Topic 12 - Financial - Statement - Analysis

Financial
Chapter
Statements
12 Analysis
100 Shares
Analysing
Financial Stmts?
$1 par value
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana © The McGraw-Hill Companies, Inc., 2007
Learning
Learning Objectives
Objectives
 Explain the purpose of  Explain and apply
analysis. methods of horizontal
 Identify the building analysis.
blocks of analysis.  Describe and apply
 Describe standards for methods of vertical
comparisons in analysis. analysis.
 Identify the tools of  Define and apply ratio
analysis. analysis.
Basics
Basics of
of Analysis
Analysis
Application
of analytical
tools
Involves
Reduces
transforming
uncertainty
data
Purpose
Purpose of
of Analysis
Analysis
Financial
Financial statement
statement analysis
analysis helps
helps users
users
make
make better
better decisions.
decisions.
Internal Users External Users

Managers Shareholders
Officers Lenders
Internal Auditors Customers
Building
Building Blocks
Blocks of
of Analysis
Analysis
Ability to meet
short-term Ability to
obligations and Liquidity generate future
to efficiently
generate
and Solvency revenues and
meet long-term
revenues Efficiency obligations
Ability to provide Ability to

financial rewards Market generate
Profitability
sufficient to
attract and retain
Prospects positive
market
financing expectations
Information
Information for
for Analysis
Analysis
Income Statement Notes
Balance Sheet
Statement of
Changes in
Shareholders’ Equity
Statement of Cash
Flows
Standards
Standards for
for Comparison
Comparison
To help me interpret our
financial statements, I
use several standards of
comparison.
 Intracompany
 Intercompany
 Industry
 Guidelines
Tools
Tools of
of Analysis
Analysis
Horizontal
Horizontal Analysis
Analysis
Comparing a company’s financial condition
and performance across time
Time
VV
Tools
Tools of
of Analysis
Analysis ee
rr
tt
Comparing a company’s ii
financial condition and cc
aa
performance to a base amount ll
AA
nn
aa
ll
yy
ss
ii
ss
Tools
Tools of
of Analysis
Analysis
Using key relations

among financial
statement items
Horizontal
Horizontal Analysis
Analysis
Now, let’s
look at
some ways
to use
horizontal
analysis.
Time
The term horizontal analysis arises from
left-to-right (or right-to-left) movement of
our eyes as we review comparative
financial statements across time.
KRISPY KREME
COMPARATIVE BALANCE SHEETS
31-Dec
Dollar Percent
2006 2005 Change Change
ASSETS
Non-current assets
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total non-current assets $ 160,000 $ 125,000
Current assets
Cash and equivalents $ 12,000 $ 23,500
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000 $ 164,700
Total assets $ 315,000 $ 289,700
Comparative
Comparative Statements
Statements
Calculate Change in Dollar Amount
Dollar Analysis Period Base Period

Change = Amount – Amount
Since we are measuring the amount of

the change between 2005 and 2006, the
dollar amounts for 2005 become the
“base” period amounts.
Comparative
Comparative Statements
Statements
Calculate Change as a Percent
Percent Dollar Change

