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Chapter 16

Chapter 16. How to Read, Analyze, and Interpret Financial Reports. #16. How to Read, Analyze, and Interpret Financial Reports. Learning Unit Objectives. Balance Sheet -- Report as of a Particular Date. LU16.1. Explain the purpose and the key items on the balance sheet

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Chapter 16

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  1. Chapter 16 How to Read, Analyze, and Interpret Financial Reports

  2. #16 How to Read, Analyze, and Interpret Financial Reports Learning Unit Objectives Balance Sheet -- Report as of a Particular Date LU16.1 Explain the purpose and the key items on the balance sheet Explain and complete vertical and horizontal analysis

  3. #16 How to Read, Analyze, and Interpret Financial Reports Learning Unit Objectives Income Statement -- Report for a Specific Period of Time LU16.2 Explain the purpose and the key items on the income statement Explain and complete vertical and horizontal analysis

  4. #16 How to Read, Analyze, and Interpret Financial Reports Learning Unit Objectives Trend and Ratio Analysis LU16.3 Explain and complete a trend analysis List, explain, and calculate key financial ratios

  5. Accounting Equation Accounting Equation: Assets = Liabilities + Owner’s Equity

  6. Balance Sheet Gives a financial picture of what a company is worth as of particular date. How much the company owes Liabilities + Owner’s Equity = Assets How much the company owns How much the owner is worth

  7. Figure 16.1 - Elements of the Balance Sheet MOOL COMPANY Balance Sheet December 31, 2011 Assets Liabilities a. Current assets: a. Current liabilities: b. Cash $ 7,000 b. Accounts payable $ 80,000 c. Accounts receivable 9,000 c. Salaries payable 12,000 d. Merchandise inventory 30,000 d. Total current liabilities $ 92,000 e. Prepaid expenses 15,000e. Long-term liabilities: f. Total current assets $61,000f. Mortgage note payable 58,000 g. Plant and equipment: g. Total liabilities $150,000 h. Building (net) $60,000 i. Land 84,000 Stockholders Equity j. Total plant and equipment 144,000a. Common stock $ 20,000 b. Retained earnings 35,000 c. Total stockholders equity 55,000 k. Total assets $205,000d. Total liab. and stkhlds equity $205,000 Assets broken down into current assets and plant and equipment. Liabilities broken down into current and long-term Total of current assets and plant and equipment. (Total is double- ruled) Total of all liabilities and stockholders’ equity.

  8. Preparing a Vertical Analysis of a Balance Sheet Step 2. Round each liability and stockholders’ equity (the portions) as a percent of total liabilities and stockholders’ equity (the base). Round as indicated. Step 1. Divide each asset (the portion) as a percent of total assets (the base). Round as indicated.

  9. Figure 16.2 - Comparative Balance Sheet: Vertical Analysis ROGER COMPANY Comparative Balance Sheet December 31, 2010 and 2011 2011 2010 Amount Percent Amount Percent Assets Current Assets: Cash $22,000 25.88 $18,000 22.22 Accounts Receivable 8,000 9.41 9,000 11.11 Merchandise inventory 9,000 10.59 7,000 8.64 Prepaid rent 4,000 4.715,0006.71 Total current assets $43,00050.59$39,00048.15* Plant and equipment: Building (net) $18,000 21.19 $18,000 22.22 Land 24,00028.2424,00029.63 Total plant and equipment $42,00049.41* $42,00051.85 Total assets $85,000100.00$81,000100.00 * Due to rounding

  10. Figure 16.2 - Comparative Balance Sheet: Vertical Analysis ROGER COMPANY Comparative Balance Sheet December 31, 2010 and 2011 2011 2010 Amount Percent Amount Percent Liabilities Current liabilities: Accounts payable $14,000 16.47 $8,000 9.88 Salaries payable 18,000 21.18 17,000 20.99 Total current liabilities $32,,000 37.65 $25,000 30.86* Long-term liabilities: Mortgage note payable $12,000 14.12 $20,000 24.69 Total liabilities $44,000 51.76* $25,000 30.86* Stockholders’ Equity Common stock $20,000 23.53 $20,000 24.69 Retained earnings 21,000 24.71 16,000 19.75 Total Stockholders’ equity $41,000 48.24 $36,000 44.44 Total Liabilities and Stockholders’ Equity $85,000 100.00 $81,000 100.00 * Due to rounding

  11. Preparing a Horizontal Analysis of a Comparative Balance Sheet Step 1. Calculate the increase or decrease (portion) in each item from the base year. Step 2. Divide the increase or decrease in Step 1 by the old or base year. Step 3. Round as indicated.

