PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA

Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CPA
McGraw-Hill/I rwin Copyright 2011 by The McGraw-Hill Companies, I nc. All rights reserved.
ANALYSIS OF FINANCIAL STATEMENTS
Chapter 17
17 - 2
Application
of analytical
tools
Involves
transforming
data
Reduces
uncertainty
BASICS OF ANALYSIS
Financial statement analysis helps users
make better decisions.
Internal Users
Managers
Officers
Internal Auditors
External Users
Shareholders
Lenders
Customers
C 1
17 - 3
BUILDING BLOCKS OF ANALYSIS
C 1
Liquidity and
efficiency
Solvency
Market
prospects
Profitability
17 - 4
INFORMATION FOR ANALYSIS
C 1
1. Income Statement (Statement of
Comprehensive Income)
2. Balance Sheet (Statement of
Financial Position)
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes to the Financial Statements
17 - 5
Intracompany
Competitors
Industry
Guidelines
STANDARDS FOR COMPARISON
C 1
When we interpret our analysis, it is essential to
compare the results we obtained to other
standards or benchmarks.
17 - 6
Horizontal Analysis
Comparing a companys financial condition and
performance across time.
TOOLS OF ANALYSIS
Vertical Analysis
Comparing a companys financial condition and
performance to a base amount.
Ratio Analysis
Measurement of key relations between financial statement
items.
C 2
17 - 7
HORIZONTAL ANALYSIS
P 1
17 - 8
COMPARATIVE STATEMENTS
Calculate Change in Dollar Amount
Dollar
Change
Analysis Period
Amount
Base Period
Amount
=
When measuring the amount of the
change in dollar amounts, compare the
analysis period balance to the base
period balance. The analysis period is
usually the current year while the base
period is usually the prior year.
P 1
17 - 9
COMPARATIVE STATEMENTS
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 the
dollar change by the base period
amount, and then multiply by 100 to
convert to a percentage.
17 - 10
$1,550,861 $835,546 = $715,315
P 1
($715,315 $835,546) 100 = 85.6%
HORIZONTAL ANALYSIS
17 - 11
HORIZONTAL ANALYSIS
($3,888,038 $11,065,186) 100 = 35.1%
$14,953,224 $11,065,186 = $3,888,038
P 1
17 - 12
TREND ANALYSIS
Trend analysis is used to reveal patterns in data
covering successive periods.
Trend
Percent
Analysis Period Amount
Base Period Amount
100
=

P 1
17 - 13
TREND ANALYSIS
Research in Motion
Income 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 $2,065,845 100 = 147.0%
2008: $6,009,395 $2,065,845 100 = 290.9%
P 1
17 - 14
TREND ANALYSIS
We can use the trend percentages to construct a
graph so we can see the trend over time.
P 1
17 - 15
VERTICAL ANALYSIS
Common-Size Statements
Common-size
Percent
Analysis Amount
Base Amount
100
=

Financial Statement Base Amount
Balance Sheet Total Assets
Income Statement Revenues
P 2
17 - 16
($1,550,861 $10,204,409) 100 = 15.2%
($835,546 $8,101,372) 100 = 10.3%
COMMON-SIZE BALANCE SHEET
P 2
17 - 17
COMMON-SIZE INCOME STATEMENT
P 2
($8,368,958 $14,953,224) 100 = 56.0%
17 - 18
COMMON-SIZE GRAPHICS
P 2
17 - 19
RATIO ANALYSIS
P 3
Liquidity
and
efficiency
Solvency
Market
prospects
Profitability
17 - 20
Current
Ratio
Acid-test
Ratio
Accounts
Receivable
Turnover
Inventory
Turnover
Days Sales
Uncollected
Days Sales
in Inventory
Total Asset
Turnover
LIQUIDITY AND EFFICIENCY
P 3
Days
Purchases in
Accounts
Payable
17 - 21
WORKING CAPITAL
Working capital represents current assets
financed from long-term capital sources that
do not require near-term repayment.
Current assets
Current liabilities
= Working capital

