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Chapter 13
Measuring and Evaluating
Financial Performance
PowerPoint Author:
Brandy Mackintosh, CA
Copyright © 2016 by McGraw-Hill Education
Learning Objective 13-1
Describe the purpose and
uses of horizontal, vertical,
and ratio analyses.
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Horizontal, Vertical, and Ratio
Analyses
Horizontal (trend) analyses are conducted to help financial statement
users recognize important financial changes that unfold over time.
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Gross Profit in 2013
Trend Analysis
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Gross Profit in 2014
Δ in Gross Profit $
and/or % from 2013
Vertical analyses focus on important relationships between items on the
same financial statement.
2014
Amount
Sales
Cost of Goods Sold
Gross Profit
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$200,000
150,000
$ 50,000
Percent
100%
75%
25%
Horizontal, Vertical, and Ratio
Analyses
Ratio analyses are conducted to understand relationships among various
items reported in one or more of the financial statements.
Receivable
Turnover
Ratio
=
Net Sales Revenue
Average Net Receivables
It is essential to understand that no analysis is complete unless it leads
to an interpretation that helps financial statement users understand and
evaluate a company’s financial results
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Learning Objective 13-2
Use horizontal (trend) analysis
to recognize financial changes
that unfold over time.
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Horizontal (Trend) Computations
Trend analyses are usually calculated in terms of
year-to-year dollar and percentage changes.
Let’s look at an example
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Horizontal (Trend) Computations
$53,417 – $50,521
× 100
$50,521
Now let’s calculate the percentage
Calculate
Now
Can
let’s
the
youlook
change
calculate
at the
in remainder
dollars
the dollar
forand
Net
of the
Sales
change in Net Sales Revenue between
Revenue
trend
percentage
analysis
between
change
offiscal
the Income
for
2013
Cost
and
Statement.
of Sales?
fiscal 2012.
fiscal 2013 and fiscal 2012.
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Learning Objective 13-3
Use vertical (common size)
analysis to understand
important relationships within
financial statements.
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Vertical (Common Size) Computations
Vertical, or common size, analysis focuses on
important relationships within financial statements.
Income Statement
Sales = 100%
Balance Sheet
Total Assets = 100%
Cost of Sales
× 100
Net Sales Revenue
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Learning Objective 13-4
Calculate financial ratios to
assess profitability, liquidity,
and solvency.
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Ratio Computations
Ratio analysis compares the amounts for one or more line
items to the amounts for other line items in the same year.
Ratios are classified into three categories . . .
Solvency ratios
examine a company’s
ability to pay
interest and repay
debt when due.
Profitability ratios
examine a company’s
ability to generate
income.
Liquidity ratios
help us determine if a
company has sufficient
current assets to repay
liabilities when due.
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Common Profitability Ratios
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Common Liquidity Ratios
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Common Solvency Ratios
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Learning Objective 13-5
Interpret the results of
financial analyses.
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Interpreting Horizontal and Vertical
Analyses
Lowe’s began relying more on debt and
less equity financing. Total liabilities
increased 11 percent and stockholders’
equity decreased by 14.5%.
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Lowe’s assets
grew only by
0.2% in fiscal
2013.
Interpreting Horizontal and Vertical
Cost of sales and operating expenses
Analyses are the most important determinants of
the company’s profitability.
Much of the increase
in Net Income in fiscal
2013 is explained by
greater control of the
Cost of Sales and
Operating Expenses.
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Interpreting Horizontal and Vertical
Analyses
Lowe’s has experienced a small
Lowe’s did a better job of
controlling its Operating
Expenses between 2012
and 2013.
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decrease in its percentage of Cost of
Sales in relation to Sales Revenue from
fiscal 2012 to 2013. Decreasing cost of
sales means higher Gross Profit.
Ratio
Calculations
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Ratio Calculations
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Profitability Ratios
Net Profit Margin – The slowly improving economy helped boost
Lowe’s profits in 2013 as shown by the increase in Net Profit Margin.
