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Chapter 17

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CA

Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved


C1

Basics of Analysis
Application Involves
Reduces
of analytical transforming
uncertainty
tools data

Financial statement analysis helps users


make better decisions.

Internal Users External Users


Managers Shareholders
Officers Lenders
Internal Auditors Customers
C1

Building Blocks of Analysis

Liquidity and
Solvency
efficiency

Market
Profitability
prospects
C1

Information for Analysis


1. Statement of Profit or Loss and
Other Comprehensive Income
(Income Statement)
2. Statement of Financial Position
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes to the Financial Statements
C2

Standards for Comparison


When we interpret our analysis, it is essential to
compare the results we obtained to other
standards or benchmarks.

Intracompany
Competitors
Industry
Guidelines
C2

Tools of Analysis
Horizontal Analysis
Comparing a company’s financial condition and
performance across time.

Vertical Analysis
Comparing a company’s financial condition and
performance to a base amount.

Ratio Analysis
Measurement of key relations between financial statement
items.
P1

Horizontal Analysis
P1

Comparative Statements
Calculate Change in Dollar Amount

Dollar Analysis Period Base Period


Change = Amount – Amount

When measuring the amount of the


change in dollar amounts, compare the
analysis period balance to the base
period balance. The analysis period is
usually the current year while the base
period is usually the prior year.
P1

Comparative Statements
Calculate Change as a Percent

Percent Dollar Change


Change
=
Base Period Amount × 100

When calculating the change as a


percentage, divide the amount of the
dollar change by the base period
amount, and then multiply by 100 to
convert to a percentage.
P1

Horizontal Analysis

1,587 – 1,670 = (83)

[(83) ÷ 1,670] × 100 = (5.0)%


P1

Horizontal Analysis

14,492 – 14,883 = (391)

[(391) ÷ 14,883] × 100 = (2.6)%


P1

Trend Analysis
Trend analysis is used to reveal patterns in data
covering successive periods.

Trend Analysis Period Amount


Percent
=
Base Period Amount ×100
P1

Trend Analysis
Adidas
Income Statement Information

Using 2009 as the base year we will get the following trend information:

Examples of 2013 Calculations for Net Sales:


2009 is base year. Set to 100%
2013: (14,492 ÷ 10,381) × 100 = 139.6%
P1

Trend Analysis

We can use the trend percentages to construct a


graph so we can see the trend over time.
P2

Vertical Analysis
Common-Size Statements

Common-size Analysis Amount


Percent
= Base Amount × 100

Financial Statement Base Amount


Statement of Financial Position Total Assets
Income Statement Revenues
P2
Common-Size
Statement of Financial Position

(1,587 ÷ 11,599) × 100 = 13.7%

(1,670 ÷ 11,651) × 100 = 14.3%


Common-Size Income
P2

Statement

(7,352 ÷ 14,492) × 100 = 50.7%


P2

Common-Size Graphics
P3

Ratio Analysis
Liquidity
and Solvency
efficiency

Market
Profitability
prospects
P3

Liquidity and Efficiency


Current Days’ Sales
Ratio Uncollected

Acid-test Days’ Sales


Ratio in Inventory

Accounts Accounts Days’


Receivable Payable Purchases in
Turnover Turnover Accounts
Payable
Inventory Total Asset
Turnover Turnover
P3

Working Capital
Working capital represents current assets financed
from long-term capital sources that do not require
near-term repayment.

Current assets
– Current liabilities
= Working capital

More working capital suggests a strong liquidity


position and an ability to meet current obligations.
P3

Current Ratio
Current Assets
Current Ratio =
Current Liabilities

This ratio measures the short-term debt-


paying ability of the company. A higher current
ratio suggests a strong liquidity position.
P3

Acid-Test Ratio
Cash + Short-term investments + Current
Acid-test ratio = receivables
Current Liabilities
Referred to as Quick Assets

This ratio is like the current ratio but excludes current assets
such as inventories and prepaid expenses that may be
difficult to quickly convert into cash.
P3

Accounts Receivable Turnover


Net sales
Accounts receivable =
Average accounts receivable,
turnover
net
(Beginning acct. rec. + Ending acct. rec.)
Average accounts receivable =
2

