Download hhtfa10_ch13_student_ppt

13-1
Copyright ©2015 Pearson Education Inc. All rights reserved.
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
Learning Objective
1. Perform horizontal analysis
13-2
Copyright ©2015 Pearson Education Inc. All rights reserved.
PERFORM HORIZONTAL ANALYSIS

Study of percentage changes from year-to-year

Two steps:
1. Compute dollar amount of change from one period
to the next
2. Divide dollar amount of change by base-period
amount
13-3
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Illustration: Amazon.com, Inc.
Amazon.com’s net sales (in millions) increased by 27.1%
during 2012, computed as follows:
Step 1 Compute the dollar amount
of change from 2011 to 2012
Step 2 Percentage change for the period
13-4
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Illustration: Amazon.com, Inc.
Exhibit 13-2 | Comparative Consolidated Statements of Operations—Horizontal
Analysis (partial exhibit)
13-5
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Illustration: Amazon.com, Inc.
Exhibit 13-3 | Consolidated Balance Sheets—Horizontal Analysis (partial exhibit)
13-6
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Illustration
Prepare a horizontal analysis of the comparative income
statements of Ama Music Co.
13-7
Advance slide in presentation mode to reveal $ Change and % Change
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Trend Percentages

Form of horizontal analysis

Base year selected and set equal to 100%

Amount of each following year stated as a percent of
base
13-8
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Trend Percentages
Amazon.com, Inc., showed income from operations as follows:
Trend percentages are computed by dividing each successive
year’s amount by the 2008 amount
13-9
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 1
Learning Objective
2. Perform vertical analysis
13-10
Copyright ©2015 Pearson Education Inc. All rights reserved.
PERFORM VERTICAL ANALYSIS

13-11
Shows relationship of a financial-statement item to its
base

Income statement, base is total revenue

Balance sheet, base is total assets
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 2
Illustration: Amazon.com, Inc.
Exhibit 13-4 | Comparative Consolidated Statements of Operations—Vertical
Analysis (partial exhibit)
13-12
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 2
Illustration: Amazon.com, Inc.
Exhibit 13-5 | Consolidated Balance Sheets—Vertical Analysis (partial exhibit)
13-13
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 2
Learning Objective
3. Prepare common-size financial statements
13-14
Copyright ©2015 Pearson Education Inc. All rights reserved.
PERPARE COMMON-SIZE FINANCIAL
STATEMENTS

Report only percentages (no dollar amounts)

Assists in the comparison of different companies

Expresses financial results in terms of a common
denominator
13-15
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 3
Calculate the common-size percentages for the following income statement:
Advance slide in
presentation
mode to reveal
answer
13-16
Copyright ©2015 Pearson Education Inc. All rights reserved.
Benchmarking

Compares company to a standard set by others

Facilitated by common-size statements

Has goal of improvement
Exhibit 13-6
13-17
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 3
Learning Objective
4. Analyze the statement of cash flows
13-18
Copyright ©2015 Pearson Education Inc. All rights reserved.
ANALYZE STATEMENT OF CASH FLOWS
Cash flow signs of a healthy company:
13-19

Net cash flow provided by operating activities
exceeds net income

Operations are the major source of cash

Investing activities include more purchases than sales
of long-term assets

Financing activities are not dominated by borrowing
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 4
ANALYZE STATEMENT OF CASH FLOWS
13-20
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 4
Learning Objective
5. Use ratios to make business decisions
13-21
Copyright ©2015 Pearson Education Inc. All rights reserved.
USE RATIOS TO MAKE BUSINESS
DECISIONS
Measuring ability to pay current liabilities
Measuring turnover and cash conversion cycle
Measuring leverage
Measuring profitability
Analyzing stock as an investment
13-22
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Ability to Pay Current Liabilities
Working
Capital
Current
Ratio
Quick
(Acid-test)
Ratio
13-23
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Ability to Pay Current Liabilities
Working Capital:
13-24

