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Chapter 13 - Financial Statement Analysis

CHAPTER 13

FINANCIAL STATEMENT ANALYSIS

Changes from Twelfth Edition

Updated from Twelfth Edition.Porter Lumber, Inc.has been updated and renamed Butler Lumber. TheSears Roebuck s. Wal-Mart and Quality Furniture om!any cases hae been dropped.

Approach

Althou!h it is not possible to do this precisely" the financial statement analysis discussion is morecoherent" we beliee" if it is built around #llustration 13-1. The theme is that the financial statement pro$yfor shareholder alue is return on inestment" and the ratios help e$plain why a !ien return was notsatisfactory %if it was not&" or at least identify the areas that need inesti!ation.

As with Chapter '" the amount of attention !ien to this chapter depends on whether or not the studentsare ta(in! or will ta(e a course in finance. #n such a course" they will" of course" deal considerably more

with financial statement analysis than is contained in this introductory treatment. )hen a finance courseis !ien" we do not assi!n the chapter" but su!!est only that students s(im throu!h it.

Students should not !et the impression that there is one *best+ list of ratios to be memori,ed. Althou!h the !ien in #llustration 13-3 could be e$panded still further" in practice the analyst will select the ratiosmost appropriate for a !ien industry settin!.

Cases

"enmo or!orationis a *bac(wards+ case in which students deduce the financial statements of /eneral0otors Corporation from the ratios.

#merbran om!any $B%is a case inolin! strai!htforward calculation of ratios.

I&enti'y the In&ustries--())* is a case showin! companies in the different industries can hae uitedisparate alues of their ratios.

Su!!lement to I&enti'y the In&ustriesis a case showin! companies in the different industries can haeuite disparate alues of their ratios.

S!rin+'iel& ational Bank is a case in financial analysis as the basis for a lendin! decision. #t inolesboth the calculation of ratios and the e$ercise of 2ud!ment.

Butler Lumber om!any, Inc.inoles the process of see(in! ban( credit to prepare proforma financial

statements usin! financial ratios.

13-1

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Problems

Problem 13-1

a. rofit 0ar!ins

percent&%4.541"5'5

4

Sales0

income6et0==

percent&%1551.1"-14

1--

Sales6

income6et6==

6 has the hi!her profit mar!in.

b. #nestment Turnoer

7$1'5

1"5'5

#nestment0

alesS0==

3$54

1"-14

nestment#6

alesS6==

0 has the hi!her inestment turnoer.

c. 8eturn on #nestment

0 6et income 0-Sales.54 $ 7 .35 %35 percent&0 Sales 0-#nestment

= =

6 6et income 6 Sales.15 $ 3 .35 %35 percent&

6 Sales 6 #nestment

= =

9oth firms hae similar returns on inestments. 9ased on this inestment criterion" the inestmentsare eually attractie.

Problem 13-2

Since the diision has no control oer the financin! of its assets employed in its operation" the most

appropriate measure of return on inestment to use to 2ud!e its performance is

assetstotalAera!e

e$penseintereste$cludin!income6et

-:4-4"555&;%:55"555

.

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455".7-:

=.5"47:=

> .13 %1.3 percent&.

Problem 13-3

Current ?ear

&374;.5'"13'"'3%:

:4".

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555"555"-5:

555".'5"11:=

> 4 3.33 times

"555:1"455"555

"555:1"

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#isc$ssion

#n seeral instances" alternatie ways of calculatin! a ratio were possible. #n each" the correct alternatiecan be found by chec(in! the way the ratios actually were computed in 1='7 %551 in the case&.

Financial statements and the method of calculatin! each item are !ien in E$. A.

The 1='< %511 in the case& return on shareholdersB euity was =.75 percent. The 1='7 %515 in the case&and 1='< 8E performance trend was obiously unsatisfactory from a lon!er-term perspectie" and =.75percent was unsatisfactory !ien AAA bond returns in 1='

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!otes

Hine1. Hine 3 - line

. 8eenue %15"'1& I daysB receiables %3=.77& ; 3743. Current liabilities %"'4& I uic( ratio %5.7 5.714 %debt;euity&. Solin!" K > 1"''4. %The "=1< comes

from line 1.&11. Hine 1 - line 151. 8eenues %15"'1& ; inested capital turnoer %.5=1&

13. Hine = J line 11. /ien14. Hine 1 - line 1717. 8eenues %15"'1& I !ross mar!in percenta!e %5.141&1

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Question (

Some years a!o in loo(in! at some oil company annual reports" # discoered %to my surprise& that therewas not uniform treatment of e$cise ta$es on !asoline. Some companies included e$cise ta$es in reenues

and then subtracted them below the !ross mar!in line as a period cost %nonincome ta$ e$pense&. thercompanies i!nored e$cise ta$es alto!ether in their statements" reflectin! the iew that the company was ineffect an inoluntary ta$ collector and that the ta$es collected were neither reenues nor e$penses to thefirm. %# personally support this iew.& The preta$ income reported by the two approaches is identical" butthe absolute amount of reenues is inflated by the first approach" thus affectin! the !ross mar!inpercenta!e %and any other ratio that inoles reenues in its calculation&.

Amerbran Company collects e$cise ta$es on tobacco products and uses the approach of includin! the

e$cise ta$es in reenues and subtractin! them as an e$pense but with the twist of treatin! the ta$es as a

product cost %pre!ross mar!in& rather than as a period cost. This approach results in the same absoluteamount of !ross mar!in as if the ta$es were i!nored alto!ether. Moweer" it ma(es the companyBs salesloo( !reater by a si!nificant amountG in 5$5" reenues e$cludin! the ta$es would hae been :"3"135"

or 37 percent lower than the amount reported. n the other hand" treatin! the ta$es as a product costreduces the !ross mar!in percenta!e. For e$ample" with the ta$es included in reenues but subtractedbelow the !ross mar!in line" in 5$5 the percenta!e would hae been :"55"135 ; :7"4

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@efinition 5$5 5$l1

.

8eturn

on Assets...........................................................................................................................................................................

P6et #ncome J

#nterestI%1-Ta$ 8ate&Q

P:3 5.45'>

4.5'

N

:1"=31"3'> 5.43>

4.3

N

6et Sales 8eenue :7"4

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1.

@ebt;Capitali,ation8atio.....................................................................................................................................................................................................

6oncurrentHiabilities

:=3"''> 5.==>

=.=N

:''5"7 5.

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/oan (fficer +

Hoan fficer 9 read the first two pa!es of the empirical study problem and turned to the financialstatements. #n e$aminin! the financial statement" he notedG %1& accounts receiable were up" %& company

had deferred ta$es on installment sales which he inferred meant that they were sellin! fi$ed assets off. %3&uestioned the accounts receiable as he would thin( that the company would be primarily a cashbusiness" %& wondered what the bad debt write-offs were" %4& wondered whether the company would bebetter off factorin! accounts receiable" %7& was curious about the purpose of the reuested line of creditbecause of the nonutili,ation of ban( credit in the past" but felt that it would be a desirable account fromthe deposit balances" and %

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Documents

Cases Chap013