CHAPTER18
Financial Statement
Analysis
18-1
PreviewofCHAPTER18
18-2
Basics of Financial Statement Analysis
Analyzing financial statements involves:
Comparison Tools of
Characteristics
Bases Analysis
Liquidity Intracompany Horizontal
Profitability Industry Vertical
Solvency averages Ratio
Intercompany
SO 1 Discuss the need for comparative analysis.
18-3
SO 2 Identify the tools of financial statement analysis.
Horizontal Analysis
Horizontal analysis, also called trend analysis, is a
technique for evaluating a series of financial statement data
over a period of time.
Purpose is to determine the increase or decrease that
has taken place.
Commonly applied to the balance sheet, income
statement, and statement of retained earnings.
18-4 SO 3 Explain and apply horizontal analysis.
Horizontal Analysis
Illustration 18-5
Horizontal analysis of
balance sheets
Changes suggest
that the company
expanded its asset
base during 2009
and financed this
expansion primarily
by retaining income
rather than assuming
additional long-term
debt.
18-5 SO 3 Explain and apply horizontal analysis.
Horizontal Analysis
Illustration 18-6
Horizontal analysis of
Income statements
Overall, gross profit
and net income were
up substantially.
Gross profit
increased
17.1%, and net
income, 26.5%.
Quality’s profit trend
appears favorable.
18-6 SO 3 Explain and apply horizontal analysis.
Horizontal Analysis
Illustration 18-7
Horizontal analysis of In the horizontal analysis of the balance sheet the ending
retained earnings
statements retained earnings increased 38.6%. As indicated earlier, the
company retained a significant portion of net income to
finance additional plant facilities.
18-7 SO 3 Explain and apply horizontal analysis.
Vertical Analysis
Vertical analysis, also called common-size analysis, is a
technique that expresses each financial statement item as
a percent of a base amount.
On an income statement, we might say that selling
expenses are 16% of net sales.
Vertical analysis is commonly applied to the balance
sheet and the income statement.
18-8 SO 4 Describe and apply vertical analysis.
Vertical Analysis
Illustration 18-8
Vertical analysis of
balance sheets
These results
reinforce the earlier
observations that
Quality is
choosing to
finance its growth
through retention
of earnings rather
than through
issuing additional
debt.
18-9 SO 4 Describe and apply vertical analysis.
Vertical Analysis
Illustration 18-9
Vertical analysis of
Income statements
Quality appears
to be a profitable
enterprise that is
becoming even
more successful.
18-10 SO 4 Describe and apply vertical analysis.
Vertical Analysis
Enables a comparison of companies of different sizes.
Illustration 18-10
Intercompany income
statement comparison
18-11 SO 4 Describe and apply vertical analysis.
Ratio Analysis
Ratio analysis expresses the relationship among selected
items of financial statement data.
Financial Ratio Classifications
Liquidity Profitability Solvency
Measures short- Measures the Measures the
term ability of the income or ability of the
company to pay its operating success company to
maturing of a company for a survive over a long
obligations and to given period of period of time.
meet unexpected time.
needs for cash.
SO 5 Identify and compute ratios used in analyzing a
18-12
firm’s liquidity, profitability, and solvency.
Ratio Analysis
A single ratio by itself is not very meaningful.
The discussion of ratios will include the
following types of comparisons.
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis
Liquidity Ratios
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 acid-test ratio,
receivables turnover, and inventory turnover.
SO 5 Identify and compute ratios used in analyzing a
18-14
firm’s liquidity, profitability, and solvency.
Ratio Analysis Liquidity Ratios
1. Current Ratio Illustration 18-12
Ratio of 2.96:1 means that for every dollar of current liabilities,
Quality has $2.96 of current assets.
SO 5 Identify and compute ratios used in analyzing a
18-15
firm’s liquidity, profitability, and solvency.
Ratio Analysis Liquidity Ratios
2. Acid-Test / Quick Ratio
Illustration 18-13
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis Liquidity Ratios
2. Acid-Test Ratio
Illustration 18-14
Acid-test ratio measures immediate liquidity.
SO 5 Identify and compute ratios used in analyzing a
18-17
firm’s liquidity, profitability, and solvency.
Ratio Analysis Liquidity Ratios
3. Receivables Turnover
Illustration 18-15
Measures the number of times, on average, the company collects
receivables during the period.
18-18 SO 5
Ratio Analysis Liquidity Ratios
Receivables Turnover
$2,097,000
= 10.2 times
($180,000 + $230,000) / 2
A variant of the receivables turnover ratio is to convert it to
an average collection period in terms of days.
365 days / 10.2 times = every 35.78 days
Receivables are collected on average every 36 days.
SO 5 Identify and compute ratios used in analyzing a
18-19
firm’s liquidity, profitability, and solvency.
Ratio Analysis Liquidity Ratios
4. Inventory Turnover
Illustration 18-16
Measures the number of times, on average, the inventory is sold
during the period.
18-20 SO 5
Ratio Analysis Liquidity Ratios
$1,281,000 Inventory Turnover
= 2.3 times
($500,000 + $620,000) / 2
A variant of inventory turnover is the days in inventory.
365 days / 2.3 times = every 159 days
Inventory turnover ratios vary considerably among
industries.
SO 5 Identify and compute ratios used in analyzing a
18-21
firm’s liquidity, profitability, and solvency.
Ratio Analysis
Profitability Ratios
Measure the income or operating success of a company for a
given period of time.
Income, or the lack of it, affects the company’s 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, price-earnings, and payout ratio.
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis Profitability Ratios
5. Profit Margin
Illustration 18-17
Measures the percentage of each dollar of sales that results in
net income.
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis Profitability Ratios
6. Asset Turnover
Illustration 18-18
Measures how efficiently a company uses its assets to generate
sales.
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis Profitability Ratios
7. Return on Asset
Illustration 18-19
An overall measure of profitability.
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis Profitability Ratios
8. Return on Common Stockholders’ Equity
Illustration 18-20
Shows how many dollars of net income the company earned for
each dollar invested by the owners.
18-26 SO 5
Ratio Analysis Profitability Ratios
9. Earnings Per Share (EPS)
Illustration 18-22
A measure of the net income earned on each share of common
stock.
18-27 SO 5
Ratio Analysis Profitability Ratios
10. Price-Earnings Ratio
Illustration 18-23
Measures the net income earned on each share of common stock.
18-28 SO 5
Ratio Analysis Profitability Ratios
11. Payout Ratio
Illustration 18-24
Measures the percentage of earnings distributed in the form of
cash dividends.
18-29 SO 5
Ratio Analysis
Solvency Ratios
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.
SO 5 Identify and compute ratios used in analyzing a
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firm’s liquidity, profitability, and solvency.
Ratio Analysis Solvency Ratios
12. Debt to Total Assets Ratio
Illustration 18-25
Measures the percentage of the total assets that creditors provide.
18-31 SO 5
Ratio Analysis Solvency Ratios
13. Times Interest Earned
Illustration 18-26
Provides an indication of the company’s ability to meet interest
payments as they come due.
18-32 SO 5
Ratio Analysis
Summary of Ratios
Illustration 18-27
18-33 SO 5
Summary of Ratios
Illustration 18-27
18-34 SO 5