PP For Chapter 6 - Financial Statement Analysis - Final

1
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Financial
Statement
Analysis
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to
edit
Master
title
style
After studying this chapter, you
should be able to:
1. List the users of financial statement.
2. Explain the importance of financial
statement analysis.
3. List basic financial statement
analytical procedures.
4. Apply financial statement analysis to
assess the solvency of a business.
5. Apply financial statement analysis to
2
stress the profitability of a business.

Objective
Objective 11
6-1
List the users of

financial statement.
to of
edit
Masterstatements
title style
TwoClick
groups
financial
1. Internal stakeholders
users:
6-1
a. Management team
b. Existing shareholders
c. Employees at all levels
2. External stakeholders
a. Creditors (suppliers and banks)
b. Inland revenue board (IRB)
c. Potential shareholders
d. Public at large
Users have different expectation on financial

User
Example of use
statements:
6-1
Management team and

existing shareholders
Assess firms financial performance, growth, and future

planning
Employees
Assess stability of the firm they are currently working

with
Creditors
Evaluate credit worthiness and solvency of the firm
Inland revenue board
Compute taxable income of the company and avoiding

tax evasion practice
Potential shareholders
Facilitate investment decisions
Public at large
Environmental awareness and corporate social

responsibilities

Objective
Objective 22
6-2
Describe importance of financial

statements
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to
edit
Master
title
style
1. Indicate financial positions of the
6-2
company for certain period

2. Provide comparative analysis of the
firm performance in relative to their
competitors
3. Benchmark firm performance with an
overall industry performance
4. Assess firm financial performance
and operating efficiency by linking
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one type of financial information to
another (ratio analysis)

Objective
Objective 33
6-3
List basic financial statement analytical

procedures:
Horizontal Analysis
Vertical Analysis
Common-size statements
8
6-3
The percentage analysis of

increases and decreases in
related items in comparative
financial statements is called
horizontal analysis.
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Comparative Balance Sheets
6-3
Mercu Tanda Sdn Bhd

Comparative Balance Sheet
December 31, 2008 and 2007
2008
Assets
Current assets
Long-term investments
Prop., plant, and equip. (net)
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders Equity
Preferred 6% stock, $100 par
Common stock, $10 par
Retained earnings
Total stockholders equity
Total liab. & stockholders eq.
2007
Increase (Decrease)
Amount
Percent
$ 550,000
95,000
444,500
50,000
$1,139,500
$ 533,000 $ 17,000
177,500
(82,500)
470,000
(25,500)
50,000
$1,230,500 $ (91,000)
3.2%
(46.5%)
(5.4%)
$ 210,000
100,000
$ 310,000
$ 243,000 $ (33,000)
200,000
100,000)
$ 443,000 $(133,000)
(13.6%)
(50.0%)
(30.0%)
$ 150,000
500,000
179,500
$ 829,500
$1,139,500
$ 150,000
500,000
137,500 $ 42,000
$ 787,500 $ 42,000
$1,230,500 $ (91,000)
30.5%
5.3%
(7.4%)
(7.4%)
10
11
Comparative Schedule of Current Assets
6-3
Mercu Tanda Sdn Bhd

Comparative Schedule of Current Assets
2008
Cash
Marketable securities
Accounts receivable (net)
Inventories
Prepaid expenses
Total current assets
$ 90,500
75,000
115,000
264,000
5,500
$550,000
2007
Increase (Decrease)
Amount
Percent
$ 64,700 $ 25,800
60,000
15,000
120,000
(5,000)
283,000 (19,000)
5,300
200
$533,000 $17,000
39.9%
25.0%
(4.2%)
(6.7%)
3.8%
3.2%
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Comparative Income Statement
6-3
Mercu Tanda Sdn Bhd

For the Year Ended December 31, 2008 and 2007
Increase (Decrease)
2008
2007
Amount
Percent
Sales
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Other income
Other expense (interest)
Income before income tax
Income tax expense
Net income
$1,530,500
32,500
$1,498,000
1,043,000
$ 455,000
$ 191,000
104,000
$ 295,000
$ 160,000
8,500
$ 168,500
6,000
$ 162,500
71,500
$ 91,000
$1,234,000
34,000
$1,200,000
820,000
$ 380,000
$ 147,000
97,400
$ 244,400
$ 135,600
11,000
$ 146,600
12,000
$ 134,600
58,100
$ 76,500
$296,500
(1,500)
$298,000
223,000
$ 75,000
$ 44,000
6,600
$ 50,600
$ 24,400
(2,500)
$ 21,900
(6,000)
$ 27,900
13,400
$ 14,500
24.0%
(4.4%)
24.8%
27.2%
19.7%
29.9%
6.8%
20.7%
18.0%
(22.7%)
14.9%
(50.0%)
20.7%
23.1%
19.0%
12
13
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Master title style
Mercu Tanda Sdn Bhd
Comparative RE Statement
6-3
Comparative Retained Earnings

