Principles of Financial Accounting - Ch 17 notes

8/11/2019 Principles of Financial Accounting - Ch 17 notes

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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPAWinston Kwok, Ph.D., CPA

McGraw-H il l/I rwin Copyri ght 2011 by The McGraw-H il l Companies, I nc. Al l ri ghts reserved.

ANALYSIS

OF

FINANCIAL

STATEMENTS

Chapter 17


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Applicationof analytical

tools

Involvestransforming

data

Reducesuncertainty

BASICSOFANALYSIS

Financial statement analysis helps usersmake better decisions.

Internal UsersManagersOfficers

Internal Auditors

External UsersShareholdersLenders

Customers

C 1


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BUILDINGBLOCKSOFANALYSIS

C 1

Liquidity and

efficiency Solvency

Marketprospects

Profitability


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INFORMATIONFORANALYSIS

C 1

1. Income Statement (Statement ofComprehensive Income)

2. Balance Sheet (Statement ofFinancial Position)

3. Statement of Changes in Equity4. Statement of Cash Flows

5. Notes to the Financial Statements


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Intracompany

CompetitorsIndustry

Guidelines

STANDARDSFORCOMPARISON

C 1

When we interpret our analysis, it is essential tocompare the results we obtained to other

standards or benchmarks.


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Horizontal Analysis

Comparing a companys financial condition andperformance across time.

TOOLSOFANALYSIS

Vertical Analysis

Comparing a companys financial condition andperformance to a base amount.

Ratio Analysis

Measurement of key relations between financial statementitems.

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HORIZONTALANALYSIS

P 1


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COMPARATIVESTATEMENTS

Calculate Change in Dollar Amount

DollarChange

Analysis PeriodAmount

Base PeriodAmount=

When measuring the amount of the

change in dollar amounts, compare theanalysis period balance to the base

period balance. The analysis period isusually the current year while the base

period is usually the prior year.

P 1


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COMPARATIVESTATEMENTS

Calculate Change as a Percent

Percent

Change

Dollar Change

Base Period Amount 100=

P 1

When calculating the change as a

percentage, divide the amount of thedollar change by the base period

amount, and then multiply by 100 toconvert to a percentage.


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$1,550,861$835,546 = $715,315

P 1

($715,315 $835,546) 100 = 85.6%

HORIZONTALANALYSIS


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HORIZONTALANALYSIS

($3,888,038 $11,065,186) 100 = 35.1%

$14,953,224$11,065,186 = $3,888,038

P 1

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TRENDANALYSIS

Trend analysis is used to reveal patterns in datacovering successive periods.

TrendPercent

Analysis Period AmountBase Period Amount

100=

P 1

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TRENDANALYSIS

Research in MotionIncome Statement Information

Using 2006 as the base year we will get the following trend information:

Examples of 2006-2008 Calculations for Revenues:2006 is base year. Set to 100%2007: $3,037,103$2,065,845100 = 147.0%

2008: $6,009,395$2,065,845100 = 290.9%

P 1

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TRENDANALYSIS

We can use the trend percentages to construct agraph so we can see the trend over time.

P 1

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VERTICALANALYSIS

Common-Size Statements

Common-size

Percent

Analysis Amount

Base Amount100

=

Financial Statement Base Amount

Balance Sheet Total Assets

Income Statement Revenues

P 2

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($1,550,861 $10,204,409) 100 = 15.2%

($835,546 $8,101,372) 100 = 10.3%

COMMON-SIZEBALANCESHEET

P 2

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COMMON-SIZEINCOMESTATEMENT

P 2

($8,368,958 $14,953,224) 100 = 56.0%

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COMMON-SIZEGRAPHICS

P 2

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RATIOANALYSIS

P 3

Liquidity

andefficiency Solvency

Marketprospects

Profitability

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CurrentRatio

Acid-testRatio

Accounts

ReceivableTurnover

InventoryTurnover

DaysSales

Uncollected

DaysSales

in Inventory

Total Asset

Turnover

LIQUIDITYANDEFFICIENCY

P 3

DaysPurchases in

AccountsPayable

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WORKINGCAPITAL

Working capitalrepresents current assetsfinanced from long-term capital sources that

do not require near-term repayment.

Current assetsCurrent liabilities= Working capital

More working capital suggests a strong liquidityposition and an ability to meet current obligations.

P 3

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This ratio measures the short-term debt-paying ability of the company. A higher current

ratio suggests a strong liquidity position.

CURRENTRATIO

Current Ratio =Current Assets

Current Liabilities

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This ratio is like the current ratio but excludes current assetssuch as inventories and prepaid expenses that may be

difficult to quickly convert into cash.

