1. List the basic financial statement analytical procedures.
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Transcript of 1. List the basic financial statement analytical procedures.
1. List the basic financial statement analytical procedures.
2. Apply financial statement analysis to assess the solvency of a business.
3. Apply financial statement analysis to assess the profitability of a business.
4. Summarize the uses and limitations of analytical measures.
5. Describe the contents of corporate annual reports.
Chapter Chapter 1515 - Financial Statement AnalysisFinancial Statement AnalysisObjectivesObjectives
Chapter Chapter 1515 - Financial Statement AnalysisFinancial Statement AnalysisObjectivesObjectives
Horizontal AnalysisHorizontal AnalysisHorizontal AnalysisHorizontal Analysis
It’s an analysis of the percentage increases and decreases of
related items in comparative financial statements.
It’s an analysis of the percentage increases and decreases of
related items in comparative financial statements.
Lincoln CompanyComparative Balance SheetDecember 31, 2006 and 2005
AssetsCurrent assets $ 550,000 $ 533,000 $ 17,000 3.2%Long-term investments 95,000 177,500 (82,500) (46.5%)Fixed assets (net) 444,500 470,000 (25,500) (5.4%)Intangible assets 50,000 50,000 — Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%) LiabilitiesCurrent liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)Long-term liabilities 100,000 200,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%) Stockholders’ EquityPreferred 6% stock, $100 par $ 150,000 $ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500 $42,000 30.5%Total stockholders’ equity $ 829,500 $ 787,500 $42,000 5.3%Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
2006 2005 Amount Percent
Balance SheetBalance SheetBalance SheetBalance SheetIncrease (Decrease)
AssetsCurrent assets $ 550,000 $ 533,000 $ 17,000 3.2%Long-term investments 95,000 177,500 (82,500) (46.5%)Fixed assets (net) 444,500 470,000 (25,500) (5.4%)Intangible assets 50,000 50,000 — Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%) LiabilitiesCurrent liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)Long-term liabilities 100,000 200,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%) Stockholders’ EquityPreferred 6% stock, $100 par $ 150,000 $ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500 $42,000 30.5%Total stockholders’ equity $ 829,500 $ 787,500 $42,000 5.3%Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
Horizontal Analysis: Horizontal Analysis:
Lincoln CompanyComparative Balance SheetDecember 31, 2006 and 2005
Difference $17,000
Base year (2005) $533,000= 3.2%
2006 2005 Amount PercentIncrease (Decrease)
AssetsCurrent assets $ 550,000 $ 533,000 $ 17,000 3.2%Long-term investments 95,000 177,500 (82,500) (46.5%)Fixed assets (net) 444,500 470,000 (25,500) (5.4%)Intangible assets 50,000 50,000 — Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%) LiabilitiesCurrent liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)Long-term liabilities 100,000 200,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%) Stockholders’ EquityPreferred stock, $100 par $ 150,000 $ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500 $42,000 30.5%Total stockholders’ equity $ 829,500 $ 787,500 $42,000 5.3%Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
Horizontal Analysis: Horizontal Analysis:
Difference $(82,500)
Base year (2005) $177,500= (46.5%)
Lincoln CompanyComparative Balance SheetDecember 31, 2006 and 2005
2006 2005 Amount PercentIncrease (Decrease)
