MANAGERIAL ACCOUNTING (ACC720)

FINANCIAL STATEMENT ANALYSIS

Basics of Financial Statement Analysis

Analyzing financial statement involves:

Company liquidity

Short-term creditor: Ability of the borrower to pay obligation when they come due Important in evaluating the safety of loan

Profitability and Solvency

Long-term creditor and stockholder: Company ability to survive in long period of time Consider amount of debt in the companys capital structure Ability to meet interest payment Assess the likelihood of dividends and the growth potential of the stock

Need for comparative analysis

Comparisons bases:
Intracompany basis - Within company in the current year with the same item or relationship in one or more year period Industry averages - Compares with industry averages published by financial ratings organization Intercompany basis - Compares with the same items or relationship in one or more competing companies
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Tools of Analysis Vertical Analysis

Horizontal Analysis Ratio Analysis
Evaluate financial statement data by expressing each item in a financial statement as a percent of a base amount. Evaluate a series of financial statement data over a period of time.

Expresses the relationship among selected items of financial statement data.

Vertical Analysis
Also called common-size analysis.
Technique that expresses each financial statement item as a percent of base amount. Vertical analysis commonly applied to the balance sheet and the income statement. On a balance sheet current asset are 22% of total assets total asset being the base amount. On income statement selling expenses are 16% of net sales net sales being the base amount.
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Balance Sheet

Tips: Each item on BS divided by total assets/liability/stockholder equity = %

Income Statement

Tips: Each item on IS divided Net Sales = %

Intercompany Income Statement

Horizontal Analysis
Also called Trend Analysis is a technique for evaluating a series of financial statement data over period of time.

Purpose- To determine the increase or decrease that has taken place.

This change may be expressed as either an amount or percentage.

Example
ABC BERHAD Net Sales (in million)

2011 $19860

2010 $19,903

2009 $18,781

Change Since Base Period= Current Year Amount-Base Year Amount Base year Amount

2009 to 2010=$19,903-$18,781 $18,781 = 6%

2009 to 2011=$19,860-$18,781 $18,78 = 5.7%

Current Result in Relation to Base Period = Current Year Amount Base year Amount

ABC BERHAD Net sales (in million) In relation to base period 2009 2011 $19,860 105.7% 2010 $19,903 106.0% 2009 $18,781 100.0%
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Balance Sheets
QUALITY DEPARTMENT STORE INC. Condensed Balance Sheets December 31
Increase or (Decrease) During 2007

2007

2006

Amount

Percent

Assets Current assets Plant assets (net) Intangible assets Total assets Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders Equity C. stock, $1 par Retained earnings Total stockholders equity T. liabilities & stockholders equity
275,400 727,600 1,003,000 $1,835,000 270,000 525,000 795,000 $1,595,000 5,400 202,600 208,000 $240,000 2.0% 38.6% 26.2% 15.0% $344,500 487,500 832,000 $303,000 497,000 800,000 $41,500 (9,500) 32,000 13.7% (1.9%) 4.0% $1,020,000 800,000 15,000 $1,835,000 $945,000 632,500 17,500 $1,595,000 $75,000 167,500 (2,500) $240,000 7.9 % 26.5% (14.3%) 15.0%

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Balance Sheet
The significance change in the financial structure from 2010 to 2011 are:
In the assets section, plant assets (net) increased $167,500 or 26.5% ($167,500$632,500)

In the liabilities section, current liabilities increased $41,500 or 13.7% ($41,500$303,000)

In the stockholders equity section, retained earnings increased $22,600 or 38.6% ($202,600$525,000)

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Income Statement
QUALITY DEPARTMENT STORE INC. Condensed Income Statement For the Years Ended December 31

Increase or (Decrease) During 2007

2007 Sales Sales returns & allowances Net sales Cost of good sold Gross profit $2,195,000 98,000 2,097,000 1,281,000 816,000 2006 $1,960,000 123,000 1,837,000 1,140,000 697,000 Amount $235,000 (25,000) 260,000 141,000 119,000 Percent 12.0% (20.3%) 14.2% 12.4% 17.1%

Selling Expenses
Administrative Expenses Total operating expenses Income from operations Other revenues & gains Interest & dividends Other expenses & losses Interest expense Income before income taxes Income tax expense Net Income

253,000
104,000 357,000 459,000 9,000 36,000 432,000 168,2000 $263,800

211,500
108,500 320,000 377,000 11,000 40,500 347,500 139,000 $208,500

41,500
(4,500) 37,000 82,000 (2,000) (4,500) 84,500 29,200 $55,300

19.6%
(4.1%) 11.6% 21.8% (18.2%) (11.1%) 24.3% 21.0% 26.5%

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Income Statement
Horizontal analysis of the income statements shows the following changes:

Net sales increased $260,000, or 14,2% ($260,000$1,837,000)

Cost of goods sold increased $141,000, 0r 12.4% ($141,000$1,140,000)

Total operating expenses increased $37,000, or 11.6% ($37,000$320,000)

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Retained Earnings Statement

QUALITY DEPARTMENT STORE INC. Retained Earnings Statement For the Years Ended December 31 Increase or (Decrease) During 2007 2007 Retained earnings, Jan. 1 Add: Net income $525,000 263,800 788,800 2006 $376,500 208,500 585,000 Amount $148,500 55,300 203,800 Percent 39.4% 26.5%

Deduct: Dividends
Retained earnings, Dec. 31

61,200
$727,600

60,000
525,000

1,200
202,600

2.0%
38.6%

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RATIO ANALYSIS
Liquidity Ratio
Measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. Short-term creditors such as bankers and suppliers are particularly interested in assessing liquidity.

Ratios include the Current Ratio, the Acidtest Ratio, Receivables Turnover, and Inventory Turnover.
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Income Statement
QUALITY DEPARTMENT STORE INC. Condensed Income Statement For the Years Ended December 31 2009 Net sales Cost of good sold Gross profit Selling Expenses Administrative Expenses Total operating expenses Income from operations Other revenues & gains Interest & dividends Other expenses & losses Interest expense $ 2,097,000 1,281,000 816,000 253,000 104,000 357,000 459,000 9,000 36,000 2008 $ 1,837,000 1,140,000 697,000 211,500 108,500 320,000 377,000 11,000 40,500

Income before income taxes

Income tax expense Net Income

432,000
168,2000 $263,800

347,500
139,000 $208,500

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Balance Sheets
QUALITY DEPARTMENT STORE INC. Condensed Balance Sheets December 31 2009 2008

Assets
Current assets Cash Short-term investment Account Receivables (net) Inventory Prepaid expenses Total current assets Plant assets (net) Intangible assets Total assets 100,000 20,000 230,000 620,000 50,000 1,020,000 800,000 15,000 $1,835,000 155,000 70,000 180,000 500,000 40,000 945,000 632,500 17,500 $1,595,000

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Balance Sheets
QUALITY DEPARTMENT STORE INC. Condensed Balance Sheets December 31 2009 Liabilities 2008

Current liabilities
Long-term liabilities

$344,500
487,500

$303,000
497,000

Total liabilities
Stockholders Equity

832,000

800,000

C. stock, $1 par
Retained earnings Total stockholders equity T. liabilities & stockholders equity

275,400
727,600 1,003,000 $1,835,000

270,000
525,000 795,000 $1,595,000

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Ratio Analysis - Liquidity Ratio

Current Ratio
Compute the Current Ratio for 2009.
Current Assets Current Liabilities $1,020,000 $344,500

= Current Ratio

= 2.96 : 1

Industry average = 1.70:1 The ratio of 2.96:1 means that for every dollar of current liabilities, the company has $2.96 of current assets.
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Asid-test ratio
Compute the Asid-test ratio for 2009.
cash + short-term investment + receivables (Net)
Current Liabilities $100,000 + $20,000 + $230,000 Current Liabilities $344,500

Asid-test ratio

= 1.02 : 1

Industry average = 0.70:1

The acid-test ratio measures immediate liquidity.

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Receivables Turnover
Compute the Receivables Turnover for 2009.
Net Credit Sales
Average Net Receivables $2,9097,000 Current Liabilities ($180,000 + $230,000) / 2

Receivables turnover

= 10.2 times

Industry average = 46.4 times It measures the number of times, on average, the company collects receivables during the period.

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$2,9097,000

($180,000 + $230,000) / 2

= 10.2 times

A variant of the receivables turnover ratio is to convert it to an Average Collection Period in terms of days.

360 days / receivables turnover

360 days/ 10.2 times = 36 days

This means that receivables are collected on average every 36 days.

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Inventory Turnover
Compute the Inventory Turnover for 2009.
Cost of Good Sold
Average Inventory $1,281,000 Current Liabilities ($500,000 + $620,000) / 2

Inventory turnover

= 2.3 times

Industry average = 4.3 times Inventory turnover measures the number of times, on average, the inventory is sold during the period.

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$1,281,000

($500,000 + $620,000) / 2

= 2.3 times

A variant of inventory turnover is the days in inventory 360 days/ 2.3 times = 159 days

Inventory turnover ratios vary considerably among industries.

