Chapter Fourteen: Financial Statement Analysis

1. Chapter Fourteen: Financial Statement Analysis

2. Managers Officers Internal Auditors Shareholders Lenders Customers Purpose of Analysis Financial statement analysis helps users make better decisions. Internal Users External Users

3. Purpose of Analysis

4. Financial Statements Are Designed for Analysis

5. Tools of Analysis Dollar & Percentage Changes Trend Percentages Component Percentages Ratios

6. Dollar Change: Dollar Change Analysis Period Amount Base Period Amount = – Dollar and Percentage Changes Percentage Change: % Percent Change Base Period Amount ÷ = Dollar Change

7. Dollar and Percentage Changes

8. Let’s look at the asset section of Clover, Inc. comparative balance sheet and income statement for 2005 and 2004. Compute the dollar change and the percentage change for cash. Dollar and Percentage Changes

10. $12,000 – $23,500 = $(11,500)

11. ($11,500 ÷ $23,500) × 100% = 48.94% Complete the analysis for the other assets.

13. Trend Percent Analysis Period Amount Base Period Amount × 100% = Trend Analysis Trend analysis is used to reveal patterns in data covering successive periods.

14. Trend Analysis Berry Products Income Information For the Years Ended December 31, 2001 is the base period so its amounts will equal 100%.

15. Examine the relative size of each item in the financial statements by computing component(or common-sized) percentages. Analysis Amount Base Amount Component Percent × = 100% Component Percentages Financial Statement Base Amount Balance Sheet Total Assets Income Statement Revenues

16. ($12,000 ÷ $315,000) × 100% = 3.8% ($23,500 ÷ $289,700) × 100% = 8.1%

20. Ratios

21. Use this information to calculate the liquidity ratios for Matrix, Inc.

22. Working Capital Working capitalis the excess of current assets over current liabilities.

23. Current Ratio Current Assets Current Liabilities = Current Ratio $65,000 $42,000 = Current Ratio This ratio measures the short-term debt-paying ability of the company. = 1.55 : 1

24. Quick Assets Current Liabilities Quick Ratio = Quick Ratio Quick assetsare cash, marketable securities, and receivables. This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash.

25. Quick Assets Current Liabilities Quick Ratio = $50,000 $42,000 Quick Ratio = = 1.19 : 1 Quick Ratio This ratio is like the current ratio but excludes current assets such as inventories that may be difficult to quickly convert into cash.

26. Debt Ratio A measure of creditor’s long-term risk. The smaller the percentage of assets that are financed by debt, the smaller the risk for creditors.

27. Uses and Limitations of Financial Ratios

28. Measures of Profitability An income statement can be prepared in either a multiple-step or single-step format. The single-step format is simpler. The multiple-step format provides more detailed information.

29. Income Statement (Multiple-Step) { Proper Heading { Gross Margin { Operating Expenses { Non- operating Items Remember to compute EPS.

30. Proper Heading Revenues & Gains Expenses & Losses Income Statement (Single-Step) { { { Remember to compute EPS.

31. Use this information to calculate the profitability ratios for Matrix, Inc.

32. Return On Assets (ROA) This ratio is generally considered the best overall measure of a company’s profitability.

33. Return On Equity (ROE) This measure indicates how well the company employed the owners’ investments to earn income.

34. End of Chapter Fourteen