Accounting 2120

1. Accounting 2120 Chapter 17 – Analysis of Financial Statements

2. Objectives • Determine liquidity and efficiency, solvency, profitability, and market prospects • Liquidity and efficiency - how fast you can convert assets to cash and to efficiently generate revenues • Solvency - being able to pay debts as they become due

3. Objectives • Profitability - having more revenues than expenses • Market prospects – ability to generate positive market expectations

4. Objectives • Objectives differ for investors and creditors • Investors - concerned with profitability, dividends and future stock prices • Creditors - concerned with liquidity and solvency • Short-term creditors - concerned with short-term liquidity and solvency • Risks are evaluated

5. Horizontal Analysis • Compare year to year • Actual dollar change • Percentage change: Actual dollar change • Base year • Trend Analysis: Annual amount • Base year • Compare percentage changes and trend analyses to industry averages

6. Vertical Analysis • Compare figures within the same year • Income statement • All items divided by net sales: Cost of goods sold/Revenues, Operating expenses/Revenues, Net income/Revenues, etc. • Balance sheet • All items divided by total assets: Cash/total assets, Accounts payable/total assets, etc.

7. Vertical Analysis • Common-size statements • Balance sheet: • Only percentages shown. • All items divided by total assets to get percentages • Income Statement: • Only percentages shown • All items divided by revenues to get percentages • Benchmark - compare figures to key competitors • Compare to industry averages

8. Liquidity and Efficiency Ratios • Pay Current liabilities • Working capital (CA-CL) • Current ratio (CA/CL) • Acid-test (quick) ratio (Quick assets/CL) • Collect receivables • Accounts receivable turnover (Credit sales/Average receivables) • Average collection period (365 days/Accts. Rec. turnover) • Sell inventory • Inventory turnover (COGS/average Inventory) • Average sale period (365 days/Inventory turnover) • Utilize assets • Total asset turnover (Net sales/Average total assets)

9. Solvency Ratios • Debt Ratio • Net liabilities/Total assets) • Equity Ratio • Total stockholders’ equity/Total assets) • Debt to Equity Ratio • Total liabilities/Total stockholders’equity • Times interest earned • Times-interest earned (Income before income taxes and interest expense/interest expense)

10. Profitability Ratios • Profit Margin (Net income/Net sales) • Gross Margin (Net sales – COGS/Net sales) • Return on total assets (Net income/Average total assets) • Return on stockholders’ equity (Net income-preferred dividends/average stockholders’ equity)

11. Market Prospect Ratios • Price/earnings ratio (Market price/EPS) • Dividend yield (Dividends per share/market price per share)

12. Additional Issues • Corporate Annual Reports • Management Discussion and Analysis • Report on adequacy of internal control • Audit report on fairness of financial statements • Red Flags in Financial Statement Analysis • Earnings problems • Decreased cash flow • Too much debt • Inability to collect receivables • Buildup of inventories • Movement of sales, inventories, and receivables

13. Sustainable Income • Continuing Operations • Discontinued Segments • Extraordinary Items

14. Homework • Problems PR17-1B, 17-5B*, BTN 17-3 • DUE WITH EXAM, FRIDAY, MAY 23