CHAPTER SEVEN

FINANCIAL STATEMENT ANALYSIS

OUTLINE
Users

of financial statement The importance of financial statement analysis Types of analysis:

y

Percentage Analysis:
Vertical Horizontal

Ratio Analysis
Liquidity Profitability Efficiency Solvency

USERS OF FINANCIAL STATEMENT

Managers Investors / Shareholders Potential Investors Creditors Regulatory Agencies Inland Revenue Consumers

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THE IMPORTANCE OF FINANCIAL STATEMENT

ANALYSIS

Helps interested users in making economic decisions:

Provide the trend of the business for a certain period of time. y Provide comparability among companies in the same industry.
y

Helps in forecasting the business s future performance

FINANCIAL ANALYSIS: COMPARISON BASIS

1 intracompany basis 2 industry averages 3 intercompany basis
Co. A Co. B Co. D Co. E Co. ABC Co. XYZ
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Company XYZ Year 1 Year 2

Co. C

TYPES OF ANALYSIS
Financial Statement Analysis Percentage Ratio i Liquidity Ratio i Profitability Ratio i Vertical Analysis i Efficiency Ratio i Solvency Ratio
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i Horizontal Analysis

HORIZONTAL ANALYSIS
} } Also known as trend analysis. Evaluates a series of financial statement data over a period of time. Purpose: to determine the increase or decrease that has taken place This change may be expressed as either an amount or a percentage.
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HORIZONTAL ANALYSIS
Evaluates: Income Statement

Balance Sheet

Formula:

Current Year Amount Base Year Amount Base Year Amount

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Baling Crest Sdn Bhd Comparative Balance Sheet As At Dec. 31, 2008 and 2009 2008 2009 Inc. (Dec) Amount % Fixed Asset: Office Equipment (net) 55,000 63,000 8,000 14.5 Current Asset: Cash 7,000 9,700 2,700 38.6 Accounts Receivable 10,000 18,000 8,000 80.0 Current Liabilities Liabilities: (2,000) (22.2) Accounts Payable 9,000 7,000 63,000 83,700 20,700 32.9 Owners Equity 63,000 83,700 63,000 83,700 20,700 20,700 32.9 32.9

Baling Crest Sdn Bhd Comparative Income Statement For the Years Ended Dec. 31, 2008 and 2009 2008 2009 Inc. (Dec) Amount % 16,000 13,200 2,800 (1,800) 8,900 16.2 29.7 5.1 (10.7) 74.2

Net Sales Cost of Goods Sold Gross Profit Selling Expenses Admin Expenses Net Income

99,000 44,500 54,500 16,800 12,000 25,700

115,000 57,700 57,300 15,000 20,900 21,400

(4,300) (16.7)

VERTICAL ANALYSIS
} Evaluates financial statement data expressing each item in a financial statement as a percent of a base amount.

Vertical analysis enables you to compare companies of different sizes.

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Baling Crest Sdn Bhd Comparative Balance Sheet As At Dec. 31, 2008 and 2009 2008 Fixed Asset: Office Equipment (net) Current Asset: Cash Accounts Receivable Current Liabilities: Liabilities Accounts Payable Total Assets Long Term Liabilities Owners Equity Total Liab & Equities Amt 55,000 7,000 10,000 % 76.4 9.7 13.9 2009 Amt % 63,000 9,700 18,000 7,000 90,700 45,000 38,700 90,700 69.5 10.7 19.8 7.7 100 49.6 42.7 100

12.5 9,000 72,000 100 30,000 33,000 72,000 41.6 45.8 100

Baling Crest Sdn Bhd Comparative Income Statement For the Years Ended Dec. 31, 2008 and 2009 2008 Amt Net Sales Cost of Goods Sold Gross Profit Selling Expenses Admin Expenses Net Income 99,000 44,500 54,500 16,800 12,000 25,700 % 100 45.0 55.0 17.0 12.0 26.0 2009 Amt % 115,000 57,700 57,300 15,000 20,900 21,400 100 50.2 49.8 13.0 18.2 18.6

RATIO ANALYSIS
}

Expresses the relationship among selected items of financial statement data. Classifications:
Liquidity Ratios Profitability Ratios Efficiency Ratios Solvency Ratios
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LIQUIDITY RATIOS
Measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. The ratios are: 5 Current Ratio (Working capital ratio) 5 Acid test ratio (Quick ratio)

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LIQUIDITY RATIO CURRENT RATIO / WORKING

CAPITAL RATIO

 measure for evaluating a companys liquidity and short-term debt-paying ability.