Change
=
Base Period Amount × 100%
CLOVER CORPORATION
31-Dec
Dollar Percent
2006 2005 Change Change*
ASSETS
Non-curent assets
Land $ 40,000 $ 40,000
Current assets
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) (48.9)
Inventory 80,000 100,000
Total assets
$12,000 – $23,500 = $(11,500)
$ 315,000 $ 289,700
* Percent rounded to first decimal point.
($11,500 ÷ $23,500) × 100% = 48.9%
CLOVER CORPORATION
Comparative Balance Sheets
31-Dec
Dollar Percent
ASSETS
Non-current assets
Land $ 40,000 $ 40,000 - 0.0
Buildings and equipment, net 120,000 85,000 35,000 41.2
Total non-current assets $ 160,000 $ 125,000 $ 35,000 28.0
Current assets
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) (48.9)
Accounts receivable, net 60,000 40,000 20,000 50.0
Inventory 80,000 100,000 (20,000) (20.0)
Prepaid expenses 3,000 1,200 1,800 150.0
Total current assets $ 155,000 $ 164,700 $ (9,700) (5.9)
Total assets $ 315,000 $ 289,700 $ 25,300 8.7
Now, let’s review the dollar
and percent changes for
the liabilities and
shareholders’ equity
accounts.
CLOVER CORPORATION
Comparativ e Balance Shee ts
31-Dec
Dollar Pe rce nt
EQUITY AND LIABILITIES
Equity
Prefe rre d shares $ 20,000 $ 20,000 - 0.0
Common shares 60,000 60,000 - 0.0
Additional paid-in capital 10,000 10,000 - 0.0
Retained earnings 80,000 69,700 10,300 14.8
Total equity $ 170,000 $ 159,700 $ 10,300 6.4
Non-current liabilities
Bonds payable , 8% $ 75,000 $ 80,000 (5,000) (6.3)
Total non-curre nt liabilitie s $ 75,000 $ 80,000 (5,000) (6.3)
Current liabilities
Accounts payable $ 67,000 $ 44,000 $ 23,000 52.3
Notes payable 3,000 6,000 (3,000) (50.0)
Total current liabilities $ 70,000 $ 50,000 $ 20,000 40.0
Total liabilitie s $ 145,000 $ 130,000 $ 15,000 11.5
Total equity and liabilities $ 315,000 $ 289,700 $ 25,300 8.7

* Perce nt rounded to first decimal point.
Now, let’s
look at trend
analysis!
Trend
Trend Analysis
Analysis
Also called trend
percent analysis
or index number
trend analysis.
Trend
Trend analysis
analysis is
is used
used to
to reveal
reveal patterns
patterns in
in data
data
covering
covering successive
successive periods.
periods.
Trend Analysis Period Amount

Percent = Base Period Amount
× 100%
Trend
Trend Analysis
Analysis
KRISPY KREME
INCOME INFORMATION
FOR THE YEARS ENDED 31 DECEMBER
Item 2006 2005 2004 2003 2002
Revenues $ 400,000 $ 355,000 $ 320,000 $ 290,000 $ 275,000
Cost of sales 285,000 250,000 225,000 198,000 190,000
Gross profit 115,000 105,000 95,000 92,000 85,000
2002 is the base period so its

amounts will equal 100%.
Trend
Trend Analysis
Analysis
KRISPY KREME
INCOME INFORMATION
Item 2006 2005 2004 2003 2002
Revenues $ 400,000 $ 355,000 $ 320,000 $ 290,000 $ 275,000
Cost of sales 285,000 250,000 225,000 198,000 190,000
Gross profit 115,000 105,000 95,000 92,000 85,000
Item 2006 2005 2004 2003 2002

Revenues 105% 100%
Cost of sales 104% 100%
Gross profit 108% 100%
(290,000 ÷ 275,000) × 100% = 105%

(198,000 ÷ 190,000) × 100% = 104%
(92,000
Larson, Wild, Chiapetta, Ropidah,÷ 85,000)
Haslinda, Aryati, Liana× 100% = 108% © The McGraw-Hill Companies, Inc., 2007
Trend
Trend Analysis
Analysis
KRISPY KREME
INCOME INFORMATION
Item 2006 2005 2004 2003 2002
Revenues $ 400,000 $ 355,000 $ 320,000 $ 290,000 $ 275,000
Cost of sales 285,000 250,000 225,000 198,000 190,000
Gross profit 115,000 105,000 95,000 92,000 85,000
Item 2006 2005 2004 2003 2002

