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FINANCIAL STATEMENT
ANALYSIS
Topics:
1. Cross-sectional analysis
It is also known as inter firm comparison. This
analysis helps in analysing financial characteristics
of an enterprise with financial characteristics of
another similar enterprise in that accounting period.
2. Time series analysis
It is also called as intra-firm comparison. According to this
method, the relationship between different items of financial
statement is established, comparisons are made and
results obtained.
The basis of comparison may be Comparison of the
financial statements of different years of the same business
unit.
Dollar Change:
Percentage Change:
% Percent
Change = Dollar Change
÷
Base Period
Amount
Dollar and Percentage Changes
Example
Let’s look at the asset section of ABC
Corporation’s comparative balance
sheet and income statement for 2003
and 2002 on the next slid.
Compute the dollar change and the
percentage for cash.
ABC CORPORATION
Comparative Balance Sheets
December 31,
Dollar Percent
2003 2002 Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 ? ?
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000 $ 164,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700
* Percent rounded to one decimal point.
ABC CORPORATION
Comparative Balance Sheets
December 31,
Dollar Percent
2003 2002 Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) ?
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000–
$12,000 $23,500
$ 164,700 = $(11,500)
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700
* Percent rounded to one decimal point.
ABC CORPORATION
Comparative Balance Sheets
December 31,
Dollar Percent
2003 2002 Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) -48.9%
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets ($11,500 ÷ $23,500)
$ 155,000 × 100% = 48.94%
$ 164,700
Property and equipment:
Land 40,000 40,000 Complete the
Buildings and equipment, net 120,000 85,000 analysis for
Total property and equipment $ 160,000 $ 125,000 the other
Total assets $ 315,000 $ 289,700
assets.
* Percent rounded to one decimal point.
ABC CORPORATION
Comparative Balance Sheets
December 31,
Dollar Percent
2003 2002 Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) -48.9%
Accounts receivable, net 60,000 40,000 20,000 50.0%
Inventory 80,000 100,000 (20,000) -20.0%
Prepaid expenses 3,000 1,200 1,800 150.0%
Total current assets $ 155,000 $ 164,700 (9,700) -5.9%
Property and equipment:
Land 40,000 40,000 - 0.0%
Buildings and equipment, net 120,000 85,000 35,000 41.2%
Total property and equipment $ 160,000 $ 125,000 35,000 28.0%
Total assets $ 315,000 $ 289,700 $ 25,300 8.7%
* Percent rounded to one decimal point.
ABC CORPORATION
Comparative Balance Sheets
December 31,
2003
Dollar Percentag
2003 2002 change e change
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 67,000 $ 44,000 $ 23,000 52.3%
Notes payable 3,000 6,000 $ (3,000) -50.0%
Total current liabilities $ 70,000 $ 50,000 $ 20,000 40.0%
Long-term liabilities: $ -
Bonds payable, 8% 75,000 80,000 $ (5,000) -6.3%
Total liabilities $ 145,000 $ 130,000 $ 15,000 11.5%
Shareholders' equity:
Preferred stock 20,000 20,000 $ - 0.0%
Common stock 60,000 60,000 $ - 0.0%
Additional paid-in capital 10,000 10,000 $ - 0.0%
Total paid-in capital $ 90,000 $ 90,000 $ - 0.0%
Retained earnings 80,000 69,700 $ 10,300 14.8%
Total shareholders' equity $ 170,000 $ 159,700 $ 10,300 6.4%
Total liabilities and shareholders' equity $ 315,000 $ 289,700 $ 25,300 8.7%
* Percent rounded to first decimal point.
Interpretation
(i) The comparative balance sheet of the company reveals that
during 2003 there has been an increase in fixed assets of
$35,000 i.e. 28.2% and Long term liabilities to outsiders have
relatively decreased by $6,000, i.e. -6.3%, . Equity share capital
has no change, but retaining earnings of the company increases
by $10,800, i.e. 14.8%.
This fact indicates that the sources of finance of the company to
purchase fixed assets are short term debts and company’s
retaining earnings.
(ii) The current assets have decreased by $ 9,700 i.e. -5.9%,
whereas the current liabilities have increased by $20, 000 i.e.
40.0%. This further confirms that the company has used short-
term finances to acquired fixed assets.
(iii) Retain Earnings have increased from $ 69,700 to
$80,000,($10,300 i.e. 14.8%) which shows that the company has
utilized Retained earnings for acquiring of fixed assets.
Trend Analysis
The change in financial statement items
from a base year to following years are
often expressed as trend percentages to
show the extent and direction of change.
Two steps are necessary to compute trend
percentages.
1. Select base year and assign a weight of 100%
for each item in the base year
2. Express each item following years as a
percentage of its base year amount.