Measures ability to pay current liabilities with current
assets

Generally, the larger the working capital, the better
the ability to pay debts

Capital is total assets minus total liabilities

Like a “current” version of total capital
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Ability to Pay Current Liabilities
Current Ratio:
13-25

Measures ability to pay current liabilities with current
assets

In general, a higher current ratio indicates a stronger
financial position
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Ability to Pay Current Liabilities
Quick (Acid-test) Ratio:
13-26

Shows ability to pay all current liabilities if they come
due immediately (quickly)

Narrower base to measure liquidity than current ratio

Ratio of 0.90 to 1.00 is acceptable in most industries
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Inventory
Turnover
Days’ Sales
Outstanding
13-27
Accounts
Receivable
Turnover
Accounts
Payable
Turnover
Copyright ©2015 Pearson Education Inc. All rights reserved.
Cash
Conversion
Cycle
LO 5
Turnover and Cash Conversion Cycle
Inventory Turnover:
13-28

Measures number of times a company sells its
average level of inventory during a year

Varies widely with nature of business

Compare ratio over time as well as with industry
averages or competitors
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Days Inventory Outstanding:

13-29
Converts inventory turnover ratio into days
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Accounts Receivable Turnover:
13-30

Measures ability to collect cash from credit customers

In general, higher the ratio, the better

Tells how many times during the year average
receivables were turned into cash
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Days’ Sales Outstanding:
13-31

How many days’ sales remain in accounts receivable

How may days it takes to collect the average level of
receivables
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Accounts Payable Turnover:

13-32
Measures number of times per year that entity pays
off its accounts payable
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Days’ Payable Outstanding:

13-33
How many days it takes a company to pay off
accounts payable
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Turnover and Cash Conversion Cycle
Cash Conversion Cycle:

Shows overall liquidity by computing the total days it takes to
convert inventory to receivables and back to cash, less the
days to pay off its suppliers
13-34
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Leverage: Overall Ability to Pay Debts
Debt Ratio
13-35
TimesInterestEarned Ratio
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Leverage: Overall Ability to Pay Debts
Debt Ratio:
13-36

Indicates percentage of assets financed with debt

Ratio of 1 reveals that debt has financed all the assets

Ratio of 0.50 means that debt finances half the assets

Higher the ratio, greater the pressure to pay interest and
principal
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Leverage: Overall Ability to Pay Debts
Times-Interest-Earned Ratio:
13-37

Measures number of times operating income can cover
interest expense

Also called interest-coverage ratio

High ratio indicates ease in paying interest; a low value
suggests difficulty
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Illustration
Using the data on the next slide, calculate the following ratios
for 2014: (Round answers to two decimal places)
a. Working capital
b. Current ratio
c. Quick (acid-test) ratio
d. Debt ratio
e. Times-interest-earned ratio
13-38
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Illustration
Summary data:
13-39
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Illustration
a. Working
capital
$248,000
13-40
=
$455,000
-
Copyright ©2015 Pearson Education Inc. All rights reserved.
$207,000
LO 5
Illustration
b. Current Ratio
$455,000
2.20
=
$207,000
13-41
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Illustration
c. Quick Ratio
$193,000
.93
=
$207,000
13-42
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Illustration
d. Debt Ratio
$304,000
.60
=
$510,000
13-43
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Illustration
e. Times-
InterestEarned Ratio
$301,000
7.34
=
$41,000
13-44
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Operating
Income
Percentage
DuPont
Analysis
Rate of
Return on
Sales
Asset
Turnover
Rate of
Return on
Total Assets
Leverage
Ratio
Rate of
Return on
Equity
Earnings Per
Share
Gross Margin
Percentage
LO 5
13-45
Copyright ©2015 Pearson Education Inc. All rights reserved.
Measuring Profitability
Gross (Profit) Margin Percentage:

13-46
Amount of profit that the entity makes from merely
selling a product before other operating costs are
subtracted
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Operating Income (Profit) Percentage:
13-47

Measures percentage of profit earned from each sales
dollar in a company’s core business operations

