CHAPTER © jsnyderdesign / iStockphoto 11 PERFORMANCE EVALUATION REVISITED.
CHAPTER © jsnyderdesign / iStockphoto 12 FINANCIAL STATEMENT ANALYSIS.
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CHAPTER © jsn yder de si gn / iSto ckph oto 12 FINANCIAL STATEMENT ANALYSIS
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Transcript of CHAPTER © jsnyderdesign / iStockphoto 12 FINANCIAL STATEMENT ANALYSIS.
CHAPTER
© jsnyderdesign / iS
tockphoto12FINANCIAL STATEMENT
ANALYSIS
12
HOW HEALTHY IS C&C?
► C&C’s cash balance has fallen dramatically, and George Douglas wonders why.
► Cedric Renn, a potential employee, wonders if C&C will be around for the long term.
► Meredith Lincoln wonders if she should increase C&C’s credit limit.
► Each can use C&C’s financial statements to help answer their question.
HORIZONTAL ANALYSISOF FINANCIAL STATEMENTS
Unit 12.1
121.Unit 12.2Unit 12.3
© Tom
wang112 / iS
tockphoto
Unit 12.4
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HORIZONTAL ANALYSIS
► Shows the percentage increase or decrease in a particular line item on the financial statements; may also be expressed in dollars
► Requires two years’ of information to calculate► The earliest year is considered the “base year”
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HORIZONTAL ANALYSIS
Current Year Amount – Base Year Amount
Base Year Amount
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HORIZONTAL ANALYSIS: SALES REVENUE
12/31/13 12/31/12 $ Change % Change
Sales revenue $5,237,000 $4,654,000 $583,000 12.5%
Cost of goods sold 3,876,432 3,464,440 411,992 11.9%
Gross margin 1,360,568 1,178,560 171,008 14.4%
Selling and administrative expenses 1,160,566 1,067,721 92,845 8.7%
Operating income 200,002 121,839 78,163 64.2%
Interest expense 41,715 43,210 (1,492) (3.5%)
Income before taxes 158,287 78,629 79,658 101.3%
Income tax expense 47,486 23,589 23,897 101.3%
Net income $ 110,801 $ 55,040 $ 55,761 101.3%
$5,237,000 - $4,654,000 = 12.5%
$4,654,000
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HORIZONTAL ANALYSIS: SALES REVENUE
12/31/13 12/31/12 $ Change % Change
Sales revenue $5,237,000 $4,654,000 $583,000 12.5%
Cost of goods sold 3,876,432 3,464,440 411,992 11.9%
Gross margin 1,360,568 1,178,560 171,008 14.4%
Selling and administrative expenses 1,160,566 1,067,721 92,845 8.7%
Operating income 200,002 121,839 78,163 64.2%
Interest expense 41,715 43,210 (1,492) (3.5%)
Income before taxes 158,287 78,629 79,658 101.3%
Income tax expense 47,486 23,589 23,897 101.3%
Net income $ 110,801 $ 55,040 $ 55,761 101.3%
DO NOT add the % change column to get totals
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HORIZONTAL ANALYSIS ALLOWS US TO…
► Identify trends and changes in account balances over time
► Predict account balances based on the identified trend
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TREND ANALYSIS
► Shows account balances as a percentage of the base year
► Can see how account balances are changing over time
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TREND ANALYSIS CALCULATION FOR REVENUE
12/31/13 12/31/012 $ Change % Change
Sales revenue $5,237,000 $4,654,000 $583,000 112.5%
Cost of goods sold 3,876,432 3,464,440 411,992 111.9%
Gross margin 1,360,568 1,178,560 171,008 114.4%
Selling and administrative expenses 1,160,566 1,067,721 92,845 108.7%
Operating income 200,002 121,839 78,163 164.2%
Interest expense 41,715 43,210 (1,492) (13.5%)
Income before taxes 158,287 78,629 79,658 201.3%
Income tax expense 47,486 23,589 23,897 201.3%
Net income $ 110,801 $ 55,040 $ 55,761 201.3%
$5,237,000 = 112.5%
$4,654,000
COMMON SIZEFINANCIAL STATEMENTS
Unit 12.1Unit 12.2Unit 12.3
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wang112 / iS
tockphoto
Unit 12.4
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COMMON-SIZE STATEMENTS