Statement
A percentage analysis
Increase
that 2008
shows2007
theAmount
Percent
(Decrease)
Retained earnings,
Jan. 1$137,500$100,000$37,500
37.5%
relationship
of each
Net incomecomponent
for year
91,000to 76,500
14,500 19.0%
the total
Total
$228,500 $176,500 $52,000 29.5%)
within a single
Dividends:
On preferredstatement
stock $ 9,000$is 9,000
called
On common stock
40,000
30,000 10,000 33.3%
vertical
analysis.
Total
$ 49,000 $ 39,000 $10,000

$179,500 $137,500 $42,000
25.6%
30.5%13
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Master
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A percentage analysis used to show
6-3
the relationship of each component to

the total within a single statement is
called vertical analysis.
14
15
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In a vertical analysis of the balance
6-3
sheet, each asset item is stated as a

percent of the total assets. Each
liability and stockholders equity item
is stated as a percent of the total
liabilities and stockholders equity.
e.g. Current asset (2008):
=(Total current asset / Total asset) x 100

= $550,000/$1,139,500
= 48.3%
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16
6-3
Mercu Tanda Sdn Bhd

Comparative Balance Sheet
For the Years Ended December 31, 2008 and 2007
2008
2007 Percent
Amount
Amount
Percent
Assets
Current assets
$ 550,000
48.3% $ 533,000
43.3%
Long-term investments
95,000
8.3
177,500
14.4
Property, plant, & equip. (net) 444,500
39.0
470,000
38.2
Intangible assets
50,000
4.4
50,000
4.1
Total
assets
$1,139,500
100.0% $1,230,500
100.0%
Total
assets
$1,139,500
100.0%$1,230,500
Liabilities
Current liabilities
$ 210,000
18.4% $ 243,000
19.7%
Long-term liabilities
100,000
8.8
200,000
16.3
Total liabilities
$ 310,000
27.2% $ 443,000
36.0%
Stockholders Equity
Preferred 6% stock, $100 par $ 150,000
13.2% $ 150,000
12.2%
2.2% Common stock, $10 par 500,000
43.9
500,000
40.6
Retained earnings
179,500
15.7
137,500
11.2
Total stockholders equity
$ 829,500
72.8% $ 787,500
64.0%
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Totalliab.
liab.&&stockholders
Stockholdersequity
equity$1,139,500100.0%$1,230,500
100.0%
Total
$1,139,500 100.0%$1,230,500100.0%
100
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Master
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In a vertical analysis of the income
6-3
statement, each item is stated as a

percent of net sales. As an example,
lets see how the percent of 12.8%
was calculated for 2008 selling
e.g.
Percentage of selling expense (2008):
expenses.
=(Selling expense/Net sales) x 100
=($191,000 / $1,498,000) x 100
= 12.8%
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Mercu Tanda Sdn Bhd

For the Years Ended December 31, 2008 and 2007
2008
Amount
Percent
Amount
2007
Percent
Sales
$1,530,500 102.2%
$1,234,000
102.8%
Sales returns and allow.
32,500
2.2
34,000
2.8
Net sales
$1,498,000 100.0%
$1,200,000
100.0%
Cost of goods sold
1,043,000
69.6
820,000
68.3
Gross profit
$ 455,000
30.4%
$ 380,000
31.7%
Selling expenses
$ 191,000
12.8%
$ 147,000
12.3%
Administrative expenses
104,000
6.9
97,400
8.1
Total operating expenses
$ 295,000
19.7%
$ 244,400
20.4%
Income from operations
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3%
$ 146,600
12.2%
Other expense (interest)
6,000
0.4
12,000
1.0
$ 162,500
10.9%
$ 134,600
11.2%
Income tax expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1%
$ 76,500
6.4%
6-3
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6-3
In a common-sized statements, all

items are expressed as a percentage.
Common-sized statements are useful
in comparing the current period with
prior periods, individual businesses, or
one business with industry
percentages.
19
20
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edit
Master
Mercu to
Tanda
Sdn Bhd
and Megah title
Sdn Bhd style
6-3
Condensed Common-size Income Statement