Current Assets Current ratio = Current Liabilities

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Eg: Current Assets Current Liabilities

2008 20,500 17,200

2009 26,700 29,600

Current ratio

20,500 17,200 = 1.19 : 1

26,700 29,600 = 0.90 : 1

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LIQUIDITY RATIO ACID TEST RATIO / QUICK RATIO

 is a measure of a companys short-term liquidity.

Acid test ratio

Quick Assets Current Liabilities

Quick asset includes cash, marketable securities and accounts receivable (excluding inventories).
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Eg: Current Assets Cash Accounts Receivable Inventories

2008 7,900 9,800 2,800 20,500 17,200 17,700 17,200 = 1.03 : 1

2009 8,700 12,000 6,000 26,700 29,600 20,700 29,600 = 0.70 : 1

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Current Liabilities Acid test ratio =

PROFITABILITY RATIOS
Measures of the income or operating success of a company for a given period of time. The ratios are: 5 Profit margin 5 Gross profit margin 5 Return on Assets 5 Return on Equity 5 Return on Common Equity 5 Earnings Per Share 5 Price - Earnings ratio
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PROFITABILITY RATIO PROFIT MARGIN

is a measure of the percentage of each dollar of sales that results in net income.

Profit margin

Net income Net sales

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Eg: Net Sales Less: Cost of Goods Sold

2008 45,000 20,200 24,800 Less: Operating Expenses Net income 14,200 10,600 = 10,600 45,000 = 23.56%

2009 52,700 23,600 29,100 14,600 14,500 14,500 52,700 = 27.51%

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Profit margin

PROFITABILITY RATIO GROSS PROFIT MARGIN

is a measure of the percentage of each dollar of sales that results in gross profit.

Gross profit margin =

Gross Profit Net Sales

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Eg: Net Sales Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Net income Gross profit margin =

2008 45,000 20,200 24,800 14,200 10,600 24,800 45,000 = 55.11%

2009 52,700 23,600 29,100 14,600 14,500 29,100 52,700 = 55.22%

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PROFITABILITY RATIO RETURN ON ASSETS

To assess the ability of the company in using its assets to earn net income without consideration in the financing of such assets.

Net income + Interest expense Return on assets = Average total assets Total assets year 1 + total assets year 2 2
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Average total assets =

Eg: Net income Interest Expense Total Assets (2007 = 69,900) Return on Assets 2008 =

2008 10,600 910 75,000

2009 14,500 760 82,000

10,600 + 910 (69,900 + 75,000 ) / 2

= 15.89% Return on Assets 2009 = 14,500 + 760 (75,000 + 82,000 ) / 2 = 19.44%

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PROFITABILITY RATIO RETURN ON EQUITY

To assess the ability of the company in managing the investments by shareholders to earn income. Net income Return on equity = Average total stockholders equity

= Total equity year 1 + total equity year 2 h Average total stockholders equity 2
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Eg: Net income Total Equities: Common Shares Preference Shares

2008 10,600 80,000 20,000 100,000

2009 14,500 86,000 20,000 106,000 14,500 (100,000 + 106,000 ) / 2 = 14.08%

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Return on Equity ( year 2009 )

PROFITABILITY RATIO RETURN ON COMMON EQUITY

To assess the ability of the company in managing the investments by common shareholders to earn its net income. Net income preferred dividends Average common stockholders equity

Return on common = equity

h Average common stockholders equity

Common equity year 1 + common equity year 2

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Eg: Net income Total Equities: Preferred Shares Common Shares * Dividends paid to preferred share Return on Common Equity ( year 2009 ) =

2008 RM 10,600 20,000 80,000 100,000

2009 RM 20,500 20,000 86,000 106,000 6,000

20,500 6,000 (80,000 + 86,000 ) / 2 = 17.47%

PROFITABILITY RATIO EARNINGS PER SHARE

a measure of net income earned on each share of common stock.

