Download Horizontal Analysis

17
Financial Statement
Analysis
Student Version
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1
Describe basic financial
statement analytical
methods.
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1
Horizontal Analysis
The percentage analysis of increases
and decreases in related items using
comparative financial statements is
called horizontal analysis.
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1
Exhibit 1
Comparative
Balance
Sheet—
Horizontal
Analysis
Horizontal Analysis:
Difference
Base year (2009)
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$17,000
= 3.2%
$533,000
1
Exhibit 2
Comparative Schedule of Current
Assets—Horizontal Analysis
Horizontal Analysis:
Difference
$25,800
= 39.9%
Base year (2009) $64,700
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1
Exhibit 3
Comparative Income Statement—
Horizontal Analysis
Horizontal Analysis:
Increase amount $296,500
= 24.0%
Base year (2009) $1,234,000
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1
Exhibit 4
Comparative Retained Earnings
Statement—Horizontal Analysis
Horizontal Analysis:
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Increase amount
$37,500
Base year (2009)
$100,000
= 37.5%
X – whatever you are comparing X to*
X
*also known as the “base”
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Horizontal analysis shows trends over time.
Cautions about horizontal analysis
•
Many people will think of a simple linear
regression when they see a trend, which is
not always the case
•
Many people will make predictions based
on too few observations, and their
predictions may seem reasonable given their
limited frame of reference
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1
Vertical Analysis
A percentage analysis used to show
the relationship of each component
to the total within a single statement
is called vertical analysis.
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1
Vertical Analysis of
Balance Sheet
In a vertical analysis of the balance
sheet, each asset item is stated as a
percent of the total assets. Each
liability and stockholders’ equity item
is stated as a percent of the total
liabilities and stockholders’ equity.
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1
Exhibit 5
Comparative
Balance
Sheet—
Vertical
Analysis
Vertical Analysis:
Current assets
Total assets
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$550,000
= 48.3%
$1,139,500
1
Vertical Analysis of the
Income Statement
In a vertical analysis of the
income statement, each
item is stated as a percent
of net sales.
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1
Exhibit 6
Comparative Income
Statement—Vertical Analysis
Vertical Analysis:
Selling expenses $191,000
= 12.8%
Net sales
$1,498,000
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1
Common-Size Statements
In a common-sized statements, all
items are expressed as a percentage.
Common-sized statements are
useful in comparing the current
period with prior periods, individual
businesses, or one business with
with industry percentages.
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1
Exhibit 7
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Common-Sized Income Statement
2
Use financial statement
analysis to assess the
solvency of a business.
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Measures of solvency are important to determine the
ability of a business to pay its creditors.
If a business can’t pay it’s creditors, it is technically
BANKRUPT.
So, solvency is a very important topic!
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2
Working Capital
The excess of current assets of a business
over its current liabilities is called
working capital. The working capital is
often used in evaluating a company’s
ability to pay current liabilities.
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2
Working Capital = Current Assets – Current Liabilities
Current assets
Current liabilities
Working capital
2010
$550,000
–210,000
$340,000
2009
$533,000
–243,000
$290,000
Indicates the ability to pay bills as they come
due and pay for current operations.
Does not tell you what current expenses are.
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2
Current Ratio
The current ratio, sometimes
called the working capital
ratio or bankers’ ratio
measures a company’s ability
to pay its current liabilities.
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2
Current Ratio =
Current Assets
Current Liabilities
Shows the number of times assets could cover liabilities.
Indicates likelihood of payment of liabilities.
Current assets
Current liabilities
Current ratio
2010
$550,000
$210,000
2.6
$550,000
$210,000
2009
$533,000
$243,000
2.2
$533,000
$243,000
Again, however, it does not address expenses.
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2
Quick Ratio
A ratio that measures the “instant”
debt-paying ability of a company
is called the quick ratio or acidtest ratio.
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2
Quick assets are cash
and other current assets
that can be quickly
converted to cash.
The quick ratio deducts inventory and
uncollectible accounts allowances from
assets to determine the cash available to
repay debts.