More working capital suggests a strong liquidity
position and an ability to meet current obligations.
P 3
17 - 22
This ratio measures the short-term debt-
paying ability of the company. A higher current
ratio suggests a strong liquidity position.
CURRENT RATIO
Current Ratio =
Current Assets
Current Liabilities
P 3
17 - 23
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.
ACID-TEST RATIO
Acid-test ratio =
Cash + Short-term investments + Current
receivables
Current Liabilities
Referred to as Quick Assets
P 3
17 - 24
This ratio measures how
many times a company
converts its receivables
into cash each year.
ACCOUNTS RECEIVABLE TURNOVER
Accounts receivable =
turnover
Net sales
Average accounts receivable,
net
Average accounts receivable =
(Beginning acct. rec. + Ending acct. rec.)
2
P 3
17 - 25
This ratio measures the
number of times
merchandise is sold and
replaced during the year.
INVENTORY TURNOVER
Inventory turnover =
Cost of goods sold
Average inventory
Average inventory =
(Beginning inventory + Ending inventory)
2
P 3
17 - 26
Provides insight into how frequently a
company collects its accounts receivable.
DAYS SALES UNCOLLECTED
Day's sales =
uncollected
Accounts receivable, net
365
Net sales
P 3
17 - 27
DAYS SALES IN INVENTORY
Day's sales in =
Inventory
Ending inventory
365
Cost of goods sold
This ratio is a useful measure in evaluating
inventory liquidity. If a product is demanded
by customers, this formula estimates how
long it takes to sell the inventory.
P3
17 - 28
DAYS PURCHASES IN ACCOUNTS
PAYABLE
Accounts =
Payable
Accounts payable
365
Cost of goods sold
This ratio is a useful measure in evaluating
how long the business takes to pay its credit
suppliers.
P3
17 - 29
CASH CONVERSION CYCLE
The sum of the days sales uncollected and the
days sales in inventory subtracting the days
purchases in accounts payable. It represents
the number of days a firms cash remains tied
up within the operations of the business.
The lower the cash conversion cycle, the more
healthy a company generally is.
P 3
17 - 30
TOTAL ASSET TURNOVER
Total asset turnover =
Net sales
Average total assets
Average assets =
(Beginning assets + Ending assets)
2
This ratio reflects a
companys ability to use
its assets to generate
sales. It is an important
indication of operating
efficiency.
P 3
17 - 31
Debt
Ratio
Equity
Ratio
Pledged Assets
to Secured
Liabilities
Times
Interest
Earned
SOLVENCY
P 3
17 - 32
DEBT AND EQUITY RATIOS
Amount Ratio
Total 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 ratio expresses total liabilities as a percent of
total assets. The equity ratio provides complementary
information by expressing total equity as a percent of total
assets.
P 3
17 - 33
DEBT-TO-EQUITY RATIO
Debt-to-equity ratio =
Total liabilities

Total equity

This ratio measures what portion of a companys
assets are contributed by creditors. A larger debt-to-
equity ratio implies less opportunity to expand
through use of debt financing.
P 3
17 - 34
TIMES INTEREST EARNED
Times interest earned =
Income before interest and
taxes

Interest expense

This is the most common measure of the
ability of a companys operations to provide
protection to long-term creditors.
Net income
+ Interest expense
+ Income taxes
= Income before interest and taxes

P 3
17 - 35
Profit
Margin
Return on
Total Assets
Return on Ordinary
Shareholders
Equity
PROFITABILITY
P 3
17 - 36
PROFIT MARGIN
Profit margin =
Net income
Net sales
This ratio describes a companys ability
to earn net income from each sales dollar.
P 3
17 - 37
Return on total asset =
Net income
Average total
assets
RETURN ON TOTAL ASSETS
Return on total assets measures how well
assets have been employed by the
companys management.
P 3
17 - 38
RETURN ON ORDINARY SHAREHOLDERS'
EQUITY
Return on ordinary shareholders'
equity =
Net income - Preference
dividends
Average ordinary shareholders'
equity
This measure indicates how well the
company employed the shareholders equity
to earn net income.
P 3
17 - 39
Price-Earnings
Ratio
Dividend
Yield
MARKET PROSPECTS
P 3
17 - 40
PRICE-EARNINGS RATIO
Price-earnings ratio =
Market price per ordinary share

Earnings per share

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.
P 3
17 - 41
DIVIDEND YIELD
Dividend yield =
Annual cash dividends per share

Market price per share

This ratio identifies the return, in terms of cash
dividends, on the current market price per share
of the companys ordinary shares.
P 3
17 - 42
ANALYSIS REPORTING
A1
1. Executive Summary
2. Analysis Overview
3. Evidential Matter
4. Assumptions
5. Key Factors
6. Inferences
The purpose of financial statement analyses is to
reduce uncertainty in business decisions through a
rigorous and sound evaluation. A financial statement
analysis report directly addresses the building blocks of
analysis and documents the reasoning.
17 - 43
END OF CHAPTER 17