This ratio measures how


many times a company
converts its receivables
into cash each year.
P3

Inventory Turnover
Cost of goods sold
Inventory turnover =
Average inventory

Average inventory = (Beginning inventory + Ending inventory)


2

This ratio measures the


number of times
merchandise is sold and
replaced during the year.
P3

Accounts Payable Turnover


Cost of goods sold
Accounts payable turnover =
Average accounts payable
(Beginning accounts payable +
Average accounts
Ending accounts payable)
payable =
2

A short-term liquidity
measure used to quantify
the rate at which a company
pays off its suppliers.
P3

DAYS’ SALES UNCOLLECTED


Day's sales = Accounts receivable, net
× 365
uncollected Net sales

Provides insight into how frequently a


company collects its accounts receivable.
P3

DAYS’ SALES IN INVENTORY


Day's sales in = Ending inventory
× 365
Inventory Cost of goods sold

This ratio is a useful measure in evaluating


inventory liquidity. If a product is demanded
by customers, this formula estimates how
long it takes to sell the inventory.
P3

DAYS’ PURCHASES IN ACCOUNTS PAYABLE


Accounts = Accounts payable
× 365
Payable Cost of goods sold

This ratio is a useful measure in evaluating


how long the business takes to pay its credit
suppliers.
P3

CASH CONVERSION CYCLE


The sum of the days’ sales uncollected and the days’
sales in inventory subtracting the days’ purchases
in accounts payable. It represents the number of
days a firm’s cash remains tied up within the
operations of the business.

The lower the cash conversion cycle, the more


healthy a company generally is.
P3

Total Asset Turnover


Net sales
Total asset turnover =
Average total assets

(Beginning assets + Ending assets)


Average assets =
2

This ratio reflects a


company’s ability to use
its assets to generate
sales. It is an important
indication of operating
efficiency.
P3

Solvency
Debt
Ratio

Equity
Ratio

Debt-to-Equity
Ratio

Times
Interest
Earned
P3

Debt and Equity Ratios


Amount Ratio
Total liabilities $ 8,000,000 66.7% [Debt ratio]
Total equity 4,000,000 33.3% [Equity ratio]
Total liabilities and equity $ 12,000,000 100.0%

$8,000,000 ÷ $12,000,000 = 66.7%

The debt ratio expresses total liabilities as a percent of


total assets. The equity ratio provides complementary
information by expressing total equity as a percent of total
assets.
P3

Debt-to-Equity Ratio
Total liabilities
Debt-to-equity ratio =
Total equity

This ratio measures what portion of a company’s


assets are contributed by creditors. A larger debt-to-
equity ratio implies less opportunity to expand
through use of debt financing.
P3

Times Interest Earned


Income before interest
Times interest earned = expense and income taxes
Interest expense

Net profit
+ Interest expense
+ Income taxes
= Income before interest and taxes

This is the most common measure of the


ability of a company’s operations to provide
protection to long-term creditors.
P3

Profitability
Profit Return on
Margin Total Assets

Return on Ordinary
Shareholders’
Equity
P3

Profit Margin
Net profit
Profit margin =
Net sales

This ratio describes a company’s ability


to earn net profit from each sales dollar.
P3

Return on Total Assets


Net profit
Return on total asset = Average total
assets

Return on total assets measures how well


assets have been employed by the
company’s management.
P3

RETURN ON ORDINARY SHAREHOLDERS' EQUITY

Return on ordinary shareholders' Net profit - Preference dividends


equity = Average ordinary shareholders'
equity

This measure indicates how well the


company employed the shareholders’ equity
to earn net profit.
P3

Market Prospects
Price-Earnings Dividend
Ratio Yield
P3

Price-EarningsMarket
Ratio price per ordinary share
Price-earnings ratio =
Earnings per share

This measure is often used by investors as a


general guideline in gauging share values.
Generally, the higher the price-earnings ratio,
the more opportunity a company has for growth.
P3

Dividend Yield
Annual cash dividends per share
Dividend yield =
Market price per share

This ratio identifies the return, in terms of cash


dividends, on the current market price per share
of the company’s ordinary shares.
A1

Analysis Reporting
A good analysis report usually consists of six sections:

1. Executive summary
2. Analysis overview
3. Evidential matter
4. Assumptions
5. Key factors
6. Inferences
End of Chapter 17