Twelve Nine

1
Twelve Nine

• 2Day Chapter 13 Howork
• 2Day Stox Contest Results
• REVUE (SPRING 2002 final exam)
• Pass back extra-credit assignments
• Thurzday ??????

2
Final Exam options

• Sunday, December 14th, 530-730 p.m., SCHOOL OF
  ACCOUNTING (2nd Floor, west end)
• Monday, December 15, 130-330 p.m., ADAMS HALL,
  Room 255
• Friday, December 19, 130-330 p.m., HERE

3
Final Stock Market Report

• 1. Cancer Sticks 7,905
• 2. IGT 6,419
• 3. Cheesecake 5,724
• 4. Spanish Rice 5,639
• 5. Nokia 5,491
• 6. Goldman Sachs 5,410

4
Final Stock Market Report

• 7. Paris Hilton 5,373
• 8. Dee Cee 5,184
• 9. Fitch Me 4,323
• 10. Human Gnomes 4,156
• 11. River Rat 4,000

5
Final Eggzam Getdown Breakdown

• Chapter 12
• Chapter 26
• Chapter 36
• Chapter 43
• Chapter 56
• Chapter 67
• Chapter 79

• Chapter 89
• Chapter 94
• Chapter 119
• Chapter 1210
• Chapter 139

6
MO

• 51 Multiple choice
• 29 True/False
• 37 Computational
• 17 Ratio Questions

7
Don't Be A Line Victim!!!
89 . . . 79 . . . 69 . . . 59 are the guaranteed
cutoffs . . . .
8
CHAPTER 13

• Financial Statement Analysis

9
FINANCIAL STATEMENT ANALYSIS

• The way to compare companies of different sizes
  is to use standard measures
• Financial ratios are standard measures that
  enable analysts to compare companies of different
  sizes

10
FINANCIAL STATEMENT ANALYSIS

• In addition to the financial statements, annual
  reports contain the following
• Notes to the financial statements, including a
  summary of the accounting methods used
• Managements discussion and analysis (MDA) of
  the financial results
• The auditors report
• Comparative financial data for a series of years

11
FINANCIAL STATEMENT ANALYSIS
For example, the graphs in the next exhibit show
Bristol-Myers Squibbs three-year trend of net
sales, market value of the companys stock, and
cumulative return to the companys stockholders
12
Representative Financial Data of Bristol-Myers
Squibb Company
Market Value Millions
Net Sales Millions
Cumulative Return to Shareholders
20,000 15,000 10,000 5,000
0
140,000 105,000 70,000 35,000
0
250 200 150 100 50 0
96 97 98
96 97 98
96 97 98
13
FINANCIAL STATEMENT ANALYSIS

• The objectives of financial statement analysis
  are to help investors
• Predict their expected returns (see the previous
  graph)
• Assess the risks associated with those returns

14
HORIZONTAL ANALYSIS

• The study of percentage changes in comparative
  statements is called horizontal analysis
• Computing a percentage change in comparative
  statements requires two steps
• Computing the dollar amount of the change from
  the base period to the later period
• Dividing the dollar amount of change by the
  base-period amount

15
Horizontal analysis is illustrated for
Bristol-Myers Squibb as follows (dollar amounts
in millions)
Increase (Decrease)
1998 1997 Amount
Percent
Sales 18,284 16,701 1,583 9.5 Net income
3,141 3,205 (64) (2.0)
16
HORIZONTAL ANALYSIS

• Trend percentages
• Are a form of horizontal analysis that examine
  more than a two- or three-year period
• Use a selected base year whose amounts are set
  equal to 100 percent

• To compute trend percentages, each item for
  following years is divided by the corresponding
  amount during the base year

Any year
Trend
Base year
17
VERTICAL ANALYSIS

• Vertical analysis of a financial statement
  reveals the relationship of each statement item
  to a specified base, which is the 100 figure
• Every other item on the financial statement is
  then reported as a percentage of that base
• When an income statement is analyzed vertically,
  net sales is usually the base

18
COMMON-SIZE STATEMENTS

• A common-size statement simplifies the comparison
  of different companies because their amounts are
  stated in percentages
• On a common-size income statement, each item is
  expressed as a percentage of the net sales amount
• In the balance sheet, the common size is total
  assets or the sum of total liabilities and
  stockholders equity

19
BRISTOL-MYERS SQUIBB COMPANY Analysis of Current
Assets December 31,1998 and 1997
Percent of Total Assets
1998
1997
Current Assets Cash and cash equivalents
Time deposits and marketable securities
Receivables, net Inventories Prepaid
expenses Total current assets Long-Term
Assets Total Assets
13.8 1.8 19.6 11.5 7.3 54.0
46.0 100.0
9.7 2.3 19.9 12.0 7.8 51.7
48.3 100.0
20
BENCHMARKING

