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Ch.13 Financial Statement Analysis

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  1. Ch.13Financial Statement Analysis

  2. Will I be paid? How good is our investment? Financial Statement Analysis Creditors Stockholders

  3. F/S Analysis Requires Proper Comparisons • Over time for the same company • Trend/horizontal analysis • With other companies in the same industry • Ratio analysis • With industry average

  4. Return on Average Equity 20042003200220012000 24.7% 26.7% 28.7% 30.1% 29.0% Trend Analysis Wm. Wrigley Jr. Company Tracking items over a series of years

  5. Types of Analysis • Liquidity Analysis • Solvency Analysis • Profitability Analysis

  6. Part I: Liquidity Analysis • Nearness to cash • Ability to pay short-term debts as they become due LO4

  7. Working Capital • Excess of current assets over current liabilities • Lacks meaningful comparisons for companies of different size –

  8. Current Ratio • Measure of short-term financial health • Consider composition of current assets Rule of thumb 2:1

  9. Acid-Test (Quick) Ratio • Stricter test of ability to pay debts • Excludes inventories and prepaid assets Quick Assets Current Liabilities

  10. Cash Flow from Operations to Current Liabilities • Focuses on cash only • Can be used to indicate the flow of cash during the year to cover the debts due Net Cash Provided by Operating Activities Average Current Liabilities

  11. Accounts Receivable Turnover Ratio Net Credit Sales Average Accounts Receivable Indicates how quickly a company is collecting (i.e., turning over) its receivables

  12. Number of Days’ Sales in Receivables Number of Days in the Period Accounts Receivable Turnover Represents the average number of days an account is outstanding

  13. Number of Days’ Sales in Receivables Example: 360 days 4.8 times = 75 days

  14. Inventory Turnover Ratio Cost of Goods Sold Average Inventory Represents the number of times per period inventory is turned over (i.e., sold).

  15. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Number of Days’ Sales in Inventory Number of Days in the Period Inventory Turnover Represents the average number of days inventory is on hand before it’s sold

  16. Cash Operating Cycle • Time between the purchase of merchandise and the collection of the from the sale Number of Days’ Sales in Inventory + Number of Days’ Sales in Receivables

  17. Part II: Solvency Analysis • Ability to stay in business over the long-term. That is, the ability to pay all the liabilities LO5

  18. Debt-to-Asset Ratio How much of the company’s assets were borrowed? Total Liabilities Total Assets

  19. 60% of the company’s assets were borrowed, and only 40% were provided by owners. Debt-to-Equity Ratio Total Liabilities Total Assets = .60

  20. Times Interest Earned • Measures ability to meet current interest payments • The greater the coverage the better Net Income + Interest Expense + Income Tax Expense Interest Expense

  21. Part III: Profitability Analysis • Rate of Return on Assets • Return on Common Stockholders’ Equity • Earnings per Share • Price/Earnings Ratio • Dividend Ratios LO6

  22. Return on Assets Ratio • Measures return to all providers of capital (creditors and owners) Net Income + Interest Expense, Net of Tax Average Total Assets

  23. The owners earned 15% on their investment in ABC Co... Not bad! Return on Common Stockholders’ Equity Net Income – Preferred Dividends Average Common Stockholders’ Equity

  24. Certificate of Stock Earnings per Share • Presents profits on a per-share basis Net Income – Preferred Dividends Weighted Average Number of Common Shares Outstanding

  25. Price/Earnings Ratio • Relates earnings to the market price of the stock Current Market Price Earnings per Share very high P/E very low P/E possibly overpriced possibly underpriced

  26. P/E Ratios Co. A = 10 to 1 Co. B = 7 to 1 Price/Earnings Ratio Both companies have earnings of $2 per share. So why the different P/E ratios?

  27. We need to decide what percentage of the firm’s income we can return to owners Dividend Payout Ratio Common Dividends per Share Earnings per Share

  28. Limitations of Financial Statement Analysis • Use of different accounting methods • Changes in accounting methods LIFO FIFO LO1

  29. ???? Limitations of Financial Statement Analysis • Difficulty of making industry comparisons (i.e., conglomerates)

  30. = Limitations of Financial Statement Analysis • Nonoperating items on income statement • Effects of inflation