AssetsCurrent assets $ 550,000 $ 533,000 $ 17,000 3.2%Long-term investments 95,000 177,500 (82,500) (46.5%)Fixed assets (net) 444,500 470,000 (25,500) (5.4%)Intangible assets 50,000 50,000 — Total assets $1,139,500 $1,230,500 $ (91,000) (7.4%) LiabilitiesCurrent liabilities $ 210,000 $ 243,000 $ (33,000) (13.6%)Long-term liabilities 100,000 200,000 (100,000) (50.0%) Total liabilities $ 310,000 $ 443,000 $(133,000) (30.0%) Stockholders’ EquityPreferred 6% stock, $100 par $ 150,000 $ 150,000 — Common stock, $10 par 500,000 500,000 — Retained earnings 179,500 137,500 $42,000 30.5%Total stockholders’ equity $ 829,500 $ 787,500 $42,000 5.3%Total liab. & SE $1,139,500 $1230,500 $(91,000) (7.4%)
Lincoln CompanyComparative Balance SheetDecember 31, 2006 and 2005
(5.4%)(5.4%)
2006 2005 Amount PercentIncrease (Decrease)
Sales $1,530,500 $1,234,000 $296,500 24.0%Sales returns 32,500 34,000 (1,500) (4.4%)Net sales $1,498,000 $1,200,000 $298,000 24.8%Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit $ 455,000 $ 380,000 $ 75,000 19.7%Selling expenses $ 191,000 $ 147,000 $ 44,000 29.9%Administrative expenses 104,000 97,400 6,600 6.8%Total operating expenses $ 295,000 $ 244,400 $ 50,600 20.7%Operating income $ 160,000 $ 135,600 $ 24,400 18.0%Other income 8,500 11,000 (2,500) (22.7%) $ 168,500 $ 146,600 $ 21,900 14.9%Other expense 6,000 12,000 (6,000) (50.0%)Income before income tax $ 162,500 $ 134,600 $ 27,900 20.7%Income tax 71,500 58,100 13,400 23.1%Net income $ 91,000 $ 76,500 $ 14,500 19.0%
Lincoln CompanyComparative Income Statement
December 31, 2006 and 2005
2006 2005 Amount PercentIncrease (Decrease)
Income StatementIncome StatementIncome StatementIncome Statement
Sales $1,530,500 $1,234,000 $296,500 24.0%Sales returns 32,500 34,000 (1,500) (4.4%)Net sales $1,498,000 $1,200,000 $298,000 24.8%Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit $ 455,000 $ 380,000 $ 75,000 19.7%Selling expenses $ 191,000 $ 147,000 $ 44,000 29.9%Administrative expenses 104,000 97,400 6,600 6.8% Total operating expenses $ 295,000 $ 244,400 $ 50,600 20.7%Operating income $ 160,000 $ 135,600 $ 24,400 18.0%Other income 8,500 11,000 (2,500) (22.7%) $ 168,500 $ 146,600 $ 21,900 14.9%Other expense 6,000 12,000 (6,000) (50.0%)Income before income tax $ 162,500 $ 134,600 $ 27,900 20.7%Income tax 71,500 58,100 13,400 23.1%Net income $ 91,000 $ 76,500 $ 14,500 19.0%
Horizontal Analysis:Horizontal Analysis:
Increase amount $296,500
Base year (2005) $1,234,000= 24.0%
24.0%
Lincoln CompanyComparative Income Statement
December 31, 2006 and 2005
2006 2005 Amount PercentIncrease (Decrease)
Sales $1,530,500 $1,234,000 $296,500 24.0%Sales returns 32,500 34,000 (1,500) (4.4%)Net sales $1,498,000 $1,200,000 $298,000 24.8%Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit $ 455,000 $ 380,000 $ 75,000 19.7%Selling expenses $ 191,000 $ 147,000 $ 44,000 29.9%Administrative expenses 104,000 97,400 6,600 6.8% Total operating expenses $ 295,000 $ 244,400 $ 50,600 20.7%Operating income $ 160,000 $ 135,600 $ 24,400 18.0%Other income 8,500 11,000 (2,500) (22.7%) $ 168,500 $ 146,600 $ 21,900 14.9%Other expense 6,000 12,000 (6,000) (50.0%)Income before income tax $ 162,500 $ 134,600 $ 27,900 20.7%Income tax 71,500 58,100 13,400 23.1%Net income $ 91,000 $ 76,500 $ 14,500 19.0%
Horizontal Analysis: Horizontal Analysis:
Increase amount $298,000
Base year (2005) $1,200,000= 24.8%
24.8%
Lincoln CompanyComparative Income Statement
December 31, 2006 and 2005
2006 2005 Amount PercentIncrease (Decrease)
Vertical AnalysisVertical AnalysisVertical AnalysisVertical Analysis
A percentage analysis can be used to show the relationship of each component to a total
within a single statement.