• Benchmarking is the practice of comparing a
  company to a standard set by other companies,
  with a view toward improvement
• Benchmarking against the industry average
• Managers, investors, and creditors need to know
  how one company compares with similar companies

21
BENCHMARKING

• The next exhibit gives the common-size income
  statement of Bristol-Myers Squibb Company
  compared with the average for the pharmaceuticals
  industry
• Its gross profit percentage is much higher than
  the industry average
• Its percentage of net income is significantly
  higher that the industry average

22
BRISTOL-MYERS SQUIBB COMPANY Common-Size Income
Statement for Comparison with Industry
Average Year Ended December 31, 1998
Bristol-Myers Squibb
Industry Average
Net sales Cost of products sold Gross
profit Operating expenses Earnings from
continuing operation before income tax Income tax
expense Earnings from continuing
operations Special items (discontinued
operations, extraordinary gains and losses, and
effect of accounting changes) Net earnings
100.0 26.6 73.4 50.1 23.3 6.1
17.2 17.2
100.0 54.7 45.3 36.5 8.8 2.3
6.5 1.4 5.1
23
STATEMENT OF CASH FLOWS IN DECISION MAKING

• The cash-flow statement summarizes sources and
  uses of the entitys cash flows
• Internal and external decision makers want to see
  the majority of cash inflows coming from
  operating activities
• WHY?

24
STATEMENT OF CASH FLOWS IN DECISION MAKING

• A company cannot stay in business for long if it
  cannot generate enough cash from operations to
  cover operating expenses
• While borrowing and investing activities provide
  cash for business use, long-term reliance on
  these activities for sources of cash is not
  advised

25
USING RATIOS TO MAKE BUSINESS DECISIONS

• A ratio expresses the relationship of one number
  to another
• The ratios used to make business decisions may be
  classified as follows
• Ratios that measure the companys ability to pay
  current liabilities
• Ratios that measure the companys ability to sell
  inventory and collect receivables

26
USING RATIOS TO MAKE BUSINESS DECISIONS

• Ratios that measure the companys ability to pay
  long-term debt
• Ratios that measure the companys profitability
• Ratios used to analyze the companys stock as an
  investment

27
MEASURING A COMPANYS ABILITY TO PAY CURRENT
LIABILITIES
Working capital is defined as follows
Working capital Current assets - Current
liabilities

• Working capital is widely used to measure a
  businesss ability to meet its short-term
  obligations with its current assets
• The larger the working capital, the better able
  is the business to pay its debts

28
CURRENT RATIO

• The current ratio
• Is current assets divided by current liabilities
• Measures the ability of the company to pay
  current liabilities with current assets

29
The current ratio of Palisades Furniture, Inc.,
at December 31, 20X3 and 20X2, follow, along with
the average for the retail furniture industry
Palisades Current Ratio
Formula
20X3
20X2
Current assets
262,000
236,000
1.85
Current ratio


1.87
Current liabilities
142,000
126,000
In most industries a current ratio of 2.0 is
considered good
Industry Average 1.70
In general, a higher current ratio indicates a
stronger financial position
30
ACID TEST RATIO

• The acid-test (or quick) ratio
• Indicates whether the entity could pay all its
  current liabilities if they came due immediately
• Is computed by dividing cash, short-term
  investments, and net current receivables
  (accounts and notes receivable, net of
  allowances) by current liabilities

31
Palisades Furnitures acid-test ratios for 20X3
and 20X2 are
Palisades Acid-Test Ratio
Formula
20X3
20X2
Cash short-term investments net current
receivables
29,000 0 114,000
32,000 0 85,000
Acid-Test ratio
1.01
0.93


Current liabilities
142,000
126,000
An acid-test ratio of 0.90 to 1.00 is acceptable
in most industries
Industry Average 0.40
32
MEASURING ABILITY TO SELL INVENTORY AND COLLECT
RECEIVABLES

• Three ratios are presented that measure the
  companys ability to sell inventory and collect
  receivables
• Inventory turnover
• Accounts receivable turnover
• Days sales in receivables

33
INVENTORY TURNOVER

• Inventory turnover is
• A measure of the number of times a company sells
  its average level of inventory during a year
• Computed by dividing the cost of goods sold by
  the average inventory for the period

34
INVENTORY TURNOVER

• A high rate of turnover indicates relative ease
  in selling inventory a low turnover indicates
  difficulty in selling
• In general, companies prefer a high inventory
  turnover
• Inventory turnover varies widely with the nature
  of the business

35
Palisades Furnitures inventory turnover for 20X3
is
Palisades Inventory Turnover
Formula
Cost of goods sold
513,000
Inventory turnover
4.58

