13-1 Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright...

13-1

Prepared byCoby Harmon

University of California, Santa BarbaraWestmont CollegeCopyright ©2015 Pearson Education Inc. All rights reserved.

13-2

1. Perform horizontal analysis

Learning Objective

Learning Objective

Copyright ©2015 Pearson Education Inc. All rights reserved.

13-3 LO 1

PERFORM HORIZONTAL ANALYSIS

Study of percentage changes from year-to-year

Two steps:

1. Compute dollar amount of change from one period

to the next

2. Divide dollar amount of change by base-period

amount


13-4 LO 1

Illustration: Amazon.com, Inc.

Step 1 Compute the dollar amount

of change from 2011 to 2012

Step 2 Percentage change for the period

Amazon.com’s net sales (in millions) increased by 27.1%

during 2012, computed as follows:


13-5 LO 1

Illustration: Amazon.com, Inc.Exhibit 13-2 | Comparative Consolidated Statements of Operations—Horizontal

Analysis (partial exhibit)


13-6 LO 1

Illustration: Amazon.com, Inc.Exhibit 13-3 | Consolidated Balance Sheets—Horizontal Analysis (partial exhibit)


13-7

Illustration

Prepare a horizontal analysis of the comparative income

statements of Ama Music Co.

Advance slide in presentation mode to reveal $ Change and % Change LO 1Copyright ©2015 Pearson Education Inc. All rights reserved.

13-8 LO 1

Trend Percentages Form of horizontal analysis

Base year selected and set equal to 100%

Amount of each following year stated as a percent of

base


13-9 LO 1

Trend Percentages

Amazon.com, Inc., showed income from operations as follows:

Trend percentages are computed by dividing each successive

year’s amount by the 2008 amount


13-10

2. Perform vertical analysis

Learning Objective

Learning Objective


13-11 LO 2

PERFORM VERTICAL ANALYSIS

Shows relationship of a financial-statement item to its

base

Income statement, base is total revenue

Balance sheet, base is total assets


13-12 LO 2

Illustration: Amazon.com, Inc.Exhibit 13-4 | Comparative Consolidated Statements of Operations—Vertical

Analysis (partial exhibit)


13-13 LO 2

Illustration: Amazon.com, Inc.Exhibit 13-5 | Consolidated Balance Sheets—Vertical Analysis (partial exhibit)


13-14

3. Prepare common-size financial statements

Learning Objective

Learning Objective


13-15 LO 3

PERPARE COMMON-SIZE FINANCIAL STATEMENTS

Report only percentages (no dollar amounts)

Assists in the comparison of different companies

Expresses financial results in terms of a common

denominator


Calculate the common-size percentages for the following income statement:

Advance slide in presentation

mode to reveal answer

Copyright ©2015 Pearson Education Inc. All rights reserved. 13-16

13-17

Benchmarking Compares company to a standard set by others

Facilitated by common-size statements

Has goal of improvementExhibit 13-6

LO 3Copyright ©2015 Pearson Education Inc. All rights reserved.

13-18

4. Analyze the statement of cash flows

Learning Objective

Learning Objective


13-19

ANALYZE STATEMENT OF CASH FLOWS

Cash flow signs of a healthy company:

Net cash flow provided by operating activities

exceeds net income

Operations are the major source of cash

Investing activities include more purchases than sales

of long-term assets

Financing activities are not dominated by borrowing


13-20

ANALYZE STATEMENT OF CASH FLOWS


13-21

5. Use ratios to make business decisions

Learning Objective

Learning Objective


13-22 LO 5

USE RATIOS TO MAKE BUSINESS DECISIONS

Measuring ability to pay current liabilities

Measuring turnover and cash conversion cycle

Measuring leverage

Measuring profitability

Analyzing stock as an investment


13-23

Ability to Pay Current Liabilities

LO 5

Working Capital

Current Ratio

Quick (Acid-test)

Ratio


13-24


LO 5

Working Capital:

Measures ability to pay current liabilities with current

assets

Generally, the larger the working capital, the better

the ability to pay debts

Capital is total assets minus total liabilities

Like a “current” version of total capital


13-25


LO 5

Current Ratio:

Measures ability to pay current liabilities with current

assets

In general, a higher current ratio indicates a stronger

financial position


13-26


LO 5

Quick (Acid-test) Ratio:

Shows ability to pay all current liabilities if they come

due immediately (quickly)

Narrower base to measure liquidity than current ratio

Ratio of 0.90 to 1.00 is acceptable in most industries


13-27 LO 5

Inventory Turnover

Accounts Receivable Turnover

Accounts Payable Turnover

Turnover and Cash Conversion Cycle

Days’ Sales Outstanding

Cash Conversion

Cycle


13-28


LO 5

Inventory Turnover:

Measures number of times a company sells its

average level of inventory during a year

Varies widely with nature of business

Compare ratio over time as well as with industry

averages or competitors


13-29


LO 5

Days Inventory Outstanding:

Converts inventory turnover ratio into days


13-30


LO 5

Accounts Receivable Turnover:

Measures ability to collect cash from credit customers

In general, higher the ratio, the better

Tells how many times during the year average

receivables were turned into cash


13-31


LO 5

Days’ Sales Outstanding:

How many days’ sales remain in accounts receivable

How may days it takes to collect the average level of

receivables


13-32


LO 5

Accounts Payable Turnover:

Measures number of times per year that entity pays

off its accounts payable


13-33


LO 5

Days’ Payable Outstanding:

