Page 1

Title Page

• Chapter Title: Analysis of Financial Statements

• Authors: Wild and Shaw

• Relevant Edition: 9th Edition

• Copyright: McGraw Hill LLC, 2022

Page 2

Learning Objectives

Conceptual Objectives

• C1: Define the building blocks of analysis and the standards for comparisons.

Analytical Objectives

• A1: Summarize and report results of analysis.

• A2: Explain the form and assess the content of a complete income statement (Appendix 13A).

Procedural Objectives

• P1: Explain and apply methods of horizontal analysis.

• P2: Describe and apply methods of vertical analysis.

• P3: Define and apply ratio analysis.

Page 3

Defining Analysis

Learning Objective C1

• Focus on building blocks of analysis and standards of comparisons.

Page 4

Purpose of Financial Statement Analysis

• Common Goals:

  1. Evaluate company performance and financial condition.

  2. Assist in evaluating:

     • Past and current performance.

     • Current financial position.

     • Future performance and risk.

• Users of Analysis:

  • Internal Users: Managers, Officers, Internal Auditors.

  • External Users: Shareholders, Lenders, Suppliers.

Page 5

Building Blocks of Analysis

• Key Areas:

  • Liquidity and Efficiency

  • Solvency

  • Profitability

  • Market Prospects

Page 6

Information for Analysis

General-purpose Financial Statements Include:

1. Income Statement

2. Balance Sheet

3. Statement of Stockholders’ Equity

4. Statement of Cash Flows

5. Notes to the Financial Statements

Page 7

Standards for Comparison

• Importance of Standards: Essential to interpret analysis results.

Types of Standards:

• Intracompany

• Competitor Analysis

• Industry Benchmarks

• Guidelines

Page 8

Tools of Analysis

Types of Analysis:

1. Horizontal Analysis: Comparing financial condition and performance across time.

2. Vertical Analysis: Comparing financial condition and performance to a base amount.

3. Ratio Analysis: Measurement of key relations between financial statement items.

Page 9

Methods of Horizontal Analysis

Learning Objective P1

• Focus on explanation and application of horizontal analysis methods.

Page 10

Overview of Horizontal Analysis

• Definition: Review of financial statement data across time.

Learning Objective P1

• Emphasis on horizontal analysis methods.

Page 11

Comparative Statements: Dollar Change

• Process for Measuring Changes:

  • Compare analysis period against base period.

  • Analysis period: Current financial statements.

  • Base period: Financial statements for comparison.

Page 12

Comparative Statements: Percent Change

• Calculation Method:

  • Divide the dollar change by the base period amount, then multiply by 100.

• Note: Four cases require additional analysis.

Page 13

Comparative Balance Sheets

• Example: Exhibit 13.1 (Refer to text for visual).

Learning Objective P1

• Reinforcement of horizontal analysis methods.

Page 14

Trend Analysis: Equation

• Purpose: Reveal patterns in data across periods.

Learning Objective P1

• Application of trend analysis in interpretation.

Page 15

Trend Analysis: Illustration

• Step-by-step method for identifying trend percents by comparing current years to a base year.

• Exhibit 13.3: Calculation and data presentation.

Page 16

Exercise 13-3: Computing and Analyzing Trend Percents

• Objective: Compute trend percents for specific accounts.

  • Data from 2017 as base year for comparison across 2018-2021.

Page 17

Exercise 13-3 Analysis Results

Summary of Trends:

1. Sales Trend: Favorable (increase).

2. Cost of Goods Sold Trend: Unfavorable (increase outpaces sales).

3. Accounts Receivable Trend: Unfavorable (increase exceeds sales growth).

Page 18

Learning Objective P2

Overview

• Focus on describing and applying methods of vertical analysis.

Page 19

Vertical Analysis Overview

• Definition: Creation of common-size statements for comparison.

Page 20

Common-Size Balance Sheet

• Example: Exhibit 13.8 (Refer to text for details).

Page 21

Data Visualizations

• Significance of visuals in understanding financial statement data.

  • Exhibits on common-size graphics demonstrated with income statements and assets.

Page 22

Exercise 13-4: Computing Common-Size Percents

• Task: Compute common-size percents from comparative income statements.

• Analysis of item impacts on net income decline.

Page 23

Exercise 13-4 Analysis Results

Findings:

• Increase in Cost of Goods Sold is primary reason for net income decline.

  • Current year net income percent vs. prior year indicates substantial decline.

Page 24

Exercise 13-5: Income Effect Analysis

• Task: Use common-size and trend percents to determine income changes over three years.

Page 25

Exercise 13-5 Supporting Calculations

• Analyzed common-size net income percent.

  • Net income has decreased over three years.

Page 26

Learning Objective P3

Overview

• Focus on defining and applying ratio analysis techniques.

Page 27

Ratio Analysis Overview

• Key areas of focus:

  • Liquidity and Efficiency

  • Solvency

  • Profitability

  • Market Prospects

Page 28

Liquidity and Efficiency Ratios

• Important Ratios:

  • Working Capital

  • Current Ratio

  • Acid-test Ratio

  • Accounts Receivable Turnover

  • Inventory Turnover

  • Days’ Sales Uncollected

  • Days’ Sales in Inventory

  • Total Asset Turnover

Page 29

Working Capital

• Definition: Current assets minus current liabilities.