Average inventory
112,000
Industry Average 3.00
Palisades Furnitures turnover of 4.58 times a
year is high for its industry, which has an
average turnover of 3.00
36
ACCOUNTS RECEIVABLE TURNOVER

• Accounts receivable turnover
• Measures a companys ability to collect cash from
  credit customers
• Is computed by dividing net sales by average net
  accounts receivable
• The resulting ratio indicates how many times
  during the year the average level of receivables
  was turned into cash

37
ACCOUNTS RECEIVABLE TURNOVER

• In general, the higher the ratio, the more
  successfully the business collects cash and the
  better off its operations
• A receivable turnover that is too high may
  indicate that credit is too tight, causing the
  loss of sales to good customers

38
Palisades Furnitures accounts receivable
turnover ratio for 20X3 is computed as follows
Palisades Accounts Receivable Turnover
Formula
Accounts receivable turnover
Net credit sales
858,000
8.62

Average net accounts receivable
99,000
Industry Average 31.3
Palisades receivable turnover of 8.62 is much
lower than the industry average, possibly because
larger stores sell their receivables
39
DAYS SALES IN RECEIVABLES

• The days-sales-in-receivables ratio tells
• How many days sales remain in Accounts
  Receivable
• Is computed by a two-step process
• First, divide net sales by 365 days to figure the
  average sales amount for one day
• Second, divide this average days sales amount
  into the average net accounts receivable

40
Palisades Days Sales in Accounts Receivable
Formula
Net sales
858,000
1. One days sales
2,351

365 days
365 days
Average net accounts receivable
Days sales in average accounts receivable
2.
99,500
42 days

One days sales
2,351
Industry Average 2 days
The days sales in receivables for Palisades is
higher (worse) than the industry average because
the company collects its own receivables
41
MEASURING A COMPANYS ABILITY TO PAY LONG-TERM
DEBT

• Two indicators of a businesss ability to pay
  long-term liabilities are the
• Debt ratio
• Times-interest-earned ratio

42
DEBT RATIO

• The debt ratio tells the proportion of the
  companys assets that it has financed with debt
• The higher the debt ratio, the higher the strain
  of paying interest each year and the principal
  amount at maturity
• The lower the ratio, the lower the businesss
  future obligations

43
Calculation of the debt ratios for Palisades
Furniture at the end of 20X3 and 20X2 is as
follows
Palisades Debt Ratio
Formula
20X3
20X2
Total liabilities
431,000
324,000
0.55
Debt ratio


0.50
Total assets
787,000
644,000
The average debt ratio for most companies
ranges from 0.57- 0.67
Industry Average 0.64
The companys debt ratio indicates a fairly
low-risk debt compared to the retail furniture
industry average
44
TIMES-INTEREST-EARNED RATIO

• The times-interest-earned ratio measures the
  number of times that operating income can cover
  interest expense
• A high times-interest-earned ratio indicates ease
  in paying interest expense
• A low value suggests difficulty

45
Calculation of Palisades times-interest-earned
ratio is as follows
Palisades Times-Interest-Earned Ratio
Formula
20X3
20X2
Income from operations
Times-interest-earned ratio
101,000
57,000
4.21


4.07
Interest expense
24,000
14,000
The norm for U.S. business ranges from 2.0 -
3.0 for most companies
Industry Average 2.30
The companys times-interest-earned ratio of
around 4.00 is significantly better than the
industry average for furniture retailers
46
MEASURING A COMPANYS PROFITABILITY

• There are four rate-of-return measurements that
  help evaluate a companys profitability
• Rate of return on net sales
• Rate of return on total assets
• Rate of return on common stockholders equity
• Earnings per share of common stock

47
RATE OF RETURN ON NET SALES

• The rate of return on net sales shows the
  percentage of each sales dollar earned as net
  income
• The higher the rate of return, the more net sales
  dollars are providing income to the business and
  the fewer net sales dollars are absorbed by
  expenses

48
The rate-of-return-on-sales ratios for Palisades
Furniture are calculated as follows
Palisades Rate of Return on Sales
Formula
20X3
20X2
Net income
Rate of return on sales
48,000
26,000
0.056
0.032



Net Sales
858,000
803,000
Industry Average 0.008
The increase in Palisades Furnitures return on
sales identifies the company as more successful
than the average furniture store
49
RATE OF RETURN ON TOTAL ASSETS

• The rate of return on total assets (return on
  assets) measures a companys success in using its
  assets to earn a profit
• The sum of interest expense and net income in the
  numerator is the return to creditors and
  shareholders who have financed the companys
  operations