Revenues 145% 129% 116% 105% 100%
Cost of sales 150% 132% 118% 104% 100%
Gross profit 135% 124% 112% 108% 100%
How would this trend analysis

look on a line graph?
© The McGraw-Hill Companies, Inc., 2007
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
Trend
Trend Analysis
Analysis
We can use the trend
percentages to construct a
160
graph so we can see the
150
trend over time.
140
Percentage
130
120 Revenues
Cost of Sales
110 Gross Profit
100
2002 2003 2004 2005 2006
Year
VV
ee
rr
tt
ii Now, let’s look at some vertical
cc analysis tools!
aa
ll
AA
nn
aa
ll
yy
ss
ii
ss
VV
Vertical
Vertical Analysis
Analysis ee
rr
tt
Vertical Analysis is also called as ii
common-size analysis cc
aa
ll
AA
nn
aa
ll
The term vertical analysis arises from the up- yy
down (down-up) movement of our eyes as we ss
review common-size financial statements. ii
ss
Common-Size
Common-Size Statements
Statements
Calculate Common-size Percent
Common-size Analysis Amount

Percent
= Base Amount × 100%
Financial
FinancialStatement
Statement Base
BaseAmount
Amount
Balance
BalanceSheet
Sheet Total
Total Assets
Assets
Income
IncomeStatement
Statement Revenues
Revenues
KRISPY KREM E
COM PARATIVE BALANCE SHEETS
31-De c
Common-size
Pe rce nts*
2006 2005 2006 2005
ASSETS
Non-curre nt asse ts
Land $ 40,000 $ 40,000
Buildings and e quipme nt, ne t 120,000 85,000
Total non-curre nt asse ts $ 160,000 $ 125,000
Curre nt asse ts
Cash and e quiv ale nts $ 12,000 $ 23,500 3.8% 8.1%
Accounts re ce iv able , ne t 60,000 40,000
Inv e ntory 80,000 100,000
Pre paid e xpe nse s 3,000 1,200
Total curre nt asse ts $ 155,000 $ 164,700
Total asse ts $ 315,000 $ 289,700 100.0% 100.0%
($12,000 ÷ $315,000)
* Pe rce nt rounde d to first de cimal point. × 100% = 3.8%
($23,500 ÷ $289,700) × 100% = 8.1%

KRISPY KREM E
COM PARATIVE BALANCE SHEETS
31-De c
Common-size
Pe rce nts*
2006 2005 2006 2005
ASSETS
Non-curre nt asse ts
Land $ 40,000 $ 40,000 12.7% 13.8%
Buildings and e quipme nt, ne t 120,000 85,000 38.1% 29.3%
Total non-curre nt asse ts $ 160,000 $ 125,000 50.8% 43.1%
Curre nt asse ts
Cash and e quiv ale nts $ 12,000 $ 23,500 3.8% 8.1%
Accounts re ce iv able , ne t 60,000 40,000 19.0% 13.8%
Inv e ntory 80,000 100,000 25.4% 34.5%
Pre paid e xpe nse s 3,000 1,200 1.0% 0.4%
Total curre nt asse ts $ 155,000 $ 164,700 49.2% 56.9%
Total asse ts $ 315,000 $ 289,700 100.0% 100.0%
* Pe rce nt rounde d to first de cimal point.
KRISPY KREME
31-Dec
Common-size
Percents*
2006 2005 2006 2005
Equity
Preferred shares $ 20,000 $ 20,000 6.3% 6.9%
Common shares 60,000 60,000 19.0% 20.7%
Additional paid-in capital 10,000 10,000 3.2% 3.5%
Retained earnings 80,000 69,700 25.4% 24.1%
Total equity $ 170,000 $ 159,700 54.0% 55.1%
Bonds payable, 8% $ 75,000 $ 80,000 23.8% 27.6%
Total non-current liabilities $ 75,000 $ 80,000 23.8% 27.6%
Current liabilities
Accounts payable $ 67,000 $ 44,000 21.3% 15.2%
Notes payable 3,000 6,000 1.0% 2.1%
Total current liabilities $ 70,000 $ 50,000 22.2% 17.3%
Total liabilities $ 145,000 $ 130,000 46.0% 44.9%
Total equity and liabilities $ 315,000 $ 289,700 100.0% 100.0%
KRISPY KREME
COMPARATIVE INCOME STATEMENTS
Common-size
Percents*
2006 2005 2006 2005
Revenues $520,000 $480,000 100.0% 100.0%
Cost of sales 360,000 315,000 69.2% 65.6%
Expenses
Selling and admin. $128,600 $126,000 24.7% 26.3%
Interest expense 6,400 7,000 1.2% 1.5%
Profit before taxes $ 25,000 $ 32,000 4.8% 6.7%
Income taxes (30%) 7,500 9,600 1.4% 2.0%
Profit for the period $ 17,500 $ 22,400 3.4% 4.7%
Profit per share $ 0.79 $ 1.01
Avg. # common shares 22,200 22,200
Liquidity
and Solvency
Efficiency
Profitability Market
Let’s use the following financial