  12. Figure 16.3 - Comparative Balance Sheet: Horizontal Analysis ABBY ELLEN COMPANY Comparative Balance Sheet December 31, 2010 and 2011 Increase(decrease) 2011 2010 Amount Percent Assets Current Assets: Cash $ 6,000 $ 4,000 $ 2,000 50.00 Accounts Receivable 5,000 6,000 (1,000) -16.67 Merchandise inventory 9,000 4,000 5,000 125.00 Prepaid rent 5,000 7,000(2,000) -28.57 Total current assets $25,000 $21,000$ 4,000 19.05 Plant and equipment: Building (net) $12,000 $12,000 0 0 Land 18,00018,000 0 0 Total plant and equipment $30,000$30,0000 0 Total assets $55,000$51,000$4,000 7.84

  13. Figure 16.3 - Comparative Balance Sheet: Horizontal Analysis ABBY ELLEN COMPANY Comparative Balance Sheet December 31, 2010 and 2011 Increase(decrease) 2010 2011 Amount Percent Liabilities Current liabilities: Accounts payable $ 3,200 $ 1,800 $ 1,400 77.78 Salaries payable 2,900 3,200 (300) -9.38 Total current liabilities $ 6,100 5,000 1,100 22.00 Long-term liabilities: Mortgage note payable 17,000 15,000 2,000 13.33 Total Liabilities $ 23,100 20,000 3,100 15.50 Owner’s Equity Abby Ellen, capital $31,900 31,000 $ 900 2.90 Total liabilities and owner’s equity $55,000 51,000 $4,000 7.84

  14. Income Statement Income Statement$ A financial report that tells how well a company is performing (its profitability or net profit) during a specific period of time. Retail Business Revenues (Sales) - Cost of merchandise sold = Gross profit from sales - Operating Expenses = Net Income (Profit) Service Business Revenues -Operating Expenses =Net Income

  15. Figure 16.4 - Income Statement MOOL COMPANY Income Statement For Month Ended December 31, 2011 Revenues a. Gross Sales $22,080 b. Less: Sales returns and allowances $ 1,082 c. Sales discounts 4321,514 d. Net Sales Cost of merchandise (goods) sold: $20,566 a. Merchandise Inventory 12/1/2004 $ 1,248 b. Purchases $10,512 c. Less: Purchases returns and allowances $336 d. Less: Purchase discounts 204 540 e. Cost of net purchases 9,972 f. Cost of merchandise (goods available for sale) $11,220 g. Less: Merchandise inventory 12/31/2004 1,600 h. Cost of merchandise (goods sold) 9,620 Gross profit from sales $10,946 Operating expenses: a. Salary $ 2,200 b. Insurance 1.300 c. Utilities 400 d. Plumbing 120 e. Rent 410 f. Depreciation 200 g. Total operating expenses 4,630 Net income $ 6,316

  16. Key Calculations on Income Statement Net sales = Gross sales - Sales returns and - Sales discounts Allowances Cost of Net purchases merchandise = Beginning + (purchase less - Ending (goods) sold inventory returns & discounts) inventory Gross profit = Net sales - Cost of merchandise from sales (goods) sold Net income = Gross profit - Operating expenses

  17. Figure 16.5 - Income Statement Vertical Analysis ROYAL COMPANY Comparative Income Statement For Years Ended December 31, 2010 and 2011 2011 Percent 2010 Percent of net of net Net Sales $45,000 100.00 $29,000 100.00 Cost of merchandise sold 19,00042.2212,00041.38 Gross profit from sales $26,00057.78$17,00058.62 Operating expenses: Depreciation $1,000 2.22 $ 500 1.72 Selling and Advertising 4,200 9.33 1,600 5.52 Research 2,900 6.44 2,000 6.90 Miscellaneous 5001.11 200.69 Total operating expenses $8,60019.11* $ 4,30014.83 Income before interest and taxes $17,400 38.67 $12,700 43.79 Interest expense 6,00013.333,000 10.34 Income before taxes $11,400 25.33* $ 9,700 33.45 Provision for taxes 5,500 12.22 3,00010.34 Net income $ 5,900 13.11 $ 6,70023.10* * Due to rounding

  18. Figure 16.6 - Horizontal Analysis Income Statement FLINT COMPANY Comparative Income Statement For Years Ended December 31, 2010 and 2011 2011 2010Increase (decrease) Amount Percent Sales $ 90,000 $80,000 $10,000 Sales returns and allowances 2,000 2,000 0 Net Sales $88,000 $78,000 $10,000 + 12.82 Cost of merchandise sold 45,00040,0005,000 + 12.50 Gross profit from sales $43,000 $38,000 $ 5,000 + 13.16 Operating expenses: Depreciation $ 6,000 $ 5,000 $ 1,000 + 20.00 Selling and Advertising 16,000 12,000 4,000 + 33.33 Research 600 1,000 (400) - 40.00 Miscellaneous 1,200500 700 + 140.00 Total operating expenses $23,800 $18,500 $ 5,300 + 28.65 Income before interest and taxes $19,200 $19,500 $ (300) - 1.54 Interest expense 4,0004,000 0 Income before taxes $15,200 $15,500 $ (300) - 1.94 Provision for taxes 3,800 4,000(200) - 5.00 Net income $11,400 $11,500 $ (100) - .87

  19. Completing a Trend Analysis Analyzes the changes that occur by expressing each number as a percent of the base year Each Item Base Amount Step 1. Select the base year (100%) Step 2. Express each amount as a percent of the base year amount (rounded to the nearest whole percent)

  20. Trend Analysis Given (base year 2009) 2012 2011 2010 2009 Sales $621,000 $460,000 $340,000 $420,000 Gross Profit 182,000 141,000 112,000 124,000 Net Income 48,000 41,000 22,000 38,000 Trend Analysis 2012 2011 2010 2009 Sales* 148% 110% 81% 100% Gross Profit 147 114 90 100 Net Income 126 108 58 100 $340,000 $420,000 * Round to nearest whole percent

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