Earnings Per Share / EPS

Net income preferred dividends = average common shares outstanding (unit)

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Eg: Net income Total Equities: Common Shares (RM1.00 per share) Dividends paid to preferred Shares Earnings per share ( year 2009 ) =

2008 10,600

2009 20,500

80,000

86,000

4,500

6,000

20,500 6,000 (80,000 + 86,000 ) / 2 = RM0.17 per share

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PROFITABILITY RATIO PRICE EARNINGS RATIO

Measures the ratio of the market price of each share of common stock to the earnings per share.

Price Earnings Ratio / PE Ratio

Market price of common stock Earnings Per Share

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Eg: Average market price for common stock Earnings Per Share

2008 RM3.25 RM0.11

2009 RM4.62 RM0.17

Price Earnings Ratio / PE Ratio

RM3.25 RM0.11 = 29.5 times

RM4.62 RM0.17 = 27.2 times

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EFFICIENCY RATIOS
Measures of the efficiency and the ability of the company in managing its resources. The ratios are: 5 Inventory Turnover 5 Asset Turnover 5 Debtors Turnover / Receivable Turnover
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EFFICIENCY RATIO INVENTORY TURNOVER

i measures the number of times, on average, the inventory is sold during the period . Purpose: to measure the liquidity of the inventory.

Inventory Turnover

Cost of goods sold = Average inventory Opening inventory + closing inventory

 Average inventory =

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Eg: Cost of goods sold Inventories

2008 20,200 2,800

2009 23,600 6,000

Inventory turnover (2009)

23,600 = ( 2,800 + 6,000 ) / 2 = 5.4 times

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EFFICIENCY RATIO ASSETS TURNOVER

measures how efficiently a company uses its assets to generate sales. Net sales Assets turnover = Average total assets Total assets year 1 + total assets year 2 2
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 Average assets =

Eg: Net Sales Total Assets

2008 45,000 75,000

2009 52,700 82,000

Assets turnover (2009)

52,700 = ( 75,000 + 82,000 ) / 2 = 0.67 times

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EFFICIENCY RATIO RECEIVABLES TURNOVER

Used to assess the liquidity of the receivables. It measures the number of times, on average, receivables are collected during the period. Net credit sales Average net A/C Receivables $ Average net receivables A. R year 1 + A. R year 2 2
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Receivables turnover =

Eg: Net Credit Sales Accounts Receivable

2008 35,000 9,800

2009 45,700 12,000

Receivables turnover (2009)

45,700 ( 9,800 + 12,000 ) / 2 = 4.2 times

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SOLVENCY RATIOS
Measures of the ability of the company to survive over a long period of time. The ratios are: 5 Debt ratio 5 Equity ratio 5 Times Interest Earned
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SOLVENCY RATIO DEBT RATIO

measures the percentage of total assets provided by creditors.

Total liabilities Debt ratio = Total assets

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Eg: Total assets Total liabilities

2008 75,000 39,000

2009 82,000 52,000

39,000 Debt ratio = 75,000 = 52 %

52,000 82,000 = 63 %
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SOLVENCY RATIO EQUITY RATIO

measures the percentage of total assets provided by shareholders.

Total owners equity Equity ratio = Total assets

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Eg: Total assets Total equities

2008 75,000 69,000

2009 82,000 69,000

Equity ratio =

69,000 75,000 = 92 %

69,000 82,000 = 84 %
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SOLVENCY RATIO TIMES INTEREST EARNED

f provides an indication of the companys ability to meet interest payments as they come due.

Times interest earned =

Income before tax and interest expense Interest expense

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Eg: Income before tax and interest Interest Expense

2008 10,600 910

2009 14,500 760

Times interest earned =

10,600 910 = 11.65 times

14,500 760 = 19.1 times

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