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CHAPTER 13

CHAPTER 13. Financial Statement Analysis. Learning Objective. To describe factors associated with communicating useful information. LO1. Factors in Communicating Useful Information.

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CHAPTER 13

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  1. CHAPTER 13 Financial Statement Analysis

  2. Learning Objective To describe factors associated with communicating useful information LO1

  3. Factors in Communicating Useful Information The primary objective of accounting is to provide information useful for decision making. To provide information that supports this objective, accountants must consider the following: Users Types of Decisions Means of Analysis

  4. Learning Objective To differentiate between horizontal and vertical analysis LO2

  5. Methods of Analysis Horizontal Analysis Vertical Analysis Ratio Analysis

  6. Milavec Company Financial Statements

  7. Milavec Company Financial Statements

  8. Absolute Amounts Percentage Analysis Horizontal Analysis Horizontal analysis (or trend analysis) refers to studying the behavior of individual financial statement items over several accounting periods.

  9. Milavec Company Horizontal Analysis

  10. Vertical Analysis Vertical analysis uses percentages to compare individual components of financial statements to a key statement figure. A common-sizefinancial statement is a vertical analysis in which each financial statement item is expressed as a percentage.

  11. Vertical Analysis of Income Statement In income statements, all items are usually expressed as a percentage of sales.

  12. Milavec Company Vertical Analysis

  13. Vertical Analysis of Balance Sheet In balance sheets, all items are usually expressed as a percentage of total assets.

  14. Learning Objective To explain ratio analysis LO3

  15. Ratio Analysis Ratio analysis involves studying various relationships between different items reported in a set of financial statements.

  16. Learning Objective To calculate ratios for assessing a company’s liquidity LO4

  17. Liquidity Ratios • Liquidity ratios indicate a company’s ability to pay short-term debts. They focus on current assets and current liabilities. • Working Capital • Current Ratio • Quick Ratio • Accounts Receivable Ratios • Inventory Ratios

  18. The excess of current assets over current liabilities is known as working capital. Working Capital

  19. The current ratio measures a company’s short-term debt paying ability. Current Ratio Current Assets Current Liabilities = Current Ratio A declining ratio may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories.

  20. Current Ratio

  21. Acid-Test Ratio Quick Assets Current Liabilities = Quick (Acid-Test) Ratio Quick assets include Cash, Current Marketable Securities, and Accounts Receivable. This ratio measures a company’s ability to meet obligations without having to liquidate inventory.

  22. Quick (Acid-Test) Ratio

  23. Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable = Accounts Receivable Turnover This ratio measures how many times a company converts its receivables into cash each year.

  24. Accounts Receivable Turnover

  25. Average Collection Period 365 Days Accounts Receivable Turnover = Average Collection Period 365 Days 16.98 Times = = 21 days Average Days to Collect Receivables This ratio measures, on average, how many days it takes to collect an accounts receivable.

  26. This ratio measures how many times a company’s inventory has been sold and replaced during the year. Inventory Turnover Cost of Goods Sold Average Inventory = Inventory Turnover

  27. Inventory Turnover INSERT Insert 20, p. 543, Text Box here

  28. Average Sale Period 365 Days Inventory Turnover = Average Sale Period 365 Days 10.80 Times = = 34 days Average Days to Sell Inventory This ratio measures how many days, on average, it takes to sell the inventory.

  29. Learning Objective To calculate ratios for assessing a company’s solvency LO5

  30. Solvency Ratios • Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure. • Debt to Assets Ratio • Debt to Equity Ratio • Number of Times Interest Earned • Plant Assets to Long-Term Liabilities

  31. This ratio measures the percentage of a company’s assets that are financed by debt. Debtto Assets Ratio Total Liabilities Total Assets = Debt to Assets Ratio

  32. This ratio indicates the relative proportions of debt to equity on a company’s balance sheet. Debtto Equity Ratio Total Liabilities Stockholders’ Equity = Debt to Equity Ratio Stockholders like a lot of debt if the company can take advantage of positive financial leverage. Creditors prefer less debt and more equity because equity represents a buffer of protection.

  33. Debt to Assets and Debt to Equity Ratios

  34. Number of TimesInterest is Earned Ratio Earnings before Interest Expense and Income Taxes Interest Expense Times Interest Earned = This is the most common measure of a company’s ability to provide protection for its long-term creditors.

  35. Number of Times Interest Earned Ratio

  36. Net Plant Assets Long-Term Liabilities Plant Assets to Long-Term Liabilities = Plant Assets to Long-Term Liabilities This ratio suggests how well long-term debt is managed to finance long-term assets.

  37. Plant Assets to Long-Term Liabilities

  38. Learning Objective To calculate ratios for assessing company management’s effectiveness LO6

  39. Profitability Ratios • Profitability ratios measure a company’s ability to generate earnings. • Net Margin (or Return on Sales) • Asset Turnover Ratio • Return on Investment • Return on Equity

  40. Net Margin Net Income Net Sales = Net Margin This measure describes the percent remaining of each sales dollar after subtracting other expenses as well as cost of goods sold.

  41. Net Margin

  42. This ratio measures how many sales dollars were generated for each dollar of assets invested. Asset Turnover Net Sales Average Total Assets = Asset Turnover Ratio

  43. Asset Turnover Ratio

  44. Return on Investment Net Income Average Total Assets = Return on Investment (ROI) This is the ratio of wealth generated (net income) to the amount invested (average total assets).

  45. Return on Investment (ROI) * The computation of average assets is calculated as beginning assets plus ending assets divided by 2.

  46. Return on Equity Net Income AverageTotal Stockholders’ Equity = Return on Equity This measure is often used to measure the profitability of the stockholders’ investment.

  47. Return on Equity

  48. Learning Objective To calculate ratios for assessing a company’s position in the stock market LO7

  49. Stock Market Ratios • Stock market ratios analyze the earnings and dividends of a company. • Earnings Per Share • Book Value • Price-Earnings (PE) Ratio • Dividend Yield

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