2010
Quick assets:
Cash
Temporary Investments
Accounts receivable (net)
a. Total quick assets
b. Current liabilities
Quick ratio (a ÷ b)
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$ 90,500
75,000
115,000
$280,500
$210,000
1.3
2009
$ 64,700
60,000
120,000
$244,700
$243,000
1.0
Analysis Example
Step 1: Descriptions
Select the facts that give the reader a
Comprehensive and fair view
of the company’s operations.
This section should be primarily descriptive. Write the
narrative from an internal accountant’s perspective.
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Lincoln Company had net sales of $1,480,000 in 2010,
with operating expenses of $290,000.
Lincoln currently has $340,000 in working capital, an
increase of $50,000 over last year.
Our current ratio has improved from 2.2 to 2.6, and our
quick ratio has improved from 1.0 to 1.3.
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Analysis Example
Step 2: Comparisons
Make comparisons to other companies and industry.
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Lincoln’s primary competitors are Madison Company,
Sugarland Inc. and Bowland Ltd. The quick ratio for
competitors and the industry overall are displayed in
the table below.
Lincoln
Madison
Sugarland
Bowland
Industry
2009
1.0
3.0
.99
1.8
1.0
2010
1.3
6.0
.99
1.2
1.2
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Analysis Example
Step 3: Discussion
Evaluate the result of your analysis and explain any
differences (if you can) from media reports, competitor
press releases, or general economic news.
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Our current ratio of 1.3 is average compared to our
competitors and industry standards.
Madison Company has been selling off its real estate
holdings resulting in large inflows of cash for the last
two years, resulting in a higher than normal current
ratio.
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Lincoln Company had net sales of $1,480,000 in 2010,
with operating expenses of $290,000.
Lincoln currently has $340,000 in working capital, an
increase of $50,000 over last year.
Our current ratio has improved from 2.2 to 2.6, and our
quick ratio has improved from 1.0 to 1.3.
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Analysis Example
Step 4: Options
Describe options available to improve the ratios.
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In order to improve our quick ratio, we could also sell
off some of our fixed assets, as Madison is doing.
We may also consider: ?????
Brainstorming
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2
Accounts Receivable Turnover
The relationship between sales and
accounts receivable may be stated as
the accounts receivable turnover.
Collecting accounts receivable as
quickly as possible improves a
company’s solvency.
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2
Accounts Receivable Turnover =
a. Net sales
Accounts receivable (net):
Beginning of year
End of year
Total
b. Average (Total ÷ 2)
Accounts receivable turnover
(a ÷ b)
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Net Sales
Average Accounts
Receivable
2010
$1,498,000
2009
$1,200,000
$ 120,000
115,500
$ 235,000
$ 117,500
$ 140,000
120,000
$ 260,000
$ 130,000
12.7
9.2
If available, it is better to use credit sales rather than net
sales as the numerator. This gives a more accurate
picture of accounts receivable turnover.
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2
Average Collection Period
The number of days’ sales in
receivables is an estimate of the length
of time (in days) the accounts
receivable have been outstanding.
Number of Days’ =
Sales in Receivables
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Average Accounts
Receivable
Net Sales
365
Average Daily
Sales
2
2010
a. Average accounts receivable
(Total accounts
receivable ÷ 2)
Net sales
b. Average daily sales
(Sales ÷ 365)
Number of days’ sales in
receivables (a ÷ b)
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2009
$ 117,500
$1,498,000
$ 130,000
$1,200,000
$
$
4,104
28.6
3,288
39.5
The accounts receivables measures are helpful in
determining how quickly the accounts receivables will
generate cash.
These measures are used to evaluate the effectiveness
of the sales, credit, and collections policies and
procedures of a company.
To improve effectiveness in this area, changes to those
areas may need attention.
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Days Payables Outstanding
The number of days’ payables
outstanding is an estimate of the length
of time (in days) the accounts payables
have been outstanding.
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2010
a. Average accounts payable
(Total accounts
payable ÷ 2)
Cost of goods
b. Average cost of goods
(cogs ÷ 365)
Number of days’ cogs in
Payables (a ÷ b)
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2009
$ 117,500
$1,498,000
$ 130,000
$1,200,000
$
$
4,104
28.6
3,288
39.5
To adjust the accounts payable cycle, what
strategies might management consider?
