysis

2011 % of Sales 2010 % of SalesNet Sales $4,300 100% $3,500 100%Cost of Goods Sold 2,900 2,300Gross Profit 1,400 1,200Operating Expenses: Selling Expenses 650 600 Administrative Exp. 525 500Total Oper. Exp. 1175 1100Net Income $225 $100

12-8

A Review of All RatiosLiquidity ratios

Measure ability to pay current bills and operating costs

Solvency ratiosMeasure ability to meet long-term

obligations and survive over long termProfitability ratios

Measure operating or income performance

Market indicatorsRatios relating current market price of

stock to earnings or dividends

12-9

Current Ratio Current Assets _ Current Liabilities

Measure ability to pay current liabilities with current assets

Helps creditors determine if a company can meet its short-term obligations

12-10

Quick Ratio Cash + s-t investments + A/R net Current liabilities

Measure ability to meet short-term obligations

Similar to the current ratioStricter test because it limits numerator to

only very liquid assets

12-11

Working CapitalCurrent assets – Current liabilities

Measure ability to meet short-term obligations

Not a ratioOften measured as part of financial

statement analysis

12-12

Inventory Turnover Ratio Cost of goods sold _Average current liabilities

Measure how quickly a company is selling its inventory

12-13

Accounts Receivable Turnover Ratio

Net credit sales _ Average net accounts receivable

Measure ability to collect the cash from its credit customers

12-14

Current Cash Debt Coverage Ratio Net cash from operating activities Average current liabilities

Measure ability to generate cash needed to pay current liabilities from company’s operations

12-15

Debt to Equity Ratio Total liabilities _Total shareholders’ equity

Compare amount of company’s debt with amount owners have invested in the company

12-16

Times Interest Earned RatioIncome from operations_ Interest expense

Compare amount of income earned in an accounting period (before interest) to interest obligation for same periodIf net income used in numerator, add back

interest expense and taxes

12-17

Cash Flow Adequacy Ratio Net cash from operating activities _Net cash required for investing activities

Cash required for investing activities Cash paid for capital expenditures and

acquisitions minus cash proceeds from disposal of capital assets

Measures the firm’s ability to generate enough cash from operating activities to pay for its capital expenditures

12-18

Return on Assets Net income + Interest expense_ Average total assets

Measure success in using assets to earn income for owners and creditorsThose who are financing the business

Interest added back to numeratorInterest part of what has been earned to

pay creditorsNet income is return to the ownersInterest expense is return to creditors

12-19

Asset Turnover Ratio Net sales _ Average total assets

Measure how efficiently a company uses its assets

12-20

Return on Equity Net income – preferred dividends _ Average common shareholders’ equityMeasure how much income is earned

with the common shareholders’ investment in the company

12-21

Gross Profit Ratio Gross profit_ Net sales

Describes percentage of sales price that is gross profitCarefully watched by managementA small shift usually indicates a big change

in the profitability of the company’s sales

12-22

Profit Margin Ratio Net income_ Net sales

Measure percentage of each sales dollar that results in net income

12-23

Earnings Per Share Net income – preferred dividends_

Weighted average # of shares of common stock outstanding

Calculate net income per share of common stock

12-24

Price-earnings Ratio Market price per common share_

Earnings per share Calculate market price for $1 of

earningsInvestors and analysts believe it

indicates future earnings potential

12-25

Dividend Yield Ratio Dividends per share _ Market price per share

Calculate percentage return on investment in a share of stock via dividends

12-26

Understanding Ratio Analysis

Ratios must be compared with something to be usefulSame company for prior periodsOther companies for same periodIndustry average for same period

12-27

Using Ratio Analysis

Industry TrendRatio FYE 2004 FYE 2003 Average +/-Current ratio 2.91 2.58 1.90Quick ratio 2.18 1.88 0.80Working capital $90.76M $63.14M N/AInventory turnover ratio 10.47 10.56 10.60Average days in inventoryAccounts rec turnover ratio 9.76 9.78Avg days to collect ARDebt to equity 0.32 0.31Times interest earned ratio 311 273 6.40Return on assets 8.83% 8.71% 4.60%Return on equity 11.57% 11.33% 10.00%Gross profit percentage 33.66% 34.24% 36.80%Earnings per share $2.55 $2.26 N/APrice-earnings ratio 16.47 17.70 19.80Dividend yield ratio No dividends paid N/A

12-28

It’s More than Just the It’s More than Just the NumbersNumbers

Information found in notes to financial statementsInventory cost flow methodsDepreciation methodsHow various items are valuedDescription of accounting policies

12-29

Business Risk, Control, and Business Risk, Control, and EthicsEthics

Investor perspectiveHow do you minimize the risks of stock

ownership?Consult with a financial professionalDiversify your investments

What kinds of investments would make up a diversified portfolio?

Can you eliminate all investment risk?

12-30

Assign #9: pg. 644 - #E12-1A, #E12-2AAssign #10: pg. 655-656 - #P12-4A, #P12-5A