How many days it takes a company to pay off

accounts payable


13-34


LO 5

Cash Conversion Cycle:

Shows overall liquidity by computing the total days it takes to

convert inventory to receivables and back to cash, less the

days to pay off its suppliers


13-35 LO 5

Debt RatioTimes-

Interest-Earned Ratio

Leverage: Overall Ability to Pay Debts


13-36 LO 5

Debt Ratio:

Indicates percentage of assets financed with debt

Ratio of 1 reveals that debt has financed all the assets

Ratio of 0.50 means that debt finances half the assets

Higher the ratio, greater the pressure to pay interest and

principal



13-37

Times-Interest-Earned Ratio:

Measures number of times operating income can cover

interest expense

Also called interest-coverage ratio

High ratio indicates ease in paying interest; a low value

suggests difficulty

LO 5



13-38 LO 5

Illustration

Using the data on the next slide, calculate the following ratios

for 2014: (Round answers to two decimal places)

a. Working capital

b. Current ratio

c. Quick (acid-test) ratio

d. Debt ratio

e. Times-interest-earned ratio


13-39 LO 5

Illustration

Summary data:


13-40 LO 5

Illustration

a. Working

capital

$455,000 $207,000-$248,000 =


13-41 LO 5

Illustration

b. Current Ratio

$455,000

$207,0002.20 =


13-42 LO 5

Illustration

c. Quick Ratio

$193,000

$207,000.93 =


13-43 LO 5

Illustration

d. Debt Ratio

$304,000

$510,000.60 =


13-44 LO 5

Illustration

e. Times-

Interest-

Earned Ratio

$301,000

$41,0007.34 =


13-45 LO 5

Measuring Profitability

Gross Margin Percentage

Operating Income

Percentage

DuPont Analysis

Rate of Return on

Sales

Asset Turnover

Rate of Return on

Total Assets

Leverage Ratio

Rate of Return on

Equity

Earnings Per Share


13-46 LO 5

Gross (Profit) Margin Percentage:

Amount of profit that the entity makes from merely

selling a product before other operating costs are

subtracted



13-47 LO 5

Operating Income (Profit) Percentage:

Measures percentage of profit earned from each sales

dollar in a company’s core business operations

Persistently high operating income compared to net

sales is an important determinant of earnings quality



13-48

DuPont Analysis:


Return on assets

Rate of return on

sales

Asset turnover

Leverage ratio

Return on equity

Leverage ratio

Return on equity

Net sales

x =

x x =

Net income Net sales

Average total

assets

x

Average total

assets

Average common

equity

x

Net income

Average common

equity

=

Detailed analysis of return on

assets (ROA) and return on

common stockholders’ equity (ROE)


13-49 LO 5

Rate of Return (Net Profit Margin Ratio) on Sales:

Shows percentage of each sales dollar earned as net

income

Higher the percentage, the more profit is being

generated by sales dollars



13-50 LO 5

Asset Turnover:

Measures amount of net sales generated for each dollar

invested in assets

Measure of how efficiently management is operating the

company

Companies with high asset turnover tend to be more

productive



13-51 LO 5

Rate of Return on Total Assets (ROA):

Measures how profitably a company uses its assets



13-52 LO 5

Leverage (Equity Multiplier) Ratio:

Measures

Impact of debt financing on profitability

Proportion of each dollar of assets financed with

stockholders’ equity



13-53

Rate of Return on Common Stockholders’ Equity:

Shows relationship between net income and common

stockholders’ investment in the company—how much

income is earned for every $1 invested

LO 5



13-54 LO 5

Earnings per Share (EPS) of Common Stock:

Amount of net income earned for each share of

outstanding common stock

Most widely quoted of all financial statistics

Only ratio that appears on the income statement


EPS =Net income – Preferred Dividends

Average number of shares of common stock outstanding


13-55 LO 5

Price/Earnings Ratio

Dividend Yield

Book Value per Share of

Common Stock

Analyzing Stock Investments


13-56 LO 5

Price-Earnings Ratio (Multiple):

Shows market price of $1 of earnings

Ratio, abbreviated P/E, appears in the Wall Street

Journal stock listings and online



13-57 LO 5

Dividend Yield:

Measures percentage of a stock’s market value

returned annually to stockholders as dividends



13-58 LO 5

Book Value per Share of Common Stock:

Indicates recorded accounting amount for each share of

common stock outstanding



13-59 LO 5

To be useful, ratios should be analyzed over a period of

years to consider all relevant factors

Any one year, or even any two years, may not represent

the company’s performance over the long term

Limitations of Ratio Analysis


13-60

6. Use other measures to make investment

decisions

Learning Objective

Learning Objective


13-61 LO 6

Combines accounting and finance data

Measures if operations have increased stockholder

wealth

Positive EVA® suggests increase in wealth

EVA = Net income before taxes + Interest expense –

Capital charge

Economic Value Added (EVA®)


13-62 LO 6

Capital charge =

Economic Value Added (EVA®)


13-63 LO 6

Earnings problems

Decreased cash flow

Too much debt

Inability to collect receivables

Buildup of inventories

Trends of sales, inventory and receivables

Red Flags in Financial Statement Analysis


13-64 LO 6

Market prices fully reflect all information

Managers cannot fool market with accounting

manipulations

Market sets fair price for stock

Appropriate investment strategy:

Manage risk

Diversify investments

Minimize transaction costs

Efficient Markets


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13-1 Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright...

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