ANALYSIS OF FINANCIAL STATEMENTS

1. ANALYSIS OF FINANCIAL STATEMENTS Chapter 17 Chapter 17: Analysis of Financial StatementsChapter 17: Analysis of Financial Statements

2. Basics of Analysis Part I We have many analytical tools we can use to analyze the financial statements of a company. These techniques help us to better understand the company and reduce any uncertainty associated with financial information. Part II Financial statement analysis is used by many people within the organization. Managers find financial analysis helpful in planning and controlling operations. External users of financial statements are also interested in the results of comprehensive financial analysis. Shareholders, creditors, and customers all want to learn as much as possible about the financial health of a company. Part I We have many analytical tools we can use to analyze the financial statements of a company. These techniques help us to better understand the company and reduce any uncertainty associated with financial information. Part II Financial statement analysis is used by many people within the organization. Managers find financial analysis helpful in planning and controlling operations. External users of financial statements are also interested in the results of comprehensive financial analysis. Shareholders, creditors, and customers all want to learn as much as possible about the financial health of a company.

3. Standards for Comparison When we complete our analysis, it is essential to compare the results we obtained to those of our competitors, other companies in our same industry, and general financial market guidelines. Dun & Bradstreet, Standard & Poor�s, and Moody�s provide a wealth of industry information. When we complete our analysis, it is essential to compare the results we obtained to those of our competitors, other companies in our same industry, and general financial market guidelines. Dun & Bradstreet, Standard & Poor�s, and Moody�s provide a wealth of industry information.

4. Tools of Analysis Horizontal analysis can be extremely helpful in learning more about a company. It is the process of properly preparing financial data in dollar and percentage formats. This information is usually shown side-by-side. Vertical analysis is the process of comparing a company�s financial condition and results of operation in reference to a base amount. For example, we may wish to know the percentage of each expense account to sales revenue for the period. Over time, the business community has developed several key ratios that are considered important when evaluating the strengths and weaknesses of a company. We will cover many of these key ratios in this chapter. Horizontal analysis can be extremely helpful in learning more about a company. It is the process of properly preparing financial data in dollar and percentage formats. This information is usually shown side-by-side. Vertical analysis is the process of comparing a company�s financial condition and results of operation in reference to a base amount. For example, we may wish to know the percentage of each expense account to sales revenue for the period. Over time, the business community has developed several key ratios that are considered important when evaluating the strengths and weaknesses of a company. We will cover many of these key ratios in this chapter.

5. Horizontal Analysis Here is the asset section of the comparative balance sheets of Best Buy. Let�s begin our horizontal analysis by calculating the dollar change and the percentage change in Cash and cash equivalents. Here is the asset section of the comparative balance sheets of Best Buy. Let�s begin our horizontal analysis by calculating the dollar change and the percentage change in Cash and cash equivalents.

6. Comparative Statements Calculate Change in Dollar Amount The first task that we face is establishing the base year and then calculating changes in reference to the base. In horizontal analysis, we use the oldest year shown as the base year and determine the dollar change between the base year and the current year. For Best Buy 2006 is the base year. The first task that we face is establishing the base year and then calculating changes in reference to the base. In horizontal analysis, we use the oldest year shown as the base year and determine the dollar change between the base year and the current year. For Best Buy 2006 is the base year.

7. Comparative Statements Calculate Change as a Percent Once we establish the base year, we calculate the percentage change by dividing the dollar change by the base year amount and multiplying by 100. With this background, let�s get started with our work on the Best Buy�s comparative balance sheet. Once we establish the base year, we calculate the percentage change by dividing the dollar change by the base year amount and multiplying by 100. With this background, let�s get started with our work on the Best Buy�s comparative balance sheet.

8. Trend Analysis To calculate the trend percentage, we divide the current period amount by the base period amount and multiply by 100. All values will be expressed as a percentage increase or decrease from the base period. The base period is usually the oldest period shown. To calculate the trend percentage, we divide the current period amount by the base period amount and multiply by 100. All values will be expressed as a percentage increase or decrease from the base period. The base period is usually the oldest period shown.