► Every line item on the financial statement is presented as a percentage of a major statement component• Total assets for the balance sheet• Net sales for the income statement
► Also known as vertical analysis
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COMMON-SIZE BALANCE SHEET
Account BalanceTotal Assets
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COMMON SIZE BALANCE SHEET
12/31/13 12/31/12
$ % $ %
Cash $ 7,752 0.42% $ 22,114 1.23%
Accounts receivable, net 623,713 33.34% 583,429 32.46%
Total inventory 640,372 34.23% 547,109 30.44%
Prepaid expenses 24,388 1.30% 8,164 0.46%
Total current assets 1,296,225 69.29% 1,160,816 64.59%
Property, plant & equipment 532,858 28.48% 600,647 33.42%
Other assets 41,704 2.23% 35,812 1.99%
Total assets $1,870,787 100.00% $1,797,275 100.00%
$7,752 = 0.42%
$1,870,787
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12/31/13
Cash 0.42%
Accounts receivable, net 33.34%
Total inventory 34.23%
Prepaid expenses 1.30%
Total current assets 69.29%
Property, plant & equipment 28.48%
Other assets 2.23%
Total assets 100.00%
COMMON-SIZE BALANCE SHEET
12/31/13
Accounts payable 23.60%
Other accrued expenses 4.64%
Short-term debt 6.68%
Current maturities of LTD 1.07%
Total current liabilities 35.99%
Long-term debt 14.97%
Total liabilities 50.96%
Common stock 11.23%
Retained earnings 37.81%
Total stockholders’ equity 49.04%
Total liabilities & equity 100.00%
Notice that the Total Assets and Total Liabilities & Stockholders’ Equity lines must total to 100%
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12/31/13
Cash 0.42%
Accounts receivable, net 33.34%
Total inventory 34.23%
Prepaid expenses 1.30%
Total current assets 69.29%
Property, plant & equipment 28.48%
Other assets 2.23%
Total assets 100.00%
12/31/13
Accounts payable 23.60%
Other accrued expenses 4.64%
Short-term debt 6.68%
Current maturities of LTD 1.07%
Total current liabilities 35.99%
Long-term debt 14.97%
Total liabilities 50.96%
Common stock 11.23%
Retained earnings 37.81%
Total stockholders’ equity 49.04%
Total liabilities & equity 100.00%
WHAT DOES THIS MEAN?
33.34% of C&C’s assets are in the form of
accounts receivable.
23.60% of C&C’s capitalization is provided by short-term creditors.
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COMMON SIZE INCOME STATEMENT
Account BalanceNet Sales
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COMMON SIZE INCOME STATEMENT
12/31/13 12/31/12Sales revenue $5,237,000 100.00% $4,654,000 100.00%Cost of goods sold 3,876,432 74.02% 3,464,440 74.44% Gross margin 1,360,568 25.98% 1,178,560 25.56%Selling and administrative expenses 1,160,566 22.16% 1,067,721 22.94%Operating income 200,002 3.82% 121,839 2.62%Interest expense 41,715 0.80% 43,210 0.93% Income before taxes 158,287 3.02% 78,629 1.69%Income tax expense 47,486 0.91% 23,589 0.51%
Net income $ 110,801 2.11% $ 55,040 1.18%
$3,876,432 = 74.02%
$5,237,000
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COMMON SIZE INCOME STATEMENT
12/31/13 12/31/12Sales revenue 100.00% 100.00%Cost of goods sold 74.02% 74.44% Gross margin 25.98% 25.56%Selling and administrative expenses 22.16% 22.94%Operating income 3.82% 2.62%Interest expense 0.80% 0.93% Income before taxes 3.02% 1.69%Income tax expense 0.91% 0.51%
Net income 2.11% 1.18%
Notice that we start with Net Sales at 100%. If there had been Gross Sales and then Sales
Returns, Gross Sales would be greater than 100%.
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WHAT DOES THIS MEAN?
12/31/13 12/31/12Sales revenue 100.00% 100.00%Cost of goods sold 74.02% 74.44% Gross margin 25.98% 25.56%Selling and administrative expenses 22.16% 22.94%Operating income 3.82% 2.62%Interest expense 0.80% 0.93% Income before taxes 3.02% 1.69%Income tax expense 0.91% 0.51%
Net income 2.11% 1.18%
This means that for every $1.00 collected in sales revenue in 2013, 74.02¢ goes to
make C&C’s goods for sale.