A percentage analysis can be used to show the relationship of each component to a total
within a single statement.
The total, or 100% item, on the balance sheet is
“total assets.”
The total, or 100% item, on the balance sheet is
“total assets.”
Lincoln CompanyComparative Balance Sheet
AssetsCurrent assets $ 550,000 48.3% $ 533,000 43.3%Long-term investments 95,000 8.3 177,500 14.4Property, plant, & equip. (net) 444,500 39.0 470,000 38.2Intangible assets 50,000 4.4 50,000 4.1
Total assets $1,139,500 100.0% $1,230,500 100.0% LiabilitiesCurrent liabilities $ 210,000 18.4% $ 243,000 19.7%Long-term liabilities 100,000 8.8 200,000 16.3
Total liabilities $ 310,000 27.2% $ 443,000 36.0% Stockholders’ EquityPreferred stock, 6%, $100 par $ 150,000 13.2% $ 150,000 12.2% Common stock, $10 par 500,000 43.9 500,000 40.6Retained earnings 179,500 15.7 137,500 11.2
Total stockholders’ equity $ 829,500 72.8% $ 787,500 64.0% Total liab. & SE $1,139,500 100.0% $1,230,500 100.0%
December 31, 2006 December 31, 2005 Amount Percent Amount Percent
Vertical Analysis: Vertical Analysis:
Current assets $550,000
Total assets $1,139,500= 48.3%
48.3%
Balance Balance SheetSheet
Balance Balance SheetSheet
Lincoln CompanyComparative Balance Sheet
AssetsCurrent assets $ 550,000 48.3% $ 533,000 43.3%Long-term investments 95,000 8.3 177,500 14.4Property, plant, & equip. (net) 444,500 39.0 470,000 38.2Intangible assets 50,000 4.4 50,000 4.1
Total assets $1,139,500 100.0% $1,230,500 100.0% LiabilitiesCurrent liabilities $ 210,000 18.4% $ 243,000 19.7%Long-term liabilities 100,000 8.8 200,000 16.3
Total liabilities $ 310,000 27.2% $ 443,000 36.0% Stockholders’ EquityPreferred 6% stock, $100 par $ 150,000 13.2% $ 150,000 12.2% Common stock, $10 par 500,000 43.9 500,000 40.6Retained earnings 179,500 15.7 137,500 11.2
Total stockholders’ equity $ 829,500 72.8% $ 787,500 64.0% Total liab. & SE $1,139,500 100.0% $1,230,500 100.0%
Vertical Analysis: Vertical Analysis:
Current assets $533,000
Total assets $1,230,500= 43.3%
43.3%
December 31, 2006 December 31, 2005 Amount Percent Amount Percent
Lincoln CompanyComparative Balance Sheet
AssetsCurrent assets $ 550,000 48.3% $ 533,000 43.3%Long-term investments 95,000 8.3 177,500 14.4Property, plant, & equip. (net) 444,500 39.0 470,000 38.2Intangible assets 50,000 4.4 50,000 4.1
Total assets $1,139,500 100.0% $1,230,500 100.0% LiabilitiesCurrent liabilities $ 210,000 18.4% $ 243,000 19.7%Long-term liabilities 100,000 8.8 200,000 16.3
Total liabilities $ 310,000 27.2% $ 443,000 36.0% Stockholders’ EquityPreferred 6% stock, $100 par $ 150,000 13.2% $ 150,000 12.2% Common stock, $10 par 500,000 43.9 500,000 40.6Retained earnings 179,500 15.7 137,500 11.2
Total stockholders’ equity $ 829,500 72.8% $ 787,500 64.0% Total liab. & SE $1,139,500 100.0% $1,230,500 100.0%
December 31, 2006 December 31, 2005 Amount Percent Amount Percent
Sales $1,530,500 102.2% $1,234,000 102.8%Sales returns 32,500 2.2 34,000 2.8Net sales $1,498,000 100.0% $1,200,000 100.0%Cost of goods sold 1,043,000 69.6 820,000 68.3Gross profit $ 455,000 30.4% $ 380,000 31.7%Selling expenses $ 191,000 12.8% $ 147,000 12.3%Administrative expenses 104,000 6.9 97,400 8.1Total operating expenses $ 295,000 19.7% $ 244,400 20.4%Income from operations $ 160,000 10.7 $ 135,600 11.3%Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2%Other expense 6,000 0.4 12,000 1.0Income before income tax $ 162,500 10.9% $ 134,600 11.2%Income tax expense 71,500 4.8 58,100 4.8Net income $ 91,000 6.1% $ 76,500 6.4%