Persistently high operating income compared to net
sales is an important determinant of earnings quality
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
DuPont Analysis:
Return on assets
Rate of
return on
sales
x
Net
income
Asset
turnover
Net sales
13-48
x
Leverage
ratio
x
Leverage
ratio
x
Average
total
assets
=
Return on
equity
=
Return on
equity
Average
total
assets
Net sales
x
Detailed analysis of return on
assets (ROA) and return on
common stockholders’ equity (ROE)
Net income
=
Average
common
equity
Copyright ©2015 Pearson Education Inc. All rights reserved.
Average
common
equity
Measuring Profitability
Rate of Return (Net Profit Margin Ratio) on Sales:
13-49

Shows percentage of each sales dollar earned as net
income

Higher the percentage, the more profit is being
generated by sales dollars
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Asset Turnover:
13-50

Measures amount of net sales generated for each dollar
invested in assets

Measure of how efficiently management is operating the
company

Companies with high asset turnover tend to be more
productive
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Rate of Return on Total Assets (ROA):

13-51
Measures how profitably a company uses its assets
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Leverage (Equity Multiplier) Ratio:

Measures

Impact of debt financing on profitability

Proportion of each dollar of assets financed with
stockholders’ equity
13-52
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Rate of Return on Common Stockholders’ Equity:

Shows relationship between net income and common
stockholders’ investment in the company—how much
income is earned for every $1 invested
13-53
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Measuring Profitability
Earnings per Share (EPS) of Common Stock:
EPS =
Net income – Preferred Dividends
Average number of shares of common
stock outstanding
13-54

Amount of net income earned for each share of
outstanding common stock

Most widely quoted of all financial statistics

Only ratio that appears on the income statement
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Analyzing Stock Investments
Price/Earnings
Ratio
Dividend
Yield
Book Value per
Share of
Common Stock
13-55
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Analyzing Stock Investments
Price-Earnings Ratio (Multiple):
13-56

Shows market price of $1 of earnings

Ratio, abbreviated P/E, appears in the Wall Street
Journal stock listings and online
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Analyzing Stock Investments
Dividend Yield:

13-57
Measures percentage of a stock’s market value returned
annually to stockholders as dividends
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Analyzing Stock Investments
Book Value per Share of Common Stock:

13-58
Indicates recorded accounting amount for each share of
common stock outstanding
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Limitations of Ratio Analysis
13-59

To be useful, ratios should be analyzed over a period of
years to consider all relevant factors

Any one year, or even any two years, may not represent
the company’s performance over the long term
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 5
Learning Objective
6. Use other measures to make investment
decisions
13-60
Copyright ©2015 Pearson Education Inc. All rights reserved.
Economic Value Added (EVA®)

Combines accounting and finance data

Measures if operations have increased stockholder
wealth

Positive EVA® suggests increase in wealth
EVA = Net income before taxes + Interest expense –
Capital charge
13-61
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 6
Economic Value Added (EVA®)
Capital charge =
13-62
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 6
Red Flags in Financial Statement Analysis
13-63

Earnings problems

Decreased cash flow

Too much debt

Inability to collect receivables

Buildup of inventories

Trends of sales, inventory and receivables
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 6
Efficient Markets

Market prices fully reflect all information

Managers cannot fool market with accounting
manipulations


13-64
Market sets fair price for stock
Appropriate investment strategy:

Manage risk

Diversify investments

Minimize transaction costs
Copyright ©2015 Pearson Education Inc. All rights reserved.
LO 6
Copyright
This work is protected by United States copyright law and is
provided solely for the use of instructors in teaching their courses
and assessing student learning. Dissemination or sale of any part of
this work (including on the World Wide Web) will destroy the integrity
of the work and is not permitted. The work and materials from it
should never be made available to students except by instructors
using the accompanying text in their classes. All recipients of this
work are expected to abide by these restrictions and to honor the
intended pedagogical purposes and the needs of other instructors
who rely on these materials.
Copyright ©2015 Pearson Education Inc. All rights reserved.