Chapter 5.pptx fiannacial statement and analysis

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1. Basics of Analysis Chapter 5 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

2. • © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 2 • • • • Liquidity Measures a firm’s ability to meet its current obligations Leverage (borrowing capacity) Measures the degree of protector for long-term creditors Profitability Measures the earning ability of a firm I nve st o r - f o c u s e d Cash flow Indicate liquidity, borrowing capacity, and profitability Ratio Analysis

3. Ratio Analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 3 Interpreted in comparison with Prior ratios Competitor ratios Industry ratios Predetermined standards Trend and variability of a ratio are important considerations.

4. Complexities and Context © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 4 Use of average data from balance sheet accounts Necessary when comparing against income statement data Does not Eliminate cyclical or seasonal variations Capture changes that occur unevenly throughout the year Analysis must be performed and understood within the context of Native accounting principles Native business practices and culture

5. The use of percentages is usually preferable to the use of absolute amounts Vertical analysis All amounts of a year expressed as a percentage of a base amount (e.g., net sales revenue, total assets) Horizontal analysis Amounts for comparative years are expressed as a percentage of the base year amount © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 5 Common-Size Analysis

6. Chapter 5, Slide #6 Vertical Analysis Sales revenue $ 100,000 1 . % $ 95,000 100 . % $ 9 1 , 1 . % Cost of goods sold 6 5 , 65 . % 6 , 8 64 . % 5 6 , 4 2 6 2 . % Gross profit 3 5 , 35 . % 3 4 , 2 36 . % 3 4 , 5 8 3 8 . % Operating expenses: Selling expense 1 4 , 14 . % 1 1 , 4 12 . % 1 , 1 1 . % General expense 1 6 , 16 . % 1 5 , 2 16 . % 1 3 , 6 5 1 5 . % Total operating expense 3 , 30 . % 2 6 , 6 28 . % 2 3 , 6 5 2 6 . % Operating Income before taxes 5 , 5 . % 7 , 60 8 . % 1 , 9 3 1 2 . % Taxes related to operations 1 , 5 1 . 5 % 2 , 28 2 . 4 % 3 , 2 7 9 3 . 6 % Net Income $ 3 , 5 3 . 5 % $ 5,320 5 . 6 % $ 7,651 8 . 4 % 2 7 Melcher Company Income Statement For the Years Ended December 31 2 9 200 8 Each financial statement element is presented as a percentage of a designated base which is sales revenue on the Income Statement. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

7. Horizontal Analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 7 2009 2008 2007 2009 2008 2007 Sales revenue $ 100,000 $ 95,000 $ 91,000 1 09 . 9 % 1 4 . 4 % 100.0% Cost of goods sold 6 5 , 00 60 , 80 5 6 , 42 1 15 . 2 % 1 7 . 8 % 100.0% Gross profit 3 5 , 00 34 , 20 3 4 , 58 1 01 . 2 % 98 . 9 % 100.0% Operating expenses: Selling expense 1 4 , 00 11 , 40 1 , 00 1 40 . % 1 1 4 . % 100.0% General expense 1 6 , 00 15 , 20 1 3 , 65 1 17 . 2 % 1 1 1 . 4 % 100.0% Total operating expense 3 , 00 26 , 60 2 3 , 65 1 26 . 8 % 1 1 2 . 5 % 100.0% Operating Income before taxes 5 , 7 , 60 1 , 93 4 5 . 7 % 69 . 5 % 100.0% Taxes related to operations 1 , 5 2 , 28 3 , 27 9 4 5 . 7 % 69 . 5 % 100.0% Net Income $ 3 , 5 $ 5 , 32 $ 7,651 4 5 . 7 % 69 . 5 % 100.0% Melcher Company Income Statement For the Years Ended December 31 Each financial statement element is presented as a percentage of a base amount from a selected year.

8. Use both absolute and percentages Guidelines: When an item has value in the base year and none in the next period, the decrease is 100% A meaningful percent change cannot be computed when one number is positive and the other number is negative A percent change is incomputable when there is no figure for the base year. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 8 Year-to-Year Change Analysis

9. Financial components vary by type of industry Merchandising Inventory is a principal asset Sales may be primarily for cash or on credit Service Inventory is low or nonexistent Manufacturing Large inventory holdings Substantial investment in plant assets © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 9 Industry Variations

10. Narrative data Annual report Trade periodicals Industry reviews Further explains the financial position of a firm © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 10 Descriptive Information

11. • © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 11 Provides context for analysis of ratios and financial data • Common types Trend analysis SIC: Standard Industrial Classification. The U.S. Department of Labor provides website for searching for key words (http://www.osha.gov/pls/imis/sksearch.html) NAICS: North American Industry Classification System Industry averages; competitor comparisons C o m p a riso n s

12. A study of the financial history of a firm Longitudinal ratio comparison Falling Rising Relatively constant Highlight Effective management Evidence of problems © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 12 Comparisons: Trend Analysis

13. Classifies business by industry Defines industries in accordance with the composition and structure of the economy Coding structure Division Major group Industry group Industry Reported in SEC registrant filings © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 13 Comparisons: SIC

14. Joint creation of NAFTA partners: Canada, U.S., and Mexico Industry is defined by similar production processes Coding structure Sector, sub-sector, industry group, NAICS industry and national industry U.S. Census Bureau provides website: www.census.gov and under “business and industry click on NAICS. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 14 Comparisons: NAICS

15. Industry comparison complicated by highly diversified companies Financial services Base their analysis on industry placement Provide composite industry data © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 15 Comparisons: Industry

16. Comparisons: Caution © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 16 Ratios are subject to variance from : Inconsistent formula construction Optional (elective) accounting treatment Different fiscal year-ends Varying financial policies Inconsistent basis (before or after tax)

17. Relative Size of Firm © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 17 Comparison of disparate size firms Capital market access Economy of scale (purchasing) Wider customer base Information Absolute: amplifies comparison difficulty Common-size: eliminates some of the difficulty Percent of market helps to define relative size

18. Domestic private and public companies Up to 20 items of information are provided for each company listed Ward’s Business Directory went digital in 2007 under Gale Directory Library. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 18 Other Resources: Ward’s Business Directory

19. Companies listed on various stock exchanges Alphabetical by exchange NYSE American Stock Exchange NASDAQ stock market Regional exchanges © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 19 Other Resources: Standard & Poor’s Stock Reports

20. 2 - vo l u m es © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 20 – V1 – V2§2 Alphabetical by firm name Industries in 7 subsections Other Resources: Standard & Poor’s Register Of Corporations, Directors, And Executives

21. Other Resources: Standard & Poor’s Analyst’s Handbook Selected income statement and balance sheet items Related ratios Applicable to Standard & Poor’s industry group stock price indexes © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 21

22. The Users of Financial Statements © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 5, Slide # 22 Management Analyze information from the perspective of both investors and creditors Investors Analysis of past and present information to project the future prospects of the entity Creditors Short-term: focus is on current resources Long-term: consider the future prospects of the firm