2006 2005 Amount Percent Amount Percent
Net sales Net sales is 100.0%is 100.0%Net sales Net sales is 100.0%is 100.0%
Lincoln CompanyComparative Income Statement
For the Years Ended December 31, 2006 and 2005
Income Income StatementStatementIncome Income
StatementStatement
Lincoln CompanyComparative Income Statement
For the Years Ended December 31, 2006 and 2005
Sales $1,530,500 102.2% $1,234,000 102.8%Sales returns 32,500 2.2 34,000 2.8Net sales $1,498,000 100.0% $1,200,000 100.0%Cost of goods sold 1,043,000 69.6 820,000 68.3Gross profit $ 455,000 30.4% $ 380,000 31.7%Selling expensesSelling expenses $ 191,000$ 191,000 12.8% $ 147,000 12.3%Administrative expenses 104,000 6.9 97,400 8.1Total operating expenses $ 295,000 19.7% $ 244,400 20.4%Income from operations $ 160,000 10.7 $ 135,600 11.3%Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2%Other expense 6,000 0.4 12,000 1.0Income before income tax $ 162,500 10.9% $ 134,600 11.2%Income tax expense 71,500 4.8 58,100 4.8Net income $ 91,000 6.1% $ 76,500 6.4%
2006 2005 Amount Percent Amount Percent
Vertical Analysis: Vertical Analysis:
Selling expenses $191,000
Net sales $1,498,000= 12.8%
12.8%
Sales $1,530,500 102.2% $1,234,000 102.8%Sales returns 32,500 2.2 34,000 2.8Net sales $1,498,000 100.0% $1,200,000 100.0%Cost of goods sold 1,043,000 69.6 820,000 68.3Gross profit $ 455,000 30.4% $ 380,000 31.7%Selling expenses $ 191,000 12.8% $ 147,000 12.3%Administrative expenses 104,000 6.9 97,400 8.1Total operating expenses $ 295,000 19.7% $ 244,400 20.4%Income from operations $ 160,000 10.7 $ 135,600 11.3%Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2%Other expense 6,000 0.4 12,000 1.0Income before income tax $ 162,500 10.9% $ 134,600 11.2%Income tax expense 71,500 4.8 58,100 4.8Net income $ 91,000 6.1% $ 76,500 6.4%
2006 2005 Amount Percent Amount Percent
Lincoln CompanyComparative Income Statement
For the Years Ended December 31, 2006 and 2005
Sales $1,530,500 102.2% $1,234,000 102.8%Sales returns 32,500 2.2 34,000 2.8Net sales $1,498,000 100.0% $1,200,000 100.0%Cost of goods sold 1,043,000 69.6 820,000 68.3Gross profit $ 455,000 30.4% $ 380,000 31.7%Selling expenses $ 191,000 12.8% $ 147,000 12.3%Administrative expenses 104,000 6.9 97,400 8.1Total operating expenses $ 295,000 19.7% $ 244,400 20.4%Income from operations $ 160,000 10.7 $ 135,600 11.3%Other income 8,500 0.6 11,000 0.9 $ 168,500 11.3% $ 146,600 12.2%Other expense 6,000 0.4 12,000 1.0Income before income tax $ 162,500 10.9% $ 134,600 11.2%Income tax expense 71,500 4.8 58,100 4.8Net income $ 91,000 6.1% $ 76,500 6.4%
2006 2005 Amount Percent Amount Percent
Lincoln CompanyComparative Income Statement
For the Years Ended December 31, 2006 and 2005
Common Size StatementsCommon Size StatementsCommon Size StatementsCommon Size Statements
Vertical analysis with both dollar and percentage amounts is also useful in
comparing one company with another or with industry averages. Such
comparisons are easier to make with the use of common-size statements in
which all items are expressed in percentages.