statements for Norton Corporation for
our ratio analysis.
KRISPY KREME
BALANCE SHEET
31 DECEMBER
2006 2005
ASSETS
Non-current assets
Land $ 165,000 $ 123,000
Current assets
Cash $ 30,000 $ 20,000
Inventory 12,000 10,000
Total assets $ 346,390 $ 300,000
KRISPY KREME
BALANCE SHEET
31-Dec
2006 2005
Equity
Common shares, $1 par value $ 27,400 $ 17,000
Additional paid-in capital 158,100 113,000
Retained earnings 48,890 50,000
Total equity $ 234,390 $ 180,000
Notes payable, long-term $ 70,000 $ 78,000
Total non-current liabilities $ 70,000 $ 78,000
Current liabilities
Accounts payable $ 39,000 $ 40,000
Notes payable, short-term 3,000 2,000
Total current liabilities $ 42,000 $ 42,000
Total liabilities $ 112,000 $ 120,000
Total equity and liabilities $ 346,390 $ 300,000
KRISPY KREME
INCOME STATEMENT
2006 2005
Revenues $ 494,000 $ 450,000
Cost of sales 140,000 127,000
Gross margin $ 354,000 $ 323,000
Expenses 270,000 249,000
Operating profit $ 84,000 $ 74,000
Interest expense 7,300 8,000
Profit before taxes $ 76,700 $ 66,000
Income taxes (30%) 23,010 19,800
Profit for the period $ 53,690 $ 46,200
Liquidity
Liquidity and
and Efficiency
Efficiency
Current
Current Inventory
Inventory
Ratio
Ratio Turnover
Turnover
Acid-test
Acid-test Days’
Days’ Sales
Sales
Ratio
Ratio Uncollected
Uncollected
Accounts
Accounts Days’
Days’ Sales
Sales
Receivable
Receivable in
in Inventory
Inventory
Turnover
Turnover
Total
Total Asset
Asset
Turnover
Turnover
KRISPY KREME
2006
Cash $ 30,000
Accounts receivable, net
Beginning of year 17,000
Ending of year 20,000
Use this information Inventory
to calculate the Beginning of year 10,000
liquidity and
Total current assets 65,000
efficiency ratios for Total current liabilities 42,000
Krispy Kreme. Total assets
Revenues 494,000
Cost of sales 140,000
Working
Working Capital
Capital
Working capital represents current assets
financed from long-term capital sources that do
not require near-term repayment.
31 Dec. 2006
Current assets $ 65,000
Current liabilities (42,000)
Working capital $ 23,000
Current
Current Ratio
Ratio
Current Current Assets

=
Ratio Current Liabilities
Current $65,000
= = 1.55 : 1
Ratio $42,000
This ratio measures the

short-term debt-paying
ability of the company.
Acid-Test
Acid-Test Ratio
Ratio
Acid-Test = Quick Assets
Ratio Current Liabilities
Quick assets are Cash, Short-Term Investments,
and Current Receivables.
Acid-Test = $50,000 = 1.19 : 1

