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1. Financial Accounting, 5e Weygandt, Kieso, & Kimmel Prepared by Kurt M. Hull, MBA CPA California State University, Los Angeles John Wiley & Sons, Inc.

2. CHAPTER 15 FINANCIAL STATEMENT ANALYSIS STUDY OBJECTIVES After studying this chapter, you should understand:

3. STUDY OBJECTIVE 1 COMPARATIVE ANALYSIS

4. STUDY OBJECTIVE 2 ANALYSIS TOOLS HORIZONTAL (TREND) ANALYSIS evaluates a series of financial statement data over a period of time. VERTICAL ANALYSIS expresses each item in a financial statement as a percent of a base amount RATIO ANALYSIS expresses the relationship among selected items of financial statement data.

5. Change since base period STUDY OBJECTIVE 3 HORIZONTAL ANALYSIS Changes are measured against a base year with the following formula.

6. HORIZONTAL ANALYSIS OF BALANCE SHEET

7. HORIZONTAL ANALYSIS OF INCOME STATEMENT

8. QUALITY DEPARTMENT STORE INC. Retained Earnings Statement ILLUSTRATION15-7 For the Years Ended December 31 Increase or (Decrease) during 1999 200 3 200 2 Amount Percentage Retained earnings, January 1 $ 525,000 $ 376,500 $ 148,500 3 9.4% Add: Net income 263,800 208,500 55,300 26.5% 788,800 585,000 203,800 Deduct: Dividends 61,200 60,000 1,200 2.0% Retained earnings, December 31 $ 727,600 $ 525,000 $ 202,600 38.6% HORIZONTAL ANALYSIS OF RETAINED EARNINGS STATEMENT The change in January 1 retained earnings is calculated as follows 39.4% 525,000-376,500 376,500 =

9. STUDY OBJECTIVE 4 VERTICAL ANALYSIS Financial statement elements are measured as a percent of the total. Balance Sheet Income Statement Elements are a percent of total assets Elements are a percent of total sales

10. QUALITY DEPARTMENT STORE INC. Condensed Balance Sheets December 31 2003 200 2 Amount Percent Amount Percent Assets Current assets $ 1,020,000 55.6% $ 945,000 59.2% Plant assets (net) 800,000 43.6% 632,500 39.7% Inta ngible assets 15,000 0.8% 17,500 1.1% Total assets $ 1,835,000 100.0% $ 1,595,000 100.0% Liabilities Current liabilities $ 344,500 18.8% $ 303,000 19.0% Long - term liabilities 487,500 26.5% 497,000 31.2% Total liabilities 832,000 45.3% 800,000 50.2% Stockholders’ Equity VERTICAL ANALYSIS OF BALANCE SHEET Common st ock, $1 par 275,400 15.0% 270,000 16.9% Retained earnings 727,600 39.7% 525,000 32.9% Total stockholders’ equity 1,003,000 54.7% 795,000 49.8% Total liabilities and stockholders’ equity $ 1,835,000 100.0% $1,595,000 100.0%

11. QUALITY DEPARTMENT STORE INC. Condensed Income Statements For the Years Ended December 31 2003 2002 Amount Percent Amount Percent Sales $ 2,195,000 104.7% $ 1,960,000 106.7% Sales returns and allowances 98,000 4.7% 123,000 6.7% Net sales 2,097,000 100.0% 1,837,000 100.0% Cost of goods sold 1,281,000 61.1% 1,140,000 62.1% Gross profit 816,000 38.9% 697,000 37.9% Selling expenses 253,000 12.0% 211,500 11.5% Administrative expenses 104,000 5.0% 108,500 5.9% Total operating expenses 357,000 17.0% 320,000 17.4% Income from operations 459,000 21.9% 377,000 20.5% Other revenues and gains VERTICAL ANALYSIS OF BALANCE SHEET Interest and dividends 9,000 0.4% 11,000 0.6% Other expenses and losses Interest expense 36,000 1.7% 40,500 2.2% Income before income taxes 432,000 20.6% 347,500 18.9% Income tax expense 168,200 8.0% 139,000 7.5% Net income $ 263,800 12.6% $ 208,500 11.4%

12. INTERCOMPANY COMPARISION OF INCOME STATEMENT

13. REVIEW QUESTION Sammy Corporation reported net sales of $300,000 and $330,000 for 2004 and 2005. Calculate the percentage increase. 330,000 - 300,000 10% = 300,000 Another way to express this change: 2005 sales are 110% of 2004 sales