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2
Inventory Turnover
The relationship between the
volume of goods (merchandise)
sold and inventory may be stated
as the inventory turnover. The
purpose of this ratio is to assess
the efficiency of the firm in
managing its inventory.
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2
Inventory Turnover =
a. Cost of goods sold
Inventories:
Beginning of year
End of year
Total
b. Average (Total ÷ 2)
Inventory turnover (a ÷ b)
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Cost of Goods Sold
Average Inventory
2010
2009
$1,043,000
$ 820,000
$ 283,000
264,000
$ 547,000
$ 273,500
$ 311,000
283,000
$ 594,000
$ 297,000
3.8
2.8
2
Number of Days’
Sales in Inventory
The number of days’ sales in
inventory is a rough measure
of the length of time it takes
to purchase, sell, and replace
the inventory.
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2
Average Inventory
Number of Days’
=
Sales in Inventory
Average Daily Cost of
Goods Sold
Cost of Goods Sold
365
a. Average inventory (Total ÷ 2)
Cost of goods sold
b. Average daily cost of goods
sold (COGS ÷ 365 days)
Number of days’ sales in
inventory (a ÷ b)
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2010
$ 273,500
$1,043,000
2009
$ 297,000
$ 820,000
$2,858
$2,247
95.7
132.2
In order to improve the inventory measures,
management may implement changes in product mix or
inventory management. Further information would be
needed to determine the correct course of action.
Possible actions include:
Offering more frequent sales promotions
Discounting obsolete inventory
Implementing just-in-time inventory practices
Adjusting re-order points
. . . More???
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The next three ratios measure the ability of the
company to obtain long-term financing for fixed assets.
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2
Ratio of Fixed Assets to
Long-Term Liabilities
The ratio of fixed assets to long-term
liabilities is a solvency measure that
indicates the margin of safety of the
noteholders or bondholders. It also
indicates the ability of the business to
borrow additional funds on a longterm basis. . . . . “Collateral”
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2
Ratio of Fixed Assets to
=
Long-Term Liabilities
Fixed Assets (net)
Long-Term
Liabilities
2010
a. Fixed assets (net)
b. Long-term liabilities
Ratio of fixed assets to
long-term liabilities (a ÷ b)
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$444,500
$100,000
4.4
2009
$470,000
$200,000
2.4
2
Debt-to-Capital Ratio
The relationship between the total
claims of the creditors and
owners—the ratio of liabilities to
stockholders’ equity—is a
solvency measure that indicates
the margin of safety for creditors.
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2
Total Liabilities
Ratio of Liabilities to
=
Stockholders’ Equity
Total Stockholders’
Equity
2010
a. Total liabilities
b. Total stockholders’ equity
Ratio of liabilities to
stockholders’ equity ( a÷ b)
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$310,000
$829,500
0.4
2009
$443,000
$787,500
0.6
2
Number of Times Interest
Charges Earned
Corporations in some industries normally
have high ratios of debt to stockholders’
equity. For such corporations, the relative
risk of the debtholders is normally
measured as the number of times interest
charges are earned (during the year),
sometimes called the fixed charge
coverage ratio.
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2
Number of Times Interest
=
Charges Earned
Income before income tax
a. Add interest expense
b. Amount available to meet
interest charges
Number of times interest
charges earned (b ÷ a)
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Income Before Income Tax
+ Interest Expense
Interest Expense
2010
2009
$162,500
6,000
$134,600
12,000
$168,500
$146,600
28.1
12.2
The three measures taken together tell creditors:
1. Long-term loans can be secured by fixed assets
2. Owners are “invested” in the assets
3. Earnings will cover interest payments
In order to improve the ability to secure long-term
loans, managers may:
•Provide additional equity
•Increase earnings
•Offer additional fixed assets to secure the loan
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Sometimes, creditors will accept preferred stock to
secure their loans. In that case they will use the
following calculation:
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2
Number of Times Preferred
Dividends Are Earned
The number of times interest charges
are earned can be adapted for use with
dividends on preferred stock.
Number of Times
Preferred Dividends =
Are Earned
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Net Income
Preferred Dividends
3
Use financial statement
analysis to assess the
profitability of a
business.