50
Computation of the return-on-assets ratio for
Palisades Furniture is as follows
Palisades 20X3 Rate of Return on Total Assets
Formula
Net income
Interest Expense

Rate of return on assets
48,000 24,000
0.101


Average total assets
715,000
Industry Average 0.042
The increase in Palisades Furnitures return on
assets is higher than the industry average
51
RATE OF RETURN ON COMMON STOCKHOLDERS EQUITY

• Rate of return on stockholders equity (return on
  equity)
• Shows the relationship between net income and
  common stockholders investment in the company
• Is calculated by dividing net income available to
  common stockholders by the average stockholders
  equity during the year

52
The rate of return on common stockholders equity
for Palisades Furniture is calculated as follows
Palisades 20X3 Rate of Return on Common
Stockholders Equity
Formula
Rate of return on common stockholders equity
Net income
Preferred Dividends
-
48,000 - 0
0.142


Average common stockholders equity
338,000
Industry Average 0.121
53
EARNINGS PER SHARE OF COMMON STOCK

• Earnings per share (EPS) is
• The amount of net income per share of the
  companys outstanding common stock
• Computed by dividing net income available to
  common stockholders by the number of common
  shares outstanding during the year

54
Computation of the firms EPS for 20X3 and 20X2
follows, assuming the company had 10,000 share of
common stock outstanding
Palisades Earnings Per Share
Formula
20X3
20X2
Net income
Preferred Dividends
Earnings per share of common stock
-
48,000 - 0
26,000 - 0
4.80
2.60



Number of shares (wt. avg.) of common stock
outstanding
10,000
10,000
Most companies strive to increase EPS by 10
-15 annually
Palisades Furnitures EPS increased 85 percent
55
ANALYZING A COMPANYS STOCK AS AN INVESTMENT

• Investors purchase stock to earn a return on
  their investment, which consists of two parts
• Gains (or losses) from selling the stock at a
  price that differs from the investors purchase
  price
• Dividends, the periodic distributions to
  stockholders

56
PRICE-EARNINGS RATIO

• The price earnings ratio is the ratio of the
  market price of a share of common stock to the
  companys earnings
• The higher a stocks P/E ratio, the higher its
  downside risk--the risk that the stocks market
  price will fall

57
Calculations for the P/E ratio of Palisades
Furniture, Inc., follow. The market price of its
common stock was 50 at the end of 20X3 and 35
at the end of 20X2
Palisades Price/Earnings Ratio
Formula
20X3
20X2
Market price per share of common stock
50.00
35.00
10.4
13.5


P/E ratio
Earnings per share
4.80
2.60
P/E ratios vary from industry to industry
Palisades Furnitures 20X3 P/E ratio indicates
that the companys stock is selling at 10.4 times
earnings
58
DIVIDEND YIELD

• Dividend yield is the ratio of dividends per
  share of stock to the stocks market price per
  share
• This ratio measures the percentage of a stocks
  market value that is returned annually as
  dividends

59
Palisades Furniture paid annual cash dividends of
1.20 per share of common stock in 20X3 and 1.00
in 20X2, and market prices of the companys
common stock were 50 in 20X3 and 35 in 20X2.
Calculation of the firms dividend yields on
common stock is as follows
Dividend Yield on Palisades Common Stock
Formula
20X3
20X2
Dividend yield on common stock
Dividend per share of common stock
1.20
1.00
0.024
0.029



Market price per share of common stock
50.00
35.00
Dividend yields vary widely, from 5 to 8 for
older, established companies, down to the range
of 0 to 3 for young growth-oriented companies
60
BOOK VALUE PER SHARE OF COMMON STOCK

• Book value per share of common stock is common
  stockholders equity divided by the number of
  shares of common stock outstanding
• Some investors rank stock on the basis of the
  ratio of market price to book value
• To these investors, the lower the ratio the more
  attractive the stock

61
Calculations of book-value-per-share-of-common-sto
ck ratios follows
Book Value per Share of Palisades Common Stock
Formula
20X3
20X2
Total stockholders equity
Book value per share of common stock
Preferred equity
-
356,000 - 0
320,000 - 0

32.00

35.60

Number of shares of common stock outstanding
10,000
10,000
62
LIMITATIONS OF FINANCIAL ANALYSIS

• Ratios have their limitations
• Financial analysis may indicate that something is
  wrong, but it may not identify the specific
  problem or show how to correct it
• Managers must evaluate data on all ratios in the
  light of other information about the company
• Ratios should be analyzed over a period of years
• Any one year, or even any two years, may not be
  representative of the companys performance over
  the long term

63
CHAPTER 13 HOWORK

• DQs 2,3,4,8,9,12,14,15,16
• CP13-2
• CP13-4
• E13-7
• E13-10
• P13-2A