14. STUDY OBJECTIVE 5 RATIO ANALYSIS

15. 2003 2002 $1,020,000 $945,000 ————— = 2.96:1 ———— = 3.12:1 $344,500 $303,000 CURRENT RATIO A LIQUIDITY RATIO Evaluates liquidity and short-term debt-paying ability. CURRENT ASSETS CURRENT RATIO = ——————————— CURRENT LIABILITIES Quality Department Store Industry average Sears, Roebuck and Co. ———————— ———————————— 1.2 8 :1 1.32:1

16. ACID-TEST/QUICK RATIO A LIQUIDITY RATIO Measures short-term liquidity. CASH + MARKETABLE SECURITIES + RECEIVABLES (NET) ACID-TEST RATIO = ———————————————————————————— CURRENT LIABILITIES

17. ACID-TEST/QUICK RATIO Quality Department Store 2003 2002 $100,000 + $20,000 + $230,000 $155,000 + $70,000 + $180,000 = 1.02 —————————————— :1 —————————————— = 1.3:1 $344,500 $303,000 Industry average Sears, Roebuck and Co. ———————— ———————————— 0.33:1 0.85:1

18. NET CREDIT SALES RECEIVABLES TURNOVER = ——————————————— AVERAGE NET RECEIVABLES RECEIVABLES TURNOVER A LIQUIDITY RATIO • Measures the liquidity of receivables. • Measures the number of times, on average, receivables are collected during the period.

19. RECEIVABLES TURNOVER Quality Department Store 2003 2002 $2,097,000 $1,837,000 [ ] [ ] —————————— = 10.2 times —————————— = 9.7 times $180,000 + $230,000 $200,000 + $180,000 —————————— —————————— 2 2 Industry average Sears, Roebuck and Co. ———————— ———————————— 10.8 times 2.4 times

20. INVENTORY TURNOVER A LIQUIDITY RATIO • Measures the number of times, on average, the inventory is sold during the period . • Measures the liquidity of the inventory. COST OF GOODS SOLD INVENTORY TURNOVER = ———————————— AVERAGE INVENTORY

21. INVENTORY TURNOVER Quality Department Store 2003 2002 $1,281,000 $1,140,000 —————————— = 2.3 times —————————— = 2.4 times [ ] [ ] $500,000 + $620,000 $450,000 + $500,000 —————————— —————————— 2 2 Industry average Sears, Roebuck and Co. ———————— ———————————— 6. 7 times 5.0 times

22. NET INCOME PROFIT MARGIN ON SALES = —————— NET SALES PROFIT MARGIN A PROFITABILITY RATIO • Measures the percentage of each dollar of sales that results in net income. • Measures how profitable the company is

23. PROFIT MARGIN Quality Department Store 2003 2002 $263,800 $208,500 ————— = 12.6% ————— = 11.4% $2,097,000 $1,837,000 Industry average Sears, Roebuck and Co. ———————— ———————————— 3 .5 7% 8. 26 %

24. ASSET TURNOVER A PROFITABILITY RATIO Measures how efficiently a company uses its assets to generate sales. NET SALES ASSET TURNOVER = ————————— AVERAGE ASSETS

25. ASSET TURNOVER Quality Department Store 2003 2002 $2,097,000 $1,837,000 = 1.21 times ——————————— = 1.22 times ——————————— [ ] [ ] $1,595,000 + $1,835,000 $1,446,000 + $1,595,000 ——————————— ——————————— 2 2 Industry average Sears, Roebuck and Co. 2.37 times 1.05 times

26. RETURN ON ASSETS A PROFITABILITY RATIO An overall measure of profitability. NET INCOME RETURN ON ASSETS = ————————— AVERAGE ASSETS

27. RETURN ON ASSETS Quality Department Store 2003 200 2 $263,800 $208,500 [ ] [ ] ——————————— = 15.4% ——————————— = 13.7% $1,595,000 + $1,835,000 $1,446,000 + $1,595,000 ——————————— ——————————— 2 2 Industry average Sears, Roebuck and Co. ———————— ———————————— 8.29% 8.7%

28. RETURN ON COMMON NET INCOME STOCKHOLDERS’ EQUITY = ——————————————————————— AVERAGE COMMON STOCKHOLDERS’ EQUITY RETURN ON COMMON EQUITY A PROFITABILITY RATIO Measures profitability from the viewpoint of the common stockholder.