Vertical analysis with both dollar and percentage amounts is also useful in
comparing one company with another or with industry averages. Such
comparisons are easier to make with the use of common-size statements in
which all items are expressed in percentages.
Common-Size Income StatementCommon-Size Income StatementCommon-Size Income StatementCommon-Size Income Statement
Solvency AnalysisSolvency AnalysisSolvency AnalysisSolvency Analysis Solvency is the ability of a business to meet
its financial obligations (debts) as they are due.
Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities.
This ability is normally assessed by examining balance sheet relationships.
Current Position AnalysisCurrent Position Analysis
Current assets $550,000 $533,000Current liabilities 210,000 243,000Working capital $340,000 $290,000
Current ratioCurrent ratio 2.6 2.6 2.2 2.2
Working Capital and Current RatioWorking Capital and Current RatioWorking Capital and Current RatioWorking Capital and Current Ratio
Use: To indicate the ability to meet currently maturing obligations.
Use: To indicate the ability to meet currently maturing obligations.
2006 2005
Divide current assets by current
liabilities
Divide current assets by current
liabilities
Quick RatioQuick RatioQuick RatioQuick Ratio
Use: To indicate instant debt-paying ability.Use: To indicate instant debt-paying ability.
2006 2005Quick assets:
Cash $ 90,500 $ 64,700Marketable securities 75,000 60,000Accounts receivable (net) 115,000 120,000 Total $280,500 $244,700
Current liabilities $210,000 $243,000Quick ratioQuick ratio 1.3 1.3 1.0 1.0
Current Position AnalysisCurrent Position Analysis
Accounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable Turnover
Net sales on account $1,498,000 $1,200,000Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000End of year 115,500 120,000Total $ 235,000 $ 260,000
Average (Total ÷ 2) $ 117,500 $ 130,000
2006 2005
Accounts Receivable AnalysisAccounts Receivable Analysis
Net sales on accountAverage accounts
receivable
Net sales on accountAverage accounts
receivable
Use: To assess the efficiency in collecting receivables and in the management of credit.
Use: To assess the efficiency in collecting receivables and in the management of credit.
Net sales on account $1,498,000 $1,200,000Accounts receivable (net):
Beginning of year $ 120,000 $ 140,000End of year 115,500 120,000Total $ 235,000 $ 260,000
Average $ 117,500 $ 130,000
Accounts receivable turnoverAccounts receivable turnover 12.7 12.7 9.2 9.2
2006 2005
Accounts Receivable AnalysisAccounts Receivable Analysis
Accounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable Turnover
Number of Days’ Sales in ReceivablesNumber of Days’ Sales in ReceivablesNumber of Days’ Sales in ReceivablesNumber of Days’ Sales in Receivables
Accounts receivable (net),end of year $ 115,000 $ 120,000
Net sales on account $1,498,000 $1,200,000Average daily sales on
account (sales ÷ 365) $ 4,104 $ 3,288
2006 2005
Accounts Receivable AnalysisAccounts Receivable Analysis
Accounts receivable, end of year
Average daily sales on account
Accounts receivable, end of year
Average daily sales on account
Number of Days’ Sales in ReceivablesNumber of Days’ Sales in ReceivablesNumber of Days’ Sales in ReceivablesNumber of Days’ Sales in Receivables
Use: To assess the efficiency in collecting receivables and in the management of credit.