9. Vertical Analysis Common-Size Statements Calculate Common-size Percent Common size financial statements are prepared for a single period. We express all items on the statement in terms of a one component of that statement. For the income statement, we normally express all items as a percent of total revenues. For the balance sheet, we generally express all items as a percent of total assets. Common size financial statements are prepared for a single period. We express all items on the statement in terms of a one component of that statement. For the income statement, we normally express all items as a percent of total revenues. For the balance sheet, we generally express all items as a percent of total assets.

10. Liquidity and Efficiency Let�s start in looking the liquidity and efficiency ratios that are calculated by most companies. We will look at the numerator and denominator of each ratio and determine what each ratio is measuring. Liquidity refers to the availability of resources to meet short-term cash requirements. It is affected by the timing of cash inflows and outflows along with prospects for future performance. Efficiency refers to how productive a company is in using its assets. Efficiency is usually measured relative to how much revenue is generated from a certain level of assets. Let�s start in looking the liquidity and efficiency ratios that are calculated by most companies. We will look at the numerator and denominator of each ratio and determine what each ratio is measuring. Liquidity refers to the availability of resources to meet short-term cash requirements. It is affected by the timing of cash inflows and outflows along with prospects for future performance. Efficiency refers to how productive a company is in using its assets. Efficiency is usually measured relative to how much revenue is generated from a certain level of assets.

11. Solvency Let�s focus now on solvency ratios. Solvency refers to a company�s long-run financial viability and its ability to cover long-term obligations. One of the most important components of solvency analysis is the composition of a company�s capital structure. Capital structure refers to a company�s financing sources. Let�s focus now on solvency ratios. Solvency refers to a company�s long-run financial viability and its ability to cover long-term obligations. One of the most important components of solvency analysis is the composition of a company�s capital structure. Capital structure refers to a company�s financing sources.

12. Profitability The next category of ratios deals with profitability measures. The next category of ratios deals with profitability measures.

13. Market Prospects As a shareholder, we often need information about the market prospects of our investment. As a shareholder, we often need information about the market prospects of our investment.

14. 17A � Sustainable Income When a company�s income-related activities include events not part of its normal, continuing operations, it must disclose this information. Reporting this information separately provides users with more information about what to expect in the future. Continuing operations shows revenues, expenses, and income generated by the company�s continuing operations. This information helps users predict future operations. Earlier chapters explained items comprising income from operations. Discontinued operations reports income or loss from operating a segment that has been discontinued and the gain or loss on the sale of the net assets of the segment. A business segment is a part of a company�s operations that serves a particular line of business or class of customers. A segment has assets, liabilities and financial results of operations that can be distinguished from those of other parts of the company. Extraordinary items are gains and losses that are both unusual and infrequent in occurrence. Some examples include losses from natural disasters and expropriation of property by a foreign government. Comprehensive income is net income plus certain gains and losses that bypass the income statement. These items are recorded directly to equity. Specifically, comprehensive income equals the change in equity for the period, excluding investments from and distributions to its stockholders. When a company�s income-related activities include events not part of its normal, continuing operations, it must disclose this information. Reporting this information separately provides users with more information about what to expect in the future. Continuing operations shows revenues, expenses, and income generated by the company�s continuing operations. This information helps users predict future operations. Earlier chapters explained items comprising income from operations. Discontinued operations reports income or loss from operating a segment that has been discontinued and the gain or loss on the sale of the net assets of the segment. A business segment is a part of a company�s operations that serves a particular line of business or class of customers. A segment has assets, liabilities and financial results of operations that can be distinguished from those of other parts of the company. Extraordinary items are gains and losses that are both unusual and infrequent in occurrence. Some examples include losses from natural disasters and expropriation of property by a foreign government. Comprehensive income is net income plus certain gains and losses that bypass the income statement. These items are recorded directly to equity. Specifically, comprehensive income equals the change in equity for the period, excluding investments from and distributions to its stockholders.

15. END OF CHAPTER 17 End of Chapter 17.End of Chapter 17.