• Importance: Indicates liquidity and ability to meet obligations.

Page 30

Current Ratio

• Definition: Measures short-term debt-paying ability.

• Implication: A higher ratio indicates stronger ability to meet obligations.

Page 31

Acid-Test Ratio

• Definition: Similar to current ratio but excludes certain current assets.

• Purpose: Measures liquidity more conservatively.

Page 32

Accounts Receivable Turnover

• Definition: Indicates how many times receivables are converted into cash within a period.

Page 33

Inventory Turnover

• Definition: Measures how long inventory is held before sales occur.

Page 34

Days’ Sales Uncollected

• Definition: How frequently accounts receivable are collected.

Page 35

Days’ Sales in Inventory

• Definition: Measures the liquidity of inventory.

Page 36

Total Asset Turnover

• Definition: Assesses how effectively a company utilizes its assets for generating sales.

Page 37

E13-6/8 Data Overview

• Showcases Simon Company’s assets, liabilities, and equity over three years.

Page 38

Exercise 13-7: Analyzing Liquidity

• Task: Compute current and acid-test ratios for Simon Company.

Page 39

Exercise 13-7 Current Ratio Analysis

Results:

• Current Ratio:

  • Current Year: 1.88:1 (worsened).

  • 1 Year Ago: 2.52:1.

  • 2 Yrs Ago: 2.87:1.

• Analysis: Liquidity deteriorated over three years.

Acid-Test Ratio Analysis

• Current Year: 0.93:1 (worsened).

• Previous years' ratios confirmed decline in short-term liquidity.

Page 40

Exercise 13-8: Analyzing and Interpreting Liquidity

Tasks and Goals:

• Compute various ratios regarding liquidity for Simon Company and determine their trends.

Page 41

Exercise 13-8 Results

Analytical Outcomes:

1. Days' Sales Uncollected: Increased (worsened).

2. Accounts Receivable Turnover: Decreased (worsened).

3. Inventory Turnover: Decreased (worsened).

4. Days' Sales in Inventory: Increased (worsened).

Page 42

Solvency Ratios

Types of Ratios:

• Debt Ratio

• Equity Ratio

• Debt-to-Equity Ratio

• Times Interest Earned

Page 43

Debt Ratio and Equity Ratio

• Debt Ratio: Measures total liabilities as a percent of total assets.

• Equity Ratio: Measures total equity as a percent of total assets.

Page 44

Debt-to-Equity Ratio

• Indicates the proportion of a company's assets financed by creditors.

• A higher ratio implies less opportunity for expansion using debt.

Page 45

Times Interest Earned Ratio

• Most common measure of a company's ability to pay interest expenses.

Page 46

Exercise 13-9: Analyzing Risk and Capital Structure

Tasks:

1. Compute debt ratio, equity ratio, debt-to-equity ratio, and times interest earned for Simon Company.

Page 47

Exercise 13-9 Analysis and Results

Findings:

1. Debt and Equity Ratios: Improved.

2. Debt-to-Equity Ratio: Increased (more debt).

3. Times Interest Earned: Improved; company less risky for creditors.

Page 48

Profitability Ratios

Key Ratios:

• Profit Margin

• Return on Equity

• Return on Total Assets

• Gross Margin Ratio

Page 49

Gross Margin Ratio

• Measures percent of gross margin in relation to net sales.

Page 50

Profit Margin Ratio

• Assesses a company's ability to earn net income from sales.

Page 51

Return on Total Assets

• Evaluates how efficiently assets generate profit.

• Relation between profit margin, total asset turnover, and return on total assets discussed.

Page 52

Exercise 13-10: Analyzing Efficiency and Profitability

Tasks:

• Compute various ratios for both current and prior years.

Page 53

Exercise 13-10 Results and Analysis

1. Profit Margin: Declined (worsened).

2. Total Asset Turnover: Slight increase.

3. Return on Total Assets: Decreased (worsened).

Page 54

Return on Equity

• Indicates how well the company earns income for its shareholders.

Page 55

Market Prospects Ratios

Key Ratios:

• Price-Earnings Ratio

• Dividend Yield

Page 56

Price-Earnings Ratio

• Measures market expectations for future growth potential.

Page 57

Dividend Yield

• Assesses dividend-paying performance for investment comparisons.

Page 58

Exercise 13-11: Analyzing Profitability

Tasks:

• Calculate various profitability ratios.

Page 59

Exercise 13-11 Results

Findings:

1. Return on Equity: Computed for current vs prior year.

2. Dividend Yield: Slight increase.

3. Price-Earnings Ratio: Increased; analysis reflects higher market expectations.

Page 60

Summary of Ratios

• Exhibit 13.16 provides visual reference of various financial ratios.

Page 61

Conclusion

• Recognition of the transformative impact of learning on financial analysis.