Use: To assess the efficiency in collecting receivables and in the management of credit.
Number of days’ sales inNumber of days’ sales in receivables 28.0 36.5receivables 28.0 36.5
Accounts receivable (net),end of year $ 115,000 $ 120,000
Net sales on account $1,498,000 $1,200,000Average daily sales on
account (sales ÷ 365) $ 4,104 $ 3,288
2006 2005
Accounts Receivable AnalysisAccounts Receivable Analysis
Inventory TurnoverInventory TurnoverInventory TurnoverInventory Turnover2006 2005
Cost of goods sold $1,043,000 $ 820,000Inventories:
Beginning of year $ 283,000 $ 311,000End of year 264,000 283,000Total $ 547,000 $ 594,000
Average (Total ÷ 2) $ 273,500 $ 297,000
Inventory AnalysisInventory Analysis
Cost of goods sold
Average inventory
Cost of goods sold
Average inventoryInventory turnover =
Inventory TurnoverInventory TurnoverInventory TurnoverInventory Turnover
Use: To assess the efficiency in the management of inventory.
Use: To assess the efficiency in the management of inventory.
2006 2005Cost of goods sold $1,043,000 $ 820,000Inventories:
Beginning of year $ 283,000 $ 311,000End of year 264,000 283,000Total $ 547,000 $ 594,000
Average (Total ÷ 2) $ 273,500 $ 297,000
Inventory turnoverInventory turnover 3.8 3.8 2.8 2.8
Inventory AnalysisInventory Analysis
Number of Days’ Sales in InventoryNumber of Days’ Sales in InventoryNumber of Days’ Sales in InventoryNumber of Days’ Sales in Inventory
2006 2005Inventories, end of year $ 264,000 $283,000Cost of goods sold $1,043,000 $820,000Average daily cost of
goods sold (COGS ÷ 365) $ 2,858 $ 2,247
Inventory AnalysisInventory Analysis
Inventories, end of year
Average daily cost of goods sold
Inventories, end of year
Average daily cost of goods sold
Number of Days’ Sales in Inventory
=
Number of Days’ Sales in InventoryNumber of Days’ Sales in InventoryNumber of Days’ Sales in InventoryNumber of Days’ Sales in Inventory
Use: To assess the efficiency in the management of inventory.
Use: To assess the efficiency in the management of inventory.
Inventories, end of year $ 264,000 $283,000Cost of goods sold $1,043,000 $820,000Average daily cost of
goods sold (COGS ÷ 365) $ 2,858 $ 2,247
Number of days’ sales Number of days’ sales
in inventoryin inventory 92.4 92.4 125.9 125.9
Inventory AnalysisInventory Analysis
2006 2005
Use: To indicate the margin of safety to long-term creditors.
Use: To indicate the margin of safety to long-term creditors.
2006 2005
Fixed assets (net) $444,500 $470,000Long-term liabilities $100,000 $200,000
Ratio of fixed assets toRatio of fixed assets to
long-term liabilitieslong-term liabilities 4.4 4.4 2.4 2.4
Ratio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term LiabilitiesRatio of Fixed Assets to Long-Term Liabilities
Long-Term CreditorsLong-Term Creditors
Ratio of Liabilities to Stockholders’ EquityRatio of Liabilities to Stockholders’ EquityRatio of Liabilities to Stockholders’ EquityRatio of Liabilities to Stockholders’ Equity
Use: To indicate the margin of safety to creditors.
Use: To indicate the margin of safety to creditors.
