Chapter 9 Financial Statement Analysis. Learning Objectives After studying this chapter, you should...
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Transcript of Chapter 9 Financial Statement Analysis. Learning Objectives After studying this chapter, you should...
![Page 1: Chapter 9 Financial Statement Analysis. Learning Objectives After studying this chapter, you should be able to… Describe basic financial statement analytical.](https://reader036.fdocuments.net/reader036/viewer/2022062304/56649ebe5503460f94bc7921/html5/thumbnails/1.jpg)
Chapter 9Chapter 9
Financial Statement AnalysisFinancial Statement AnalysisFinancial Statement AnalysisFinancial Statement Analysis
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Learning ObjectivesLearning Objectives
After studying this chapter, you should be able to…
Describe basic financial statement analytical methods.
Use financial statement analysis to assess the solvency of a business.
Use financial statement analysis to assess the profitability of a business.
Describe the contents of corporate annual reports.
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Learning Objective 1Learning Objective 1
Describe basic financial statement analytical procedures
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Horizontal Analysis
• The percentage analysis of increases and decreases in related items in comparative financial statements
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Vertical Analysis
• A percentage analysis used to show the relationship of each component to the total within a single statement
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Benefits of Analysis
• Horizontal and vertical analysis are useful in assessing relationships and trends in financial conditions and operations of a business
• Vertical analysis is useful for comparing one company with another or with industry averages
• Both are made easier with common-size financial statements
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Common-Size Statements
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Learning Objective 2Learning Objective 2
Apply financial statement analysis to assess the solvency of a business
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Solvency and Profitability
• Solvency – the ability to meet debt obligations as they become due
• Profitability – the ability to earn income
Solvency and Profitability are interrelated!Solvency and Profitability are interrelated!
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Solvency Analysis
• Normally assessed by examining balance sheet relationships, using the following major analyses:– Current position analysis– Accounts receivable analysis– Inventory analysis– Ratio of fixed assets to long-term liabilities– Ratio of liabilities to stockholders’ equity– Number of times interest charges are earned
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Current Position Analysis
• Using measures to assess a business’s ability to pay its current liabilities – Working capital – current assets less current liabilities– Current ratio – current assets divided by current liabilities– Quick ratio – total “quick” assets divided by current
liabilities
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Current Position Analysis – Working Capital and Current Ratio
Lincoln CompanyLincoln Company
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Current Position Analysis – Quick Ratio
Quick AssetsQuick Assets$280,500$280,500
Quick AssetsQuick Assets$160,000$160,000
Quick Ratio = Quick Assets / Current LiabilitiesLincoln Quick Ratio = $280,500 / $210,000 = 1.3Jefferson Quick Ratio = $160,000 / $210,000 = .77
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Accounts Receivable Analysis
• Measures efficiency of collection• Reflects liquidity
Accounts receivable turnover = Accounts receivable turnover = Net SalesNet Sales Avg. A/RAvg. A/R
Days’ Sales in Receivables = Days’ Sales in Receivables = Avg. A/RAvg. A/R Net Sales/365Net Sales/365
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Accounts Receivable Turnover
The company increased its accounts receivable turnover by 38% measured in terms of the number of times receivables are collected within the year.
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Days’ Sales in Receivables
The company improved its collections of accounts receivable by 10.9 days in 2009 measured in days receivables have been outstanding.
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Inventory Analysis
• Measures inventory efficiency– Avoid tying up funds in inventory.– Avoid obsolescence.
• Reflects liquidity
Inventory turnover = Inventory turnover = COGSCOGS Avg. InventoryAvg. Inventory
Days’ Sales in Inventory = Days’ Sales in Inventory = Avg. InventoryAvg. InventoryCOGS/365COGS/365
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Inventory Turnover
The company turned its inventory 1 time more in 2009, measured in terms of the number of times inventory turns over within the year.
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Days’ Sales in Inventory
The company reduced the time it held inventory by nearly 28% in 2009 measured in days the inventory was held in warehouses.
