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Financial Statement Analysis

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    1. Financial Statement Analysis Chapter 18

    2. Objectives Perform horizontal analysis of comparative financial statements Perform vertical analysis of financial statements Prepare and use common size financial statements Compute the standard financial ratios Measure economic value added

    3. The Annual Report Usually Contains ... Presidents letter to the Stockholders Management Discussion and Analysis of the financial statements Financial Statements Notes to the Financial Statements a summary of accounting methods used An Auditors Report Comparative Financial Data for 5 to 10 years

    4. Horizontal Analysis Interested in the percent change Step 1: Figure the dollar amount change from the base period to the later period. Step 2: Divide the dollar amount of change by the base amount to get a percent change.

    5. Horizontal Analysis

    6. Trend Percentages... are computed by selecting a base year whose amounts are set equal to 100%. The amounts of each following year are expressed as a percentage of the base amount.

    7. Year 2005 2004 2003 Revenues $27,611 $24,215 $21,718 Cost of sales 15,318 14,709 13,049 Gross profit $12,293 $ 9,506 $ 8,669 2003 is the base year. Trend Percentages

    8. Year 2005 2004 2003 Revenues % % % Cost of sales % % % Gross profit % % % Trend Percentages

    9. Vertical Analysis... compares each item in a financial statement to a base number set to 100%. Every item on the financial statement is then reported as a percentage of that base.

    10. Vertical Analysis

    11. Vertical Analysis

    12. Vertical Analysis

    13. Common-size Statements On the income statement, each item is expressed as a percentage of net sales. On the balance sheet, the common size is the total on each side of the accounting equation. Common-size statements are used to compare one company to other companies, and to the industry average.

    14. Benchmarking

    15. Ratio Classification Measuring ability to pay current liabilities Measuring ability to sell inventory and collect receivables Measuring ability to pay short-term and long-term debt Measuring profitability Analyzing stock as an investment

    16. Palisades Furniture Example

    17. Palisades Furniture Example

    18. Palisades Furniture Example

    19. Palisades Furniture Example

    20. Measuring Ability to Pay Current Liabilities

    21. Measuring Ability to Pay Current Liabilities Palisades current ratio: 20x4: 20x5: The industry average is 1.50. The current ratio decreased slightly during 20x5.

    22. Measuring Ability to Pay Current Liabilities

    23. Measuring Ability to Pay Current Liabilities Palisades acid-test ratio: 20x4: 20x5: The industry average is .40. The companys acid-test ratio improved considerably during 20x5.

    24. Measuring Ability to Sell Inventory

    25. Measuring Ability to Sell Inventory Palisades inventory turnover: 20x5: The industry average is 3.4. A high number indicates an ability to quickly sell inventory.

    26. Measuring Ability to Collect Receivables

    27. Measuring Ability to Collect Receivables Palisades accounts receivable turnover: 20x5: The industry average is 51 times. Palisades receivable turnover is much lower than the industry average. The company is a home-town store that sells to local people who tend to pay their bills over a lengthy period of time.

    28. Measuring Ability to Collect Receivables

    29. Measuring Ability to Collect Receivables Palisades days sales in Accounts Receivable for 20x5: One days sales: Days sales in Accounts Receivable: The industry average is 7 days.

    30. Measuring Ability to Pay Debt

    31. Measuring Ability to Pay Debt Palisades debt ratio: 20x4: 20x5: The industry average is 0.64. Palisades Furniture expanded operations during 20x5 by financing through borrowing.

    32. Measuring Ability to Pay Debt

    33. Measuring Ability to Pay Debt Palisades times-interest-earned ratio: 20x4: 20x5: The industry average is 2.80. The companys times-interest-earned ratio increased in 20x5. This is a favorable sign.

    34. Measuring Profitability

    35. Measuring Profitability Palisades rate of return on sales: 20x4: 20x5: The industry average is 0.008. The increase is significant in itself and also because it is much better than the industry average.

    36. Measuring Profitability

    37. Measuring Profitability Palisades rate of return on total assets for 20x5: The industry average is 0.078. How does Palisades compare to the industry?

    38. Measuring Profitability

    39. Measuring Profitability Palisades rate of return on common stockholders equity for 20x5: The industry average is 0.121. Why is this ratio larger than the return on total assets (.101)?

    40. Measuring Profitability

    41. Measuring Profitability Palisades earnings per share: 20x4: 20x5: This large increase in EPS is considered very unusual.

    42. Analyzing Stock as an Investment Price/earning ratio is the ratio of market price per share to earnings per share. 20x4: 20x5: Given Palisades Furnitures 20x5 P/E ratio of ____, we would say that the companys stock is selling at ____ times earnings.

    43. Analyzing Stock as an Investment

    44. Analyzing Stock as an Investment Dividend yield on Palisades common stock: 20x4: 20x5: An investor who buys Palisades Furniture common stock for $60 can expect to receive ___% of the investment annually in the form of cash dividends.

    45. Analyzing Stock as an Investment

    46. Analyzing Stock as an Investment Book value per share of Palisades common stock: 20x4: 20x5: Book value bears no relationship to market value.

    47. Limitations of Financial Analysis Business decisions are made in a world of uncertainty. No single ratio or one-year figure should be relied upon to provide an assessment of a companys performance.

    48. Economic Value Added (EVA) Economic value added (EVA) combines accounting income and corporate finance to measure whether the companys operations have increased stockholder wealth. EVA = Net income + Interest expense Capital charge Capital charge = (notes pay. + bonds pay. + stockholders equity) x cost of capital

    49. Red Flags Earnings Problems Decreased Cash Flow Too Much Debt Inability to Collect Receivables Buildup of Inventory Strange Movements of Sales, Inventories, and Receivables

    50. Review Horizontal Analysis Trend Percentages Vertical Analysis Common Size Statement Benchmarking Ratio Analysis Other Evaluation Tools