Total liabilities $310,000 $443,000Total stockholders’ equity $829,500 $787,500Ratio of liabilities toRatio of liabilities to
stockholders’ equitystockholders’ equity 0.37 0.37 0.56 0.56
Long-Term CreditorsLong-Term Creditors
2006 2005
Number of Times Interest Charges EarnedNumber of Times Interest Charges EarnedNumber of Times Interest Charges EarnedNumber of Times Interest Charges Earned
2006 2005
Income before income tax $ 900,000 $ 800,000Add interest expense 300,000 250,000Amount available for interest $1,200,000 $1,050,000
Long-Term CreditorsLong-Term Creditors
Income beforeincome tax + interest expense
Interest expense
Income beforeincome tax + interest expense
Interest expense
Number of Times Interest
Charges Earned=
Number of Times Interest Charges EarnedNumber of Times Interest Charges EarnedNumber of Times Interest Charges EarnedNumber of Times Interest Charges Earned
Use: To assess the risk to debtholders in terms of number of times interest charges were earned.
Use: To assess the risk to debtholders in terms of number of times interest charges were earned.
2006 2005
Income before income tax $ 900,000 $ 800,000Add interest expense 300,000 250,000Amount available for interest $1,200,000 $1,050,000
Number of times earnedNumber of times earned 4.0 4.0 4.2 4.2
Long-Term CreditorsLong-Term Creditors
Profitability AnalysisProfitability AnalysisProfitability AnalysisProfitability Analysis
Profitability is the ability of an entity to earn profits.
This ability to earn profits depends on the effectiveness and efficiency of operations as well as resources available.
Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet.
Ratio of Net Sales to AssetsRatio of Net Sales to AssetsRatio of Net Sales to AssetsRatio of Net Sales to Assets2006 2005
Net sales $1,498,000 $1,200,000Total assets:
Beginning of year $1,053,000 $1,010,000End of year 1,044,500 1,053,000Total $2,097,500 $2,063,000
Average (Total ÷ 2) $1,048,750 $1,031,500
The Common StockholderThe Common Stockholder
Excludes long-term investmentsExcludes long-term investments
The Common StockholderThe Common Stockholder
Use: To assess the effectiveness of the use of assets.
Use: To assess the effectiveness of the use of assets.
Ratio of net sales to assets 1.4 1.2Ratio of net sales to assets 1.4 1.2
Ratio of Net Sales to AssetsRatio of Net Sales to AssetsRatio of Net Sales to AssetsRatio of Net Sales to Assets2006 2005
Net sales $1,498,000 $1,200,000Total assets:
Beginning of year $1,053,000 $1,010,000End of year 1,044,500 1,053,000Total $2,097,500 $2,063,000
Average (Total ÷ 2) $1,048,750 $1,031,500
Rate Earned on Total AssetsRate Earned on Total AssetsRate Earned on Total AssetsRate Earned on Total Assets
Use: To assess the profitability of the assets.Use: To assess the profitability of the assets.
2006 2005
Rate earned on total assets 8.2% 7.3%Rate earned on total assets 8.2% 7.3%
Net income $ 91,000 $ 76,500Plus interest expense 6,000 12,000
Total $ 97,000 $ 88,500Total assets:
Beginning of year $1,230,500 $1,187,500End of year 1,139,500 1,230,500Total $2,370,000 $2,418,000Average (Total ÷ 2) $1,185,000 $1,209,000
The Common StockholderThe Common Stockholder
Rate Earned on Stockholders’ EquityRate Earned on Stockholders’ EquityRate Earned on Stockholders’ EquityRate Earned on Stockholders’ Equity
Use: To assess the profitability of the investment by stockholders.
Use: To assess the profitability of the investment by stockholders.
Rate earned on stockholders’Rate earned on stockholders’equity 11.3% 10.0% equity 11.3% 10.0%
Net income $ 91,000 $ 76,500Stockholders’ equity:
Beginning of year $ 787,500 $ 750,000End of year 829,500 787,500Total $1,617,000 $1,537,500Average (Total ÷ 2) $ 808,500 $ 768,750
2006 2005
The Common StockholderThe Common Stockholder
Leverage10%
5%
0%
Rate earned on total assets
Rate earned on stockholders’ equity
8.2%
11.3%
Leverage 3.1%
2006
7.3%
10.0%Leverage
2.7%
2005
Rate Earned on Common Stockholders’ EquityRate Earned on Common Stockholders’ EquityRate Earned on Common Stockholders’ EquityRate Earned on Common Stockholders’ Equity
2006 2005
The Common StockholderThe Common Stockholder
Net income $ 91,000 $ 76,500Less preferred dividends 9,000 9,000Remainder—common stock $ 82,000 $ 67,500Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000End of year 679,500 637,500Total $1,317,000 $1,237,500Average (Total ÷ 2) $ 658,500 $ 618,750
Use: To assess the profitability of the investment by common stockholders.