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Ratio of Fixed Assets to Long-Term Liabilities
• Indicates the margin of safety for note-holders or bondholders• Indicates the ability to borrow additional funds on a long-term
basis
Fixed Assets (net)Fixed Assets (net) Long-term LiabilitiesLong-term Liabilities
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Ratio of Fixed Assets to Long-Term Liabilities
The company increased its margin of safety in financing fixed assets mainly by lowering long-term debt.
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Ratio of Liabilities to Stockholders’ Equity
• Indicates the margin of safety for creditors.• Indicates the ability to withstand adverse business conditions.
Total LiabilitiesTotal Liabilities Total Stockholders’ EquityTotal Stockholders’ Equity
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Ratio of Liabilities to Stockholders’ Equity
The ratio shows an increasing margin of safety for creditors.
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Number of Times Interest Charges Earned
• Indicates the general financial strength of the business. • Indicates the ability to withstand adverse business conditions.
Income before Taxes + Interest Expense Income before Taxes + Interest Expense Interest ExpenseInterest Expense
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Number of Times Interest Charges Earned
The number of times interest charges are earned improved from 12.2 to 28.1, a significant measure of safety for creditors.
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Learning Objective 3Learning Objective 3
Apply financial statement analysis to assess the profitability of a business
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Profitability Analysis
• Normally assessed by examining the income statement and balance sheet resources, using the following major analyses:– Ratio of net sales to assets– Rate earned on total assets– Rate earned on stockholders’ equity– Rate earned on common stockholders’ equity– Earnings per share on common stock– Price-earnings ratio– Dividends per share– Dividend yield
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Ratio of Net Sales to Assets
• Shows how effectively a firm utilizes its assets
Net SalesNet Sales Avg. Total Assets (excluding LT Investments)Avg. Total Assets (excluding LT Investments)
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Rate Earned on Total Assets
Interest Expense + Net IncomeInterest Expense + Net Income Avg. Total AssetsAvg. Total Assets
• Measures the profitability of total assets without considering how the assets are financed.
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Rate Earned on Stockholders’ Equity
Net IncomeNet Income Avg. Stockholders’ EquityAvg. Stockholders’ Equity
• Emphasizes the rate of income earned on the amount invested by the stockholders.
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Leverage
The company’s leverage of 3.1% for 2009 compares favorably with the 2.7% leverage for 2008.
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Rate Earned on Common Stockholders’ Equity
Net Income – Preferred DividendsNet Income – Preferred DividendsAvg. Common Stockholders’ EquityAvg. Common Stockholders’ Equity
• Focuses on the rate of profits earned on the amounts invested by the common stockholders.
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Earnings Per Share on Common Stock
Net Income – Preferred DividendsNet Income – Preferred DividendsCommon Shares OutstandingCommon Shares Outstanding
• The income earned for each share of common stock.
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Price-Earnings Ratio
Market Price Per Share of Common StockMarket Price Per Share of Common StockAnnual Earnings Per ShareAnnual Earnings Per Share
• Indicator of the firm’s future earnings prospects.
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Dividends per Share and Earnings per Share
Dividends per Share = Common Dividends Dividends per Share = Common Dividends Common SharesCommon Shares
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Dividends Per Share and Dividend Yield
Dividend Yield = Common Dividend/ShareDividend Yield = Common Dividend/Share Market Price/ShareMarket Price/Share
• Dividend yield shows the rate of return to common stockholders in terms of cash dividends.
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Learning Objective 5Learning Objective 5
Describe the contents of corporate annual reports
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Corporate Annual Reports
• Summarize operating activities for the past year and plans for the future.
• Many variations in the order and form, but all include:– Financial statements and notes– Management discussion and analysis– Independent auditors’ report
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Management Discussion and Analysis (MDA)
• Provides critical information in interpreting the financial statements and assessing the future of the company.
• Includes an analysis about past performance and financial condition.
• Discusses management’s opinion about future performance. • Discusses significant risk exposure.
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Independent Auditors’ Report
• Publicly traded companies must get an independent opinion on the fairness of the financial statements.
• This opinion must be included in the annual report along with an opinion on the accuracy of management’s internal control assertion.
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End of Chapter 9End of Chapter 9