Trend Analysis
140%
120%
100% Revenues
80% Cost of sales
60% Gross profit
40%
20%
0%
1999 2000 2001 2002 2003
Component Percentages
Indicate the relative size of each item included in a total.
Examine the relative size of each item in the financial statements
by computing component (or common-sized) percentages.
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Example: Common-size analysis
Consider the CS Company, which reports the following financial
information:
Year 2008 2009 2010 2011 2012 2013
Cash $400.00 $404.00 $408.04 $412.12 $416.24 $420.40
Inventory 1,580.00 1,627.40 1,676.22 1,726.51 1,778.30 1,831.65
Accounts receivable 1,120.00 1,142.40 1,165.25 1,188.55 1,212.32 1,236.57
Net plant and equipment 3,500.00 3,640.00 3,785.60 3,937.02 4,094.50 4,258.29
Intangibles 400.00 402.00 404.01 406.03 408.06 410.10
Total assets $6,500.00 $6,713.30 $6,934.12 $7,162.74 $7,399.45 $7,644.54
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Example: Common-size analysis
Vertical Common-Size Analysis:
Year 2008 2009 2010 2011 2012 2013
Cash 6% 6% 5% 5% 5% 5%
Inventory 23% 23% 23% 23% 22% 22%
Accounts receivable 16% 16% 16% 15% 15% 15%
Net plant and equipment 50% 50% 51% 51% 52% 52%
Intangibles 6% 6% 5% 5% 5% 5%
Total assets 100% 100% 100% 100% 100% 100%
Graphically:
100%
Proportion
50%
of Assets
0%
2008 2009 2010 2011 2012 2013
Fiscal Year
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Example: Common-Size Analysis
Horizontal Common-Size Analysis (base year is 2008):
Year 2008 2009 2010 2011 2012 2013
Cash 100.00% 101.00% 102.01% 103.03% 104.06% 105.10%
Inventory 100.00% 103.00% 106.09% 109.27% 112.55% 115.93%
Accounts receivable 100.00% 102.00% 104.04% 106.12% 108.24% 110.41%
Net plant and equipment 100.00% 104.00% 108.16% 112.49% 116.99% 121.67%
Intangibles 100.00% 100.50% 101.00% 101.51% 102.02% 102.53%
Total assets 100.00% 103.08% 106.27% 109.57% 112.99% 116.53%
Graphically:
130%
Percentage 120%
of Base
110%
Year
Amount 100%
90%
2008 2009 2010 2011 2012 2013
Fiscal Year
Cash Inventory Accounts receivable Net plant and equipment Intangibles Total assets
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Financial Ratio Analysis
Financial ratio analysis is the use of relationships
among financial statement accounts to gauge the financial
condition and performance of a company.
We can classify ratios based on the type of information
the ratio provides:
Solvency Profitability
Activity Ratios Liquidity Ratios
Ratios Ratios
Effectiveness Ability to
in putting its Ability to meet manage
Ability to
asset short-term, expenses to
satisfy debt
investment to immediate produce
obligations.
use. obligations. profits from
sales.
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Activity Ratios
Turnover ratios reflect the number of times assets flow into and out
of the company during the period.
A turnover is a measure of the efficiency of putting assets to work.
Ratios:
How many times inventory is
created and sold during the
period.
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Operating cycle components
The operating cycle is the length of time from when a
company makes an investment in goods and services to the
time it collects cash from its accounts receivable.
The net operating cycle is the length of time from when a
company makes an investment in goods and services,
considering the company makes some of its purchases on
credit, to the time it collects cash from its accounts
receivable.
The length of the operating cycle and net operating cycle
provides information on the company’s need for liquidity:
The longer the operating cycle, the greater the need for
liquidity.
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Operating Cycle Formulas
Average time it
takes to create
and sell
inventory.
Average time it
takes to collect
on accounts
receivable.
Average time it
takes to pay
suppliers.
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Operating Cycle Formulas
Time from investment in
inventory to collection
of accounts.
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Liquidity
Liquidity is the ability to satisfy the company’s short-
term obligations using assets that can be most readily
converted into cash.
Liquidity ratios:
Ability to satisfy current
liabilities using current assets.
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Solvency Analysis
A company’s business risk is determined, in large part,
from the company’s line of business.
Financial risk is the risk resulting from a company’s
choice of how to finance the business using debt or equity.
We use solvency ratios to assess a company’s financial
risk.
There are two types of solvency ratios: component
percentages and coverage ratios.
Component percentages involve comparing the elements
in the capital structure.
Coverage ratios measure the ability to meet interest and
other fixed financing costs.
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Solvency ratios
Proportion of assets financed with debt.
Component-Percentage
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Profitability
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Profitability ratios: Margins
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Profitability Ratios: Returns
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