Analyzing Financial Statements

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Analyzing Financial Statements

• Chapter 23

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Learning Objective 1

• Preparing comparative
• balance sheets.

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Comparative Balance Sheets
Assets 20x8 20x7
Change Current Assets Cash
3,040 4,080 (1,040) (25.5) Accounts
Receivable Net 20,000 16,000 4,000
25.0 Merchandise Inventory 24,160
26,120 (1,960) (7.5) Prepaid Expenses
80,000 60,000 200 33.3 Total Current
Assets 48,000 46,800 1,200 2.6 Plant
and Equipment Office Equipment,
Net 125,200 116,800 8,400 7.2 Total
Assets 173,200 163,600 9,600 5.9
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Comparative Balance Sheets
Liabilities 20x8
20x7 Change Current
Liabilities Notes Payable 20,960 17,320 3,6
40 21.0 Accounts Payable 240
280 (40) (14.3) Total Current
Liabilities 21,200 17,600 3,600
20.5 Long-Term Liabilities Mortgage
Payable 60,000 60,000 -0- -0-
Total Liabilities 81,200 77,600 3,600 4.6
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Comparative Balance Sheets
Stockholders Equity 20x8 20x7
Change Common Stock, 10 par 60,000
60,000 -0- -0- Retained Earnings
32,000 26,000 6,000 23.1 Total
Stockholders Equity 92,000 86,000 6,000
7.0 Total Liabilities and Stockholders
Equity 173,200 163,600 9,600 5.9
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Learning Objective 2

• Using horizontal and vertical
• analysis techniques.

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Learning Unit 23-1

• What is horizontal analysis?
• Comparative balance sheets are analyzed for
  percentages of change increases or (decreases).
• Compute the dollar change from the base period to
  the later period.
• Divide the dollar change by the base period
  amount.

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Learning Unit 23-1
20x8 20x7 Difference Cash 3,04
0 4,080 (1,040)
1,040 4,080 .2549, or 25.5
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Learning Unit 23-1

• Vertical analysis compares each item on a
  report to a base number set to 100.
• The base will be either total assets or total
  liabilities and stockholders equity on a balance
  sheet.

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Learning Unit 23-1
Assets 20x8 Current
Assets Cash 3,040
1.8 Accounts Receivable Net 20,000
11.5 Merchandise Inventory 24,160
13.9 Prepaid Expenses 800
.5 Total Current Assets 48,000
27.7 Plant and Equipment Office Equipment,
Net 125,200 72.3 Total Assets 173,20
0 100.0
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Learning Unit 23-2

• Comparative income statement changes are shown
  also as percentage increases or decreases.
• In the case of the income statement, each item is
  shown as a percentage of net sales.

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Learning Unit 23-2
20x8 Net Sales 317,600
100.0 Cost of Goods Sold 198,000
62.3 Gross Profit from Sales 119,600
37.7 Total Operating Expenses 83,600
26.3 Operating Income 36,000 11.3 Less
Interest Expense 4,200 1.3 Income
Before Taxes 31,800 10.0 Income
Taxes 15,900 5.0 Net
Income 15,900 5.0
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Learning Unit 23-2

• What is trend analysis?
• It is a special type of horizontal analysis that
  deals with the percentage of changes in certain
  key items over several years.

Trend Any year Base year
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Learning Unit 23-2

• Year 20x8 20x7 20x5
• Sales 317,600 302,000 270,000
• Cost of Goods Sold 198,000 194,000
  142,000
• Gross Profit 119,600 108,000 128,000
• 20x5 is the base year.

What are the trend percentages?
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Learning Unit 23-2

• Year 20x8 20x7 20x5
• Sales 118 112 100
• Cost of Goods Sold 139 137 100
• Gross Profit 93 84 100

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Learning Objective 3

• Calculating the four different
• types of ratios liquidity ratios,
• asset management ratios,
• debt management ratios,
• and profitability ratios.

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Learning Unit 23-3

• A ratio is the relationship of two quantities or
  numbers, one divided by the other.
• Ratios can be compared over time for one
  business.
• They also can be compared to readily available
  industry ratios.

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Learning Unit 23-3
Liquidity Ratios
Current ratio Total current assets Total
current liabilities
Acid test ratio (Current assets Merchandise
inventory Prepaid expenses) Current
liabilities
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Learning Unit 23-3

• The current ratio indicates ability to pay
  short-term obligations.
• The acid test, or quick, ratio shows availability
  of assets that can easily be converted to cash to
  pay current liabilities.

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Learning Unit 23-3
Asset Management Ratios
Accounts receivable turnover Net credit sales
Average accounts receivable
Average collection period 365 days Accounts
receivable turnover
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Learning Unit 23-3
Accounts receivable turnover shows how many
times accounts receivable is converted to cash
in one year.
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Learning Unit 23-3
Inventory turnover Cost of goods sold Average
inventory
Asset turnover Net sales Total assets
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Learning Unit 23-3

• The inventory turnover calculates the number of
  times inventory turns over in one period.
• The asset turnover indicates whether or not
  assets have been used efficiently to generate
  sales.

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Learning Unit 23-3
Debt Management Ratios
Debt to total assets Total liabilities Total
assets
Debt to stockholders equity Total liabilities
Stockholders equity
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Learning Unit 23-3

• The debt-to-total-assets ratio indicates the
  amount of assets that are financed by creditors.
• The debt-to-stockholders-equity ratio shows
  stockholders risk compared to creditors risk.

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Learning Unit 23-3
Times interest earned Income before taxes and
interest expense Interest expense
It reveals ability to meet interest payment due
dates.
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Learning Unit 23-3
Profitability Ratios
Gross profit rate Gross profit Net sales
Return on sales Net income before taxes Net
sales
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Learning Unit 23-3

• The gross profit ratio indicates how much of the
  sales income is available to pay expenses and
  generate a net income.
• A high return on sales ratio usually means that
  inventory consists of high priced items such as
  autos and furniture.

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Learning Unit 23-3
Rate of return on total assets Net income
before interest and taxes Total assets
Rate of return on common stockholders equity
(Net income before taxes preferred dividends)
Common stockholders equity
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Learning Unit 23-3

• The rate of return on total assets indicates
  earning power.
• The rate of return on common stockholders equity
  shows the amount of the net income share that
  remains for the common stockholders (after
  preferred dividends are deducted).

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End of Chapter 23