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COMMON SIZE STATEMENTS ALLOW US TO…
► Look at changes in the makeup of the base component• Has COGS as a percentage of net sales increased
this year?► Compare companies of different absolute sizes
• Qualcomm vs. Ericsson► Compare a firm to industry averages
RATIO ANALYSIS
Unit 12.1Unit 12.2Unit 12.3
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Unit 12.4
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RATIO ANALYSIS
► A comparison of the relationship between two or more financial statement items
► Reveals symptoms of underlying strengths and weaknesses
► Four major categories• Liquidity ratios• Leverage ratios• Profitability ratios• Market measure ratios
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RATIO ANALYSIS ALLOWS US TO…
► Compare a company with industry averages or norms (cross-sectional analysis)
► Examine changes in a company’s ratios over time (longitudinal analysis)
► Focus further investigations into a company’s performance (reveals symptoms, not answers)
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LIQUIDITY RATIOS
► What is liquidity?• Ability to convert assets into cash within a year or the
length of the business cycle► Why is it important?
• Need to pay bills on time• Need to take advantage of opportunities
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WORKING CAPITAL CALCULATION
Total Current Assets – Total Current Liabilities
Current Assets 12/31/13
Cash $ 7,752
Accounts receivable, net 623,713
Total inventory 640,372
Prepaid expenses 24,388
Total current assets $1,296,225
Current Liabilities 12/31/13
Accounts payable $441,602
Other accrued expenses 86,749
Short-term debt 125,000
Current maturities of LTD 20,000
Total current liabilities $673,351$1,296,225 – $673,351 = $622,874
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CURRENT RATIO CALCULATION
Total Current Assets
Total Current Liabilities
Current Assets 12/31/13
Cash $ 7,752
Accounts receivable, net 623,713
Total inventory 640,372
Prepaid expenses 24,388
Total current assets $1,296,225
Current Liabilities 12/31/13
Accounts payable $441,602
Other accrued expenses 86,749
Short-term debt 125,000
Current maturities of LTD 20,000
Total current liabilities $673,351$1,296,225
$673,351= 1.93
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CURRENT RATIO – WHAT DOES IT MEAN?
► Literally, that C&C has 1.93 times more current assets than current liabilities
► Measures the buffer to cover shrinkage in asset value in the event of forced liquidation
► Measures ability to absorb random business shocks and uncertain cash flows
► Rule of thumb 2:1, but don’t let it get too high; very industry-sensitive
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ACID-TEST RATIO CALCULATION
Cash + Cash Equivalents + A/R
Total Current Liabilities
Current Assets 12/31/13
Cash $ 7,752
Accounts receivable, net 623,713
Total inventory 640,372
Prepaid expenses 24,388
Total current assets $1,296,225
Current Liabilities 12/31/13
Accounts payable $441,602
Other accrued expenses 86,749
Short-term debt 125,000
Current maturities of LTD 20,000
Total current liabilities $673,351= 0.94$7,752 + $623,713
$673,351
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ACID-TEST RATIO – WHAT DOES IT MEAN?
► Literally, C&C has 0.94 times “highly liquid” current assets as current liabilities
► More stringent test than current ratio since it uses only the most liquid current assets
► Rule of thumb is 1:1
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CURRENT AND ACID-TEST RATIO LIMITATIONS
► Static measures of liquidity► Not useful for predictions of cash flows► No insight into quality of the assets► No insight into timing of cash conversion
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ACTIVITY RATIOS
► What are they used for?• Provides some insight into the quality of the assets
underlying the liquidity ratios• To measure how well a company is managing (using)
its assets► Two areas we’ll study
• Accounts Receivable• Inventory
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A/R TURNOVER CALCULATION
Net Credit Sales
Average A/R
Current Assets 12/31/13 12/31/12
Cash $ 7,752 $22,114
Accounts receivable, net 623,713 583,429
Total inventory 640,372 547,109
Prepaid expenses 24,388 8,164
Total current assets $1,296,225 $1,797,275
Income Statement 12/31/13
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
$5,237,000
($623,713 + $583,429) / 2= 8.68 times
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WHAT DOES IT MEAN?
► A/R Turnover• Measures how many times receivables are generated
and collected within a year• Higher turnover means faster collection of cash
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AVERAGE COLLECTION PERIOD
365 Days
A/R Turnover
365 days
8.68 times= 42 days
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INVENTORY TURNOVER CALCULATION
Cost of Goods Sold
Average Inventory
Current Assets 12/31/13 12/31/12
Cash $ 7,752 $22,114
Accounts receivable, net 623,713 583,429
Total inventory 640,372 547,109
Prepaid expenses 24,388 8,164
Total current assets $1,296,225 $1,160,816
Income Statement 12/31/13
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
$3,876,432
($640,372 + $547,109) / 2= 6.53 times
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WHAT DOES IT MEAN?