Gross Profit Percentage – Lowe’s gross profit percentage indicates
how much profit was made on each dollar of sales after deducting
the Cost of Goods Sold.
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Profitability Ratios
Fixed Asset Turnover – indicates how much revenue the company
generates in sales for each dollar invested in fixed assets,
Home Depot 2013 fixed asset turnover ratio was 3.32
Return on Equity (ROE) – Compares the amount of net income to
average stockholders’ equity. ROE reports the net amount earned
during the period as a percentage of each dollar contributed by
stockholders and retained in the business.
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Profitability Ratios
Earnings Per Share (EPS) – Shows the amount of earnings
generated for each share of outstanding common stock.
Price /Earnings (P/E) Ratio – Shows the relationship between EPS
and the market price of one share of the company’s stock.
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Liquidity Ratios
Let’s change our attention to an examination of liquidity
ratios. The analyses in this section focus on the
company’s ability to survive in the short term, by
converting assets to cash that can be used to pay current
liabilities as they come due.
Receivable Turnover Ratio – Most retail home improvement
companies have low levels of accounts receivable relative to sales
revenue because they collect the majority of their sales
immediately in cash.
Receivable
Turnover
Ratio
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=
Net Sales Revenue
Average Net Receivables
Liquidity Ratios
Inventory Turnover Ratio – The inventory turnover ratio indicates how
frequently inventory is bought and sold. The “days to sell” indicates the
average number of days needed to sell each purchase of inventory.
Home Depot sells its inventory in an average of 77 days in 2013.
Current Ratio – The current ratio measures the company’s ability to
pay its current liabilities
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Solvency Ratios
Debt to Assets Ratio – indicates the proportion of total assets that
creditors finance.
In 2013, The Home Depot had a debt-to-assets ratio of 69 percent.
Times Interest Earned – indicates how many times the company’s
interest expense was covered by its operating results.
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Learning Objective 13-6
Describe how analyses
depend on key accounting
decisions and concepts.
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Underlying Accounting Decisions
and Concepts
Accounting Decisions
Difference in Strategies,
e.g., type of financing.
Difference in Operations,
e.g., quality of items sold.
Difference in Accounting
Methods, e.g., FIFO vs.
LIFO.
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Accounting Concepts
Companies may elect to use any acceptable generally
accepted accounting principle (GAAP) as long as they
apply the principle consistently.
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Conceptual Framework for Financial
Accounting and Reporting
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Factors Contributing to Going-Concern
Problems
Factors that commonly contribute to
going-concern problems are listed below.
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Chapter 13
Supplement 13A
Nonrecurring and Other Special
Items
Copyright © 2016 by McGraw-Hill Education
Learning Objective 13-S1
Describe how nonrecurring
and other comprehensive
income items are reported.
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Nonrecurring Items




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Extraordinary Items
Very few events qualify as
extraordinary items.
Cumulative Effect of Changes in
Accounting Methods
Direct adjustment to Retained Earnings rather
than income reporting.
Discontinued Operations
For discontinued component two items are reported:
1. Operating income prior to the date of disposal.
2. Gain or loss on sale or disposal of net assets.
Nonrecurring Items
NONRECURRING ITEM
Discontinued Operations.
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Other Special Items
Comprehensive Income includes:
1. Gains or losses from certain foreign currency
exchange rate changes.
2. Gains or losses resulting from the change in value
of certain types of investments.
Excluded from net income
because they are likely to
disappear before they are
ever realized.
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Chapter 13
Supplement 13B
Reviewing and
Contrasting IFRS and
GAAP
Copyright © 2016 by McGraw-Hill Education
Learning Objective 13-S2
Describe significant
differences between GAAP
and IFRS.
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Overview
At a basic level both IFRS and GAAP are concerned with
accounting rules that describe
1) when an item should be recognized in the accounting
system,
2) how that item should be classified (asset , liability, equity,
expense, or revenue), and
3) the amount at which each item should be measured.
IFRS
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Yes
Report fixed assets at
fair value.
No
GAAP
End of Chapter 13
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