Ratio $42,000
This ratio is like the current
ratio but excludes current assets
such as inventories and prepaid
expenses that may be difficult to
quickly convert into cash.
Accounts
Accounts Receivable
Receivable Turnover
Turnover
Accounts Sales on Account
Receivable = Average Accounts Receivable
Turnover
Accounts $494,000
Receivable = ($17,000 + $20,000) ÷ 2 = 26.7 times
Turnover
This ratio measures how many

times a company converts its
receivables into cash each year.
Inventory
Inventory Turnover
Turnover
Inventory Cost of Sales
=
Turnover Average Inventory
Inventory $140,000
= = 12.73 times
Turnover ($10,000 + $12,000) ÷ 2
This ratio measures the number

of times merchandise
is sold and replaced during the year.
Days’
Days’ Sales
Sales Uncollected
Uncollected
Days’ Sales Accounts Receivable

= × 3
Uncollected Net Sales
65
Days’ Sales $20,000
= × 365 = 14.8
Uncollected $494,000
days
This ratio measures the liquidity

of receivables.
Days’
Days’ Sales
Sales in
in Inventory
Inventory
Days’ Sales Ending Inventory
= × 3
in Inventory Cost of Sales
65
Days’ Sales $12,000

= × 365 = 31.29
in Inventory $140,000
days
This ratio measures the liquidity

of inventory.
Total
Total Asset
Asset Turnover
Turnover
Total Asset Net Sales
=
Turnover Average Total Assets
Total Asset $494,000

= = 1.53 times
Turnover ($300,000 + $346,390) ÷ 2
This ratio measures the

efficiency of assets in producing
sales.
Solvency
Solvency
Debt
Debt
Ratio
Ratio
Equity
Equity
Ratio
Ratio
Pledged
PledgedAssets
Assets
to
to Secured
Secured
Liabilities
Liabilities
Times
Times
Interest
Interest
Earned
Earned
Use this information to calculate the
solvency ratios for Norton Corporation.
KRISPY KREME
2006
Profit before interest
expense and income taxes $ 84,000
Interest expense 7,300
Total shareholders' equity 234,390
Total liabilities 112,000
Total assets 346,390
Debt
Debt Ratio
Ratio
Debt Total Liabilities
=
Ratio Total Assets
Debt $112,000
= = 32.3%
Ratio $346,390
This ratio measures what portion of a

company’s assets are contributed by
creditors.
Equity
Equity Ratio
Ratio
Equity Total Equity

=
Ratio Total Assets
Equity $234,390
= = 67.7%
Ratio $346,390
This ratio measures what portion of a

company’s assets are contributed by
owners.
Pledged
Pledged Assets
Assets to
to Secured
Secured Liabilities
Liabilities
Pledged
Assets to = Book Value of Pledged Assets
Secured Book Value of Secured Liabilities
Liabilities
This ratio measures the protection to

secured creditors.
Times
Times Interest
Interest Earned
Earned
Profit before Interest Expense
Times and Income Taxes
Interest =
Earned Interest Expense
Times $84,000
Interest = = 11.51
$7,300
Earned
This is the most common measure of the
ability of a firm’s operations to provide
protection to the long-term creditor.
Profitability
Profitability
Profit Basic
Basic
Profit
Margin Earnings
Earnings per
per
Margin
Share
Share
Gross
Gross Book
BookValue
Value
Margin
Margin per
per Common
Common
Share
Share
Return
Return on
on Return
Return on
on
Total
Total Assets
Assets Common
Common
Shareholders’
Shareholders’
Equity
Equity
KRISPY KREME
2006
Number of common shares
outstanding all year 27,400
Use this
Profit for the period $ 53,690
information
to calculate Shareholders' equity
the Beginning of year 180,000
profitability
ratios for
Krispy Revenues 494,000
Kreme. Cost of sales 140,000
Total assets
Profit
Profit Margin
Margin
Profit Profit for the period

=
Margin Net Sales
Profit $53,690
= = 10.87%
Margin $494,000
This ratio describes a

company’s ability to earn a net
income from sales.
Gross
Gross Margin
Margin
Gross Net Sales - Cost of Sales
=
Margin Net Sales
Gross $494,000 - $140,000