29. RETURN ON COMMON EQUITY Quality Department Store 2003 2002 $263,800 $208,500 ——————————— = 29.3% ——————————— = 28.5% ] ] [ [ $795,000 + $1,003,000 $667,000 + $795,000 ——————————— ——————————— 2 2

30. EARNINGS PER SHARE A PROFITABILITY RATIO EPS measures net income earned on each share of common stock. EARNINGS NET INCOME PER SHARE = ———————————————————————————— WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

31. EARNINGS PER SHARE Quality Department Store 2003 2002 $263,000 $208,500 ————————— = $.97 ————— = $.77 [ ] 270,000 + 275,400 270,000 ————————— 2

32. PRICE TO EARNINGS A PROFITABILITY RATIO Measures the ratio of the market price of each share of common stock to the earnings per share. MARKET PRICE PER SHARE OF COMMON STOCK PRICE-EARNINGS RATIO = ————————————————————————— EARNINGS PER SHARE

33. PRICE TO EARNINGS Quality Department Store 2003 2002 $12.00 $ 8.00 ——— =12.4 times ——— = 10.4 times $ .97 $ .77 Industry average Sears, Roebuck and Co. ———————— ——————————— 26 times 3.8 times

34. PAYOUT RATIO A PROFITABILITY RATIO Measures the percentage of earnings distributed in the form of cash dividends. CASH DIVIDENDS PAYOUT RATIO = ————————————————————————— NET INCOME

35. PAYOUT RATIO A PROFITABILITY RATIO Quality Department Store 2003 2002 = 23.2% $61,200 $60,000 = 28.8% ————— ————— $263,800 $208,500 Industry average Sears, Roebuck and Co. ———————— ——————————— 16.0% 9.6%

36. TIMES INTEREST EARNED A SOLVENCY RATIO Measures ability to meet interest payments as they come due. Income before Income Taxes and Interest Expense Interest Expense Quality Department Store 2003 2002 $468,000 $388,000 ———— = 13 times ———— = 9.6 times $36,000 $40,500

37. DEBT TO TOTAL ASSETS A SOLVENCY RATIO Total Debt Total Assets Measures % of total assets provided by creditors Quality Department Store 2003 2002 $832,000 = 45.30% $800,000 = 50.20% $1,835,000 $1,595,000 Industry average Sears, Roebuck and Co. ———————— ———————————— 40.1% 76.9%

38. REVIEW QUESTION Ace Ventura Pet Detective, Inc. reported the following: Cash $125,000 Marketable Securities $342,500 Accounts Receivable $780,000 Inventory $56,000 Prepaid Insurance $3,600 Prepaid Rent $4,900 Total Assets $1,729,000 Current Liabilities $562,000 Calculate the Quick Ratio. 2.22 = (125000+342500+780000) / 562000

39. STUDY OBJECTIVE 6 EARNINGS POWER & IRREGULAR ITEMS Three types of “Irregular” items: 1) Discontinued operations 2) Extraordinary items 3) Changes in accounting principle Earnings power is the NORMAL LEVEL OF INCOME to be obtained in the future. Earnings power is affected by irregular items.

40. DISCONTINUED OPERATIONS • The disposal of a significant segment of a business. • The income or (loss) form discontinued operations consists of two parts: • The income or (loss) form operations and • The gain/loss on the disposal of the segment • The results are shown “net of tax”

41. DISCONTINUED OPERATIONS STATEMENT PRESENTATION For the year ended December 31, 2006

42. EXTRAORDINARY ITEMS • Extraordinary items are events and transactions that meet two conditions. • unusual in nature and • infrequent in occurrence • the results are shown “net of tax”

43. EXTRAORDINARY ITEMS STATEMENT PRESENTATION For the year ended December 31, 2006

44. ORDINARY VS. EXTRAORDINARY

45. CHANGE IN ACCOUNTING PRINCIPLE • Occurs when the principle used in the current year is different form the one used last year. When this happens: • The new principle is used to report the results of operations for current year • The cumulative effect of the change on all prior year income statements should be disclosed “net of tax”

46. CHANGE IN PRINCIPLE STATEMENT PRESENTATION For the year ended December 31, 2006

47. STUDY OBJECTIVE 7 LIMITATIONS OF F/S ANALYSIS

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