► Inventory Turnover• Measures how many times inventory is sold within a
year• Higher turnover means faster sale of inventory and
less likely to have obsolete items, but too high may indicate stock-out problems
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AVERAGE DAYS TO SELL INVENTORY CALCULATION
365 Days
Inventory Turnover
365 days
6.53 times= 55.9 days
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LEVERAGE RATIOS
► Longer time-frame of concern than short-term creditors
► Interested in short-term position for payment of interest
► Interested in long-term position for repayment of loan balance
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DEBT RATIO CALCULATION
Total Liabilities
Total Assets
Assets 12/31/13
Total current assets $1,296,225
Property, plant & equipment, net 532,858
Other assets 41,704
Total assets $1,870,787
Liabilities 12/31/13
Total current liabilities $673,351
Long-term debt 280,000
Total liabilities $953,351
$953,351
$1,870,787= 50.9%
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DEBT-TO-EQUITY RATIO CALCULATION
Total Liabilities
Total Stockholders’ Equity
Liabilities 12/31/13
Total current liabilities $673,351
Long-term debt 280,000
Total liabilities 953,351
Common stock 210,000
Retained earnings 707,436
Total stockholders’ equity 917,436
Total liabilities & stockholders’ equity $1,807,787
$953,351
$917,436= 1.04
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WHAT DOES IT MEAN?
► Debt-to-Equity Ratio• At C&C there is $1.04 in debt for every $1 of
stockholder’s equity. Put another way, about 50% of the asset base is financed through debt, or borrowed money, while 50% is financed by stockholders’ capital
• The higher the ratio, the greater the risk assumed by the creditors
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THE TIMES-INTEREST-EARNED CALCULATION
Earnings before Interest and Taxes
Interest ExpenseIncome Statement 12/31/13
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
Selling and administrative expenses 1,160,566
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
$200,002
$41,715
= 4.79 times
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PROFITABILITY RATIOS
► Focuses on returns to the stockholder
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GROSS MARGIN CALCULATION
Gross Margin
Net Sales
$1,360,568
$5,237,000
= 25.98%
Income Statement 12/31/13
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
Selling and administrative expenses 1,160,566
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
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RETURN ON ASSETS CALCULATION
NI + [ Interest Expense × (1 – tax rate) ]
Average Total AssetsIncome Statement 12/31/13
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
Balance Sheet 12/31/13 12/31/12
Total assets $1,870,787 $1,797,275
= 7.63%
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RETURN ON COMMON STOCKHOLDER’S EQUITY CALCULATION
NI – Preferred Dividends
Average Common Stockholders’ EquityIncome Statement 12/31/13
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
Balance Sheet 12/31/13 12/31/12
Common stock 210,000 210,000
Retained earnings 707,436 596,635
Total common equity $917,436 $806,635
$110,801 - $0
($917,436 + $806,635) / 2= 12.85%
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MARKET MEASURE RATIOS
► Only calculated for publicly traded stocks
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EARNINGS PER SHARE CALCULATIONNI – Preferred Dividends
Average Number of Shares Outstanding
$2,485 - $0 = $2.77
897.3
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PRICE/EARNINGS RATIO CALCULATION
Market Price per Share
Earnings per Share
$61.66
$2.77= 21.90 times
(Closing market price, 05/31/13)
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DIVIDEND PAYOUT RATIO CALCULATION
Dividends per Share
Earnings per Share
$0.81
$2.77= 29%
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SOME THINGS TO REMEMBER…
► Ratios are a snapshot► The firm’s choice of accounting principles
influences reported income► Read the footnotes to find unusual items► Contingent liabilities could influence future
earnings► Discontinued operations or extraordinary items
may influence future performance
INDUSTRY ANALYSIS
Unit 12.1Unit 12.2Unit 12.3Unit 12.4
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INDUSTRY CLASSIFICATION
► Standard Industrial Classification (SIC) code• 2329 for C&C
► North American Industrial Classification System (NAICS) code• 315280 for C&C
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SOURCES OF INDUSTRY DATA
► Published Industry Analyses► Government Statistics► Industry trade groups
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GOVERNMENT DATA EXAMPLE
Value of U.S. Men’s and Boys’ Team Sports Uniform Shipments
Sources: U.S. Census Bureau, Annual Survey of Manufactures Value of Product Shipments: 2001, 2004, 2006, 2008, 2010
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TRADE ASSOCIATION DATA EXAMPLE
Sources: SMGA, Sports Participation Topline Report: 2006 Edition; 2007 Sports and Fitness Participation Report; 2008 Sports and Fitness Participation Report; 2009 Sports and Fitness Participation Report
U.S. Participants in Team Baseball, 6 Years of Age or Older, at Least Once per Year