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Ratio Analysis - Profitability Ratio

Measure the income or operating success of a company for a given period of time. Income, or the lack of it, affects the companys ability to obtain debt and equity financing, liquidity position, and the ability to grow.

Ratios include the Profit Margin, Asset Turnover, Return On Assets, Return On Common Stockholders Equity, Earnings Per Share, Priceearnings, and Payout ratio.

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Profit Margin
Compute the Profit Margin for 2009.
Net Income
Net Sales $263,800 Current Liabilities $2,097,000 Profit Margin

= 12.6%

Industry average = 8.0%

Measures the percentage of each dollar of sales that results in net income.
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Asset Turnover
Compute the Asset Turnover for 2009.
Net Sales
Average Asset $2,097,000 Current Liabilities ($1,595,000 + 1,835,000) / 2 Asset Turnover

= 1.22 times

Industry average = 1.40 times

Measures how efficiently a company uses its assets to generate sales.

Asset turnovers shows that Quality generated sales of $1.22 for each dollar it invested in assets.
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Return on Assets
Compute the Return on Assets for 2009.
Net Income
Average Asset $263,800 Current Liabilities ($1,595,000 + 1,835,000) / 2 Return on Asset

= 15.4%

Industry average = 8.9%

An overall measure of profitability.

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Return on Common Stockholders Equity

Compute the Return on Common Stockholders Equity for 2009.
Net Income Average common Stockholders Equity Return on Common Stockholders Equity

$263,800 ($795,000 + 1,003,000) / 2

= 29.3%

Industry average = 18.3% Shows how many dollars of net income the company earned for each dollar invested by the owners.
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Earnings per Shares (EPS)

Compute the Earnings per Share (EPS) for 2009.
Net Income Weighted-Average Common Shares Outstanding $263,800 ($270,000 + 275,400) / 2 Earnings per Shares

= $0.97

A measure of the net income earned on each share of common stock.

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Payout Ratio
Compute the Payout Ratio for 2009.
Cash dividends Net Income Payout Ratio

$61,200 $263,800

= 23.2%

Industry average = 16.1% Measures the percentage of earnings distributed in the form of cash dividends.
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Ratio Analysis - Solvency Ratio

Solvency ratios measure the ability of a company to survive over a long period of time. Debt To Total Assets and Times Interest Earned are two ratios that provide information about debt-paying ability.

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Debt to Total Assets Ratio

Compute the Debt to Total Assets Ratio for 2009.
Total Debt Total Assets Debt to Total Assets Ratio

$832,000 $1,835,000

= 45.3%

Industry average = 34.2% Measures the percentage of the total assets that creditors provide.
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Times Interest Earned

Compute the Times Interest Earned for 2009.
Income before Incomes Taxes and Interest Expense Interest Expense Times Interest Earned

$ 459,000 + 9,000 $36,000

= 13 times

Industry average = 16.1 times Provides an indication of the companys ability to meet interest payments as they come due.
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SUMMARY LIQUIDITY RATIO

RATIO LIQUIDITY RATIO 1. Current Ratio Current assets Current liabilities 2. Acid-test (Quick) Ratio Cash + short-term investment + receivables (net) Current liabilities 3. Receivables Turnover Measures liquidity of receivables Measures short-term debt-paying ability FORMULA PURPOSE / USE

Measures immediate short-term liquidity

Net credit sales Averages net receivables

4.

Inventory Turnover

Cost of goods sold Average inventory

Measures liquidity of inventory

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SUMMARY PROFITABILITY RATIO

5. RATIO PROFITABILITY RATIO Profit Margin FORMULA PURPOSE / USE Net income Net sales Net sales Average assets 7. Return On Assets Net income Average assets Net income - preferred dividends Average common stockholders' equity Net income - preferred dividends Weighted-average common shares outstanding 10. Price-earnings (P-E) Ratio Market price per share of stock Measure net income generated by each dollars of sales Measures how efficiently assets are used to generate sales Measure profitability of assets

6.

Asset Turnover

8.

Return On Common Stockholders' Equity Earnings Per Share (EPS)

Measures profitability of owners investment Measures net income earned on each

9.

share of common stock

Measure the ratio of the market price per share to earnings per share Measure percentage of earnings distributed in the form of cash dividends

Earnings per share

11. Payout Ratio Cash dividends Net income

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SUMMARY SOLVENCY RATIO

RATIO SOLVENCY RATIOS 12 . Debt To Total Assets Ratio

FORMULA

PURPOSE / USE

Total debt Total assets

Measures the percentage of total assets provided by creditors Measures ability to meet interest payments as they come due

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Times Interest Earned

Income before income taxes & interest expenses Interest expenses

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