= = 71.66%
Margin $494,000
This ratio measures the amount

remaining from $1 in sales that is left
to cover operating expenses and a
profit after considering cost of sales.
Return
Return on
on Total
Total Assets
Assets
Return on = Profit for the period
Total Assets Average Total Assets
Return on $53,690
Total Assets
= ($300,000 + $346,390) ÷ 2 = 16.61%
This ratio is generally considered

the best overall measure of a
company’s profitability.
Return
Return on
on Common
Common
Shareholders’
Shareholders’ Equity
Equity
Return on
Common Profit for the period - Preferred Dividends
Shareholders’ = Average Common Shareholders’
Equity Equity
Return on
Common $53,690 - 0
= ($180,000 + $234,390) ÷ 2 = 25.9%
Shareholders’
Equity
This measure indicates how well the

company employed the owners’
investments to earn income.
Book
Book Value
Value per
per Common
Common Share
Share
Book Value Shareholders’ Equity Applicable to

per Common Shares
=
Common Number of Common Shares
Share Outstanding
This ratio measures

liquidation at reported
amounts.
Basic
Basic Earnings
Earnings per
per Share
Share
Basic Earnings
per Profit for the period - Preferred Dividends
Share = Weighted-Average Common Shares
Outstanding
Basic Earnings
per $53,690 - 0
Share = = $1.96 per share
27,400
This measure indicates how much

income was earned for each share of
common shares outstanding.
Market
Market Prospects
Prospects
Price-
Price-
Earnings
Earnings
Ratio
Ratio
Dividend
Dividend
Yield
Yield
Market
Market Prospects
Prospects
Use this
KRISPY KREME
information
31 December 2006
to calculate Earnings per Share $ 1.96
the market Market Price 15.00
ratios for Annual Dividend per Share 2.00
Krispy
Kreme.
Price-Earnings
Price-Earnings Ratio
Ratio
Price-Earnings Market Price Per Share
=
Ratio Earnings Per Share
Price-Earnings $15.00
= = 7.65 times
Ratio $1.96
This measure is often used by investors as a general

guideline in gauging share values. Generally, the
higher the price-earnings ratio, the more opportunity
a company has for growth.
Dividend
Dividend Yield
Yield
Dividend Annual Dividends Per Share
=
Yield Market Price Per Share
Dividend $2.00
= = 13.3%
Yield $15.00
This ratio identifies the return, in terms of

cash dividends, on the current market
price of the share.
End of Chapter 12

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Financial

Internal Users External Users

Ability to provide Ability to

Using key relations

Dollar Analysis Period Base Period

Since we are measuring the amount of

Percent Dollar Change

Total equity and liabilities $ 315,000 $ 289,700 $ 25,300 8.7

Trend Analysis Period Amount

2002 is the base period so its

Item 2006 2005 2004 2003 2002

(290,000 ÷ 275,000) × 100% = 105%

Item 2006 2005 2004 2003 2002

How would this trend analysis

Common-size Analysis Amount

($23,500 ÷ $289,700) × 100% = 8.1%

Let’s use the following financial

Current Current Assets

This ratio measures the

Acid-Test = $50,000 = 1.19 : 1

This ratio measures how many

This ratio measures the number

Days’ Sales Accounts Receivable

This ratio measures the liquidity

Days’ Sales $12,000

This ratio measures the liquidity

Total Asset $494,000

This ratio measures the

This ratio measures what portion of a

Equity Total Equity

This ratio measures what portion of a

This ratio measures the protection to

Profit Profit for the period

This ratio describes a

Gross $494,000 - $140,000

This ratio measures the amount

This ratio is generally considered

This measure indicates how well the

Book Value Shareholders’ Equity Applicable to

This ratio measures

This measure indicates how much

This measure is often used by investors as a general

This ratio identifies the return, in terms of

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