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The purpose of a business is to earn a
profit. If the investment in a business is
not earning at least as much as the same
amount of money invested in a certificate
of deposit or other investment vehicle,
why work so hard?
The next set of measures help to
determine whether the business is
profitable, and how it could be made more
profitable.
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3
Profitability Analysis
Profitability analysis focuses
primarily on the relationship
between operating results and
the resources available to a
business.
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Before we get started, let’s look at:
Net Sales: Sales after sales discounts and returns
&
Net Income: Generally, income after cost of goods and
operating expenses and before interest, taxes, and
depreciation and amortization (EBITDA, EBITD,
EBIT, etc.)
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3
Ratio of Net Sales to Assets =
a. Net sales
Total assets:
Beginning of year
End of year
Total
b. Average (Total ÷ 2)
Average Total
Assets
2010
$1,498,000
2009
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
Ratio of net sales to assets (a ÷ b)
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Net Sales
1.4
1.2
This measure shows how well assets are being used to
generate sales. Specific industries use variations of this
measure, such as:
Sales per square foot
Sales per room (hotel)
Sales per employee
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3
Rate Earned on Total Assets =
Net income
Plus interest expense
a. Total
Total assets:
Beginning of year
End of year
Total
b. Average (Total ÷ 2)
Rate earned on total
assets (a ÷ b)
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Net Income +
Interest Expense
Average Total Assets
2010
$ 91,000
6,000
$ 97,000
2009
$ 76,500
12,000
$ 88,500
$1,230,500
1,139,500
$2,370,000
$1,185,000
$1,187,500
1,230,500
$2,418,000
$1,209,000
8.2%
7.3%
Market Measures of Profitability
for Public Corporations
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3
Rate Earned on
=
Stockholders’ Equity
a. Net income
Stockholders’ equity:
Beginning of year
End of year
Total
b. Average (Total ÷ 2)
Rate earned on stockholders’
equity (a ÷ b)
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Net Income
Average Total
Stockholders’ Equity
2010
$ 91,000
2009
$ 76,500
$ 787,500
829,500
$1,617,000
$ 808,500
$ 750,000
787,500
$1,537,500
$ 768,750
11.3%
10.0%
3
Rate Earned on Common
=
Stockholders’ Equity
Net income
Less preferred dividends
a. Remainder—common stock
Common stockholders’ equity:
Beginning of year
End of year
Total
b. Average (Total ÷ 2)
Rate earned on common
stockholders’ equity (a ÷ b)
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Net Income –
Preferred Dividends
Average Common
Stockholders’ Equity
2010
91,000
9,000
82,000
2009
$ 76,500
9,000
$ 67,500
$ 637,500
679,500
$1,317,000
$ 658,500
$ 600,000
637,500
$1,237,500
$ 618,750
12.5%
10.9%
$
$
3
Net Income –
Preferred Dividends
Earnings per Share (EPS)
=
on Common Stock
Shares of Common Stock
Outstanding
Net income
Preferred dividends
a. Remainder—identified with
common stock
b. Shares of common stock
Earnings per share on common
stock (a ÷ b)
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2010
$91,000
9,000
2009
$76,500
9,000
$82,000
50,000
$67,500
50,000
$1.64
$1.35
3
Market Price per Share of
Common Stock
Price-earnings (P/E) ratio =
Earnings per Share on
Common Stock
Market price per share of
common stock
Earnings per share on common
stock
Price-earnings ratio on
common stock
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2010
2009
$41.00
$27.00
÷ 1.64
÷ 1.35
25
20
3
Dividends per Share =
Dividends
Shares of Common Stock
Outstanding
2010
2009
a. Dividends
$40,000 $30,000
b. Shares of common stock outstanding 50,000 50,000
Dividends per share of common stock
(a ÷ b)
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$0.80
$0.60
3
Dividends per Share of
Common Stock
Dividend Yield =
Market Price per Share of
Common Stock
a. Dividends per share of
common stock
b. Market price per share of
common stock
Dividend yield on
common stock
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2010
2009
$ 0.80
$ 0.60
41.00
27.00
2.0%
2.2%
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