ACID-TESTRATIO

Acid-test ratio =

Cash + Short-term investments + Currentreceivables

Current LiabilitiesReferred to as Quick Assets

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This ratio measures howmany times a companyconverts its receivables

into cash each year.

ACCOUNTSRECEIVABLETURNOVER

Accounts receivable =turnover

Net salesAverage accounts receivable,

net

Average accounts receivable =(Beginning acct. rec. + Ending acct. rec.)

2

P 3

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This ratio measures thenumber of times

merchandise is sold andreplaced during the year.

INVENTORYTURNOVER

Inventory turnover =Cost of goods soldAverage inventory

Average inventory = (Beginning inventory + Ending inventory)2

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Provides insight into how frequently acompany collects its accounts receivable.

DAYSSALES UNCOLLECTED

Day's sales =uncollected

Accounts receivable, net 365

Net sales

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DAYSSALES IN INVENTORY

Day's sales in =Inventory

Ending inventory 365

Cost of goods sold

This ratio is a useful measure in evaluatinginventory liquidity. If a product is demandedby customers, this formula estimates how

long it takes to sell the inventory.

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DAYSPURCHASES IN ACCOUNTSPAYABLE

Accounts =Payable

Accounts payable 365

Cost of goods sold

This ratio is a useful measure in evaluatinghow long the business takes to pay its credit

suppliers.

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CASH CONVERSION CYCLE

The sum of the dayssales uncollected and thedayssales in inventory subtracting the dayspurchases in accounts payable. It represents

the number of days a firms cash remains tiedup within the operations of the business.

The lower the cash conversion cycle, the morehealthy a company generally is.

P 3

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TOTALASSETTURNOVER

Total asset turnover =Net sales

Average total assets

Average assets =(Beginning assets + Ending assets)

2

This ratio reflects a

companys ability to useits assets to generate

sales. It is an importantindication of operating

efficiency.

P 3

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DebtRatio

Equity

Ratio

Pledged Assetsto Secured

Liabilities

TimesInterestEarned

SOLVENCY

P 3

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DEBTANDEQUITYRATIOS

Amount RatioTotal liabilities $ 8,000,000 66.7% [Debt ratio]Total equity 4,000,000 33.3% [Equity ratio]

Total liabilities and equity $ 12,000,000 100.0%

$8,000,000$12,000,000 = 66.7%

The debt ratioexpresses total liabilities as a percent oftotal assets. The equity ratioprovides complementary

information by expressing total equity as a percent of totalassets.

P 3

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DEBT-TO-EQUITYRATIO

Debt-to-equity ratio =Total liabilitiesTotal equity

This ratio measures what portion of a companysassets are contributed by creditors. A larger debt-to-

equity ratio implies less opportunity to expand

through use of debt financing.

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TIMESINTERESTEARNED

Times interest earned =

Income before interest andtaxes

Interest expense

This is the most common measure of theability of a companys operations to provide

protection to long-term creditors.

Net income+ Interest expense

+ Income taxes

= Income before interest and taxes

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ProfitMargin

Return onTotal Assets

Return on OrdinaryShareholders

Equity

PROFITABILITY

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PROFITMARGIN

Profit margin =Net incomeNet sales

This ratio describes a companys abilityto earn net income from each sales dollar.

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Return on total asset =Net income

Average total

assets

RETURNONTOTALASSETS

Return on total assets measures how well

assets have been employed by thecompanys management.

P 3

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RETURN ON ORDINARY SHAREHOLDERS'EQUITY

Return on ordinary shareholders'equity =

Net income - Preferencedividends

Average ordinary shareholders'equity

This measure indicates how well thecompany employed the shareholdersequity

to earn net income.

P 3

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Price-EarningsRatio

DividendYield

MARKETPROSPECTS

P 3

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PRICE-EARNINGSRATIO

Price-earnings ratio =Market price per ordinary share

Earnings per share

This measure is often used by investors as ageneral guideline in gauging share values.

Generally, the higher the price-earnings ratio,the more opportunity a company has for growth.

P 3

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DIVIDENDYIELD

Dividend yield =Annual cash dividends per share

Market price per share

This ratio identifies the return, in terms of cashdividends, on the current market price per share

of the companys ordinary shares.

P 3

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ANALYSISREPORTING

A1

1. Executive Summary2. Analysis Overview3. Evidential Matter4. Assumptions5. Key Factors

6. Inferences

The purpose of financial statement analyses is toreduce uncertainty in business decisions through a

rigorous and sound evaluation. A financial statement

analysis report directly addresses the building blocks ofanalysis and documents the reasoning.

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ENDOFCHAPTER17

Documents

Principles of Financial Accounting - Ch 17 notes