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ACC1002X

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You are on page 1of 48

14 - 2

LEARNING OBJECTIVES

1. Understand the importance of financial

analysis.

2. Apply horizontal and vertical analyses.

3. Explain the purpose and identify the building

blocks of analysis.

4. Apply ratio analysis.

14 - 3

BASICS OF ANALYSIS

Application Involves

Reduces

of analytical transforming

uncertainty

tools data

make better decisions.

Managers Shareholders

Officers Lenders

Internal Auditors Customers

14 - 4

Liquidity and

Solvency

efficiency

Market

Profitability

prospects

14 - 5

Other Comprehensive Income

(including the Income Statement)

2. Statement of Financial Position

3. Statement of Changes in Equity

4. Statement of Cash Flows

5. Notes to the Financial Statements

14 - 6

When we interpret our analysis, it is essential to

compare the results we obtained to other

standards or benchmarks.

Intracompany

Competitors

Industry

Guidelines

14 - 7

TOOLS OF ANALYSIS

Horizontal Analysis

Comparing a company’s financial condition and

performance across time.

Vertical Analysis

Comparing a company’s financial condition and

performance to a base amount.

Ratio Analysis

Measurement of key relations between financial statement

items.

14 - 8

HORIZONTAL ANALYSIS

14 - 9

COMPARATIVE STATEMENTS

Calculate Change in Dollar Amount

Change = Amount – Amount

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.

14 - 10

COMPARATIVE STATEMENTS

Calculate Change as a Percent

Change

=

Base Period Amount × 100

percentage, divide the amount of the

dollar change by the base period

amount, and then multiply by 100 to

convert to a percentage.

14 - 11

HORIZONTAL ANALYSIS

1,683 – 1,587 = 96

14 - 12

HORIZONTAL ANALYSIS

14 - 13

TREND ANALYSIS

covering successive periods.

Percent

=

Base Period Amount ×100

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TREND ANALYSIS

Adidas

Income Statement Information

2010 is base year. Set to 100%

2014: 14,534 ÷ 11,990 × 100 = 121.2%

14 - 15

TREND ANALYSIS

graph so we can see the trend over time.

14 - 16

VERTICAL ANALYSIS

Common-Size Statements

Percent

= Base Amount × 100

Statement of Financial Position Total Assets

Income Statement Revenues

14 - 17

COMMON-SIZE

STATEMENT OF FINANCIAL POSITION

14 - 18

14 - 19

RATIO ANALYSIS

Liquidity

and Solvency

efficiency

Market

Profitability

prospects

14 - 20

Ratio Uncollected

Ratio in Inventory

Receivable Payable Purchases in

Turnover Turnover Accounts

Payable

Inventory Total Asset

Turnover Turnover

14 - 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

position and an ability to meet current obligations.

14 - 22

CURRENT RATIO

Current Assets

Current Ratio =

Current Liabilities

paying ability of the company. A higher current

ratio suggests a strong liquidity position.

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ACID-TEST RATIO

Acid-test ratio = receivables

Current Liabilities

Referred to as Quick Assets

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.

14 - 24

Net sales

Accounts receivable =

Average accounts receivable,

turnover

net

(Beginning acct. rec. + Ending acct. rec.)

Average accounts receivable =

2

many times a company

converts its receivables

into cash each year.

14 - 25

INVENTORY TURNOVER

Cost of goods sold

Inventory turnover =

Average inventory

2

number of times

merchandise is sold and

replaced during the year.

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Cost of goods sold

Accounts payable turnover =

Average accounts payable

(Beginning accounts payable +

Average accounts

Ending accounts payable)

payable =

2

A short-term liquidity

measure used to quantify

the rate at which a company

pays off its suppliers.

14 - 27

× 365

uncollected Net sales

company collects its accounts receivable.

14 - 28

× 365

inventory Cost of goods sold

inventory liquidity. If a product is demanded

by customers, this formula estimates how

long it takes to sell the inventory.

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PAYABLE

× 365

accounts payable = Cost of goods sold

how long the business takes to pay its credit

suppliers.

14 - 30

days’ sales in inventory subtracting the days’

purchases in accounts payable. It represents

the number of days a firm’s cash remains tied

up within the operations of the business.

healthy a company generally is.