Use: To assess the profitability of the investment by common stockholders.
2006 2005
Rate earned on commonRate earned on common stockholders’ equity 12.5% 10.9%stockholders’ equity 12.5% 10.9%
Net income $ 91,000 $ 76,500Less preferred dividends 9,000 9,000Remainder—common stock $ 82,000$ 82,000 $ 67,500$ 67,500Common stockholders’ equity:
Beginning of year $ 637,500 $ 600,000End of year 679,500 637,500Total $1,317,000 $1,237,500Average (Total ÷ 2) $ 658,500$ 658,500 $ 618,750 $ 618,750
The Common StockholderThe Common StockholderRate Earned on Common Stockholders’ EquityRate Earned on Common Stockholders’ EquityRate Earned on Common Stockholders’ EquityRate Earned on Common Stockholders’ Equity
Earnings Per Share on Common StockEarnings Per Share on Common StockEarnings Per Share on Common StockEarnings Per Share on Common Stock
2006 2005
Earnings per share on common stock $1.64 $1.35Earnings per share on common stock $1.64 $1.35
Net income $ 91,000 $ 76,500Less preferred dividends 9,000 9,000Remainder—common stock $ 82,000 $ 67,500Shares of common stock 50,000 50,000
Use: To assess the profitability of the investment by common stockholders.
Use: To assess the profitability of the investment by common stockholders.
The Common StockholderThe Common Stockholder
Price-Earnings RatioPrice-Earnings RatioPrice-Earnings RatioPrice-Earnings Ratio
Use: To indicate future earnings prospects, based on the relationship between market value of common stock and earnings.
Use: To indicate future earnings prospects, based on the relationship between market value of common stock and earnings.
2006 2005
Price-earnings ratio on common stock 25 20Price-earnings ratio on common stock 25 20
Market price per share of common $41.00 $27.00Earnings per share on common ÷ 1.64 ÷ 1.35
The Common StockholderThe Common Stockholder
Dividends and Earnings Per Share
Dividends Earnings
$0.80
$1.64
2006
$0.60
$1.35
2005
Per share
$2.00$2.00
$1.50$1.50
$1.00$1.00
$0.50$0.50
$0.00
Dividend Yield on Common StockDividend Yield on Common StockDividend Yield on Common StockDividend Yield on Common Stock
Use: To indicate the rate of return to common stockholders in terms of dividends.
Use: To indicate the rate of return to common stockholders in terms of dividends.
2006 2005
Dividend yield on common stock 1.95% 2.22% Dividend yield on common stock 1.95% 2.22%
Dividends per share of common $ 0.80 $ 0.60Market price per share of common ÷ 41.00 ÷ 27.00
The Common StockholderThe Common Stockholder
Corporate Annual ReportsCorporate Annual ReportsCorporate Annual ReportsCorporate Annual Reports
In addition to financial statements, the annual report includes a management discussion analysis (MDA) and an independent auditors’ report.
The MDA includes an analysis of the results of operations and discusses management’s
opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition.
Corporate Annual ReportsCorporate Annual ReportsCorporate Annual ReportsCorporate Annual Reports
In addition to financial statements, the annual report includes a management discussion analysis (MDA) and an independent auditors’ report.
Before issuing annual statements, all publicly held corporations are required to have an independent audit of their financial statements. The CPAs who conduct the audit render an opinion as
to the fairness of the statements.