14 - 31

Net sales

Total asset turnover =

Average total assets

Average assets =

2

company’s ability to use

its assets to generate

sales. It is an important

indication of operating

efficiency.

14 - 32

SOLVENCY

Debt

Ratio

Equity

Ratio

Debt-to-Equity

Ratio

Times

Interest

Earned

14 - 33

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%

total assets. The equity ratio provides complementary

information by expressing total equity as a percent of total

assets.

14 - 34

DEBT-TO-EQUITY RATIO

Total liabilities

Debt-to-equity ratio =

Total equity

assets are contributed by creditors. A larger debt-to-

equity ratio implies less opportunity to expand

through use of debt financing.

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Profit before interest expense

Times interest earned = and income taxes

Interest expense

Net profit

+ Interest expense

+ Income taxes

= Profit before interest expense and taxes

ability of a company’s operations to provide

protection to long-term creditors.

14 - 36

PROFITABILITY

Profit Return on

Margin Total Assets

Shareholders’ Per Share

Equity

14 - 37

PROFIT MARGIN

Net profit

Profit margin =

Net sales

to earn net profit from each sales dollar.

14 - 38

Net profit

Return on total asset =

Average total assets

assets have been employed by the

company’s management.

14 - 39

EQUITY

equity = Average ordinary shareholders'

equity

company employed the shareholders’ equity

to earn net profit.

14 - 40

– Shows the amount of net income earned for each

outstanding ordinary share

– Most widely used ratio

– Net income available divided by the weighted-

average number of ordinary shares outstanding

during the year.

14 - 41

MARKET PROSPECTS

Price-Earnings Dividend

Ratio Yield

14 - 42

PRICE-EARNINGS RATIO

Market price per ordinary share

Price-earnings ratio =

Earnings per share

general guideline in gauging share values.

Generally, the higher the price-earnings ratio,

the more opportunity a company has for growth.

14 - 43

DIVIDEND YIELD

Annual cash dividends per share

Dividend yield =

Market price per share

dividends, on the current market price per share

of the company’s ordinary shares.

14 - 44

PROBLEMS

going-concern problems are listed below.

14 - 45

SUPPLEMENTARY EXAMPLES

14 - 46

Horizontal and Vertical Analyses

The average price of a gallon of gas in 2013 dropped $0.12 (3 percent) from $3.61

in 2012 (to $3.49 in 2013). Let’s see whether these changes are reflected in the

income statement of Chevron Corporation for the year ended December 31, 2013

(amounts in billions).

Required:

1. Conduct a horizontal analysis by calculating the year-over-year changes in each

line item, expressed in dollars and in percentages (rounded to one decimal place).

How did the change in gas prices compare to the changes in Chevron Corp.’s total

revenues and costs of crude oil and products?

2. Conduct a vertical analysis by expressing each line as a percentage of total

revenues (round to one decimal place). Excluding income tax and other operating

costs, did Chevron earn more profit per dollar of revenue in 2013 compared to

2012?

14 - 47

on the Current Ratio

The Sports Authority, Inc., is a private full-line sporting goods

retailer. Assume one of the Sports Authority stores reported

current assets of $88,000 and its current ratio was 1.75, and then

completed the following transactions:

1) paid $6,000 on accounts payable,

2) purchased a delivery truck for $10,000 cash,

3) wrote off a bad account receivable for $2,000, and

4) paid previously declared dividends in the amount of $25,000.

Required:

Compute the updated current ratio rounded to two decimal places,

after each transaction.

14 - 48

Profitability and Liquidity Ratios

Dollar General Corporation operates approximately 9,400 general

merchandise stores that feature quality merchandise at low prices to

meet the needs of middle-, low-, and fixed-income families in southern,

eastern, and mid-western states. For the year ended January 31, 2014,

the company reported average inventories of $2,475 (in millions) and an

inventory turnover of 4.89. Average total fixed assets were $2,080

(million), and the fixed asset turnover ratio was 8.14.

Required:

1. Calculate Dollar General’s gross profit percentage (expressed as a

percentage with one decimal place). What does this imply about the

amount of gross profit made from each dollar of sales? TIP: Work

backward from the fixed asset turnover and inventory turnover ratios

to compute the amounts needed for the gross profit percentage.

2. Is this an improvement from the gross profit percentage of 31.7

percent earned during the previous year?

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