For the year Ended December 31, 2008
Mercu Tanda
Megah
20
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Objective
Objective 44
6-4
Apply financial statement

analysis to assess the solvency of
a business:
21
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6-4
Using measures to assess a

businesss ability to pay its current
liabilities is called current position
analysis. Such analysis is of special
interest to short-term creditors.
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Ratios used to assess current position analysis:
6-4
Working capital
Current ratio
Quick ratio
Accounts receivable turnover
Number of Days Sales in Receivables
Inventory turnover
Number of days sales in inventory
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6-4
The ability of a business to meet its

financial obligations (debts) is called
solvency.
The ability of a business to earn
income is called profitability.
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25
6-4
Ratios used in assessing business

solvency:
Ratio of Fixed Assets to Long-Term Liabilities

Ratio of Liabilities to Stockholders Equity
Number of Times Interest Charges Earned
25
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ClickCapital
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Working
6-4
Master title style
The excess of current assets of a

business over its current liabilities is
called working capital. The working
capital is often used in evaluating a
companys ability to meet currently
maturing
debts.
Working capital:
Total current assets total current
liabilities
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6-4
Mercu Tanda Sdn Bhd

Current asset:
Cash
a.
b.
Accounts receivable (net)

Inventories
Prepaid expenses
Current liabilities
Working capital (a b)
$ 90,500
75,000
115,000
264,000
5,500
$550,000
210,000
$340,000
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6-4
Current Ratio
The current ratio, sometimes called

the working capital ratio or bankers
ratio, is computed by dividing the
total current assets by the total
current liabilities.
Current ratio:
total current liabilities
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6-4
Mercu Tanda Sdn Bhd
2008
2007
a. Current assets
$550,000
$533,000
b. Current liabilities
210,000 243,000
Working capital (a b) $340,000 $290,000
Current ratio (a/b)
2.6
2.2
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6-4
Quick Ratio
A ratio that measures the instant

debt-paying ability of a company is
called the quick ratio or acid-test
ratio.
Quick ratio:
total quick assets
total current liabilities
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Quick
Quickassets
assetsare
arecash
cash
and
andother
othercurrent
currentassets
assets
that
thatcan
canbe
bequickly
quickly
converted
convertedtotocash.
cash.
6-4
Mercu Tanda Sdn Bhd

2008
2007
Quick assets:
Cash
$ 90,500 $ 64,700
75,000 60,000
Accounts receivable (net) 115,000 120,000
a. Total quick assets $280,500 $244,700
b. Current liabilities $210,000 $243,000
Quick ratio (a/b)
1.3
1.0
31
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Accounts
Turnovertitle
Click Receivable
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style
6-4
The relationship between sales and

accounts receivable may be stated as
the accounts receivable turnover. The
ratio is to assess the efficiency of the
firm in collecting receivables and in
the managing of credit.
A/R turnover:
Net sales
average Accounts receivable
32
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6-4
Mercu Tanda Sdn Bhd
a. Net sales
Accounts receivable (net):
Beginning of year
End of year
Total
b. Average (Total/2)
2008
$1,498,000
2007
$1,200,000
$ 120,000
115,500
$ 235,000
$ 117,500
$ 140,000
120,000
$ 260,000
$ 130,000
Accounts receivable turnover

(a/b)
12.7
33
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Master
title style
Number
of Days
Sales
in Receivables
6-4
The number of days sales in receivables is

an estimate of the length of time (in days)
the accounts receivable have been
outstanding. Comparing this measure with
the credit terms provides information on the
efficiency in collecting receivables.
Formula:
Average Accounts receivable

Average daily sales on account34
35
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Master
title style
Mercu
Tanda Sdn Bhd
a. Average (Total/2)
Net sales
b. Average daily sales on
account (Sales/365)
Number of days sales in
receivables (a/b)
2008
$ 117,500
$1,498,000
$
2007
$ 130,000
$1,200,000
4,104 $
28.6
6-4
3,288
39.5
35
36
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Inventory
Turnover
Master title style
6-4
The relationship between the volume

of goods (merchandise) sold and
inventory may be stated as the
inventory turnover. The purpose of
this ratio is to assess the efficiency of
the
firm in managing its inventory.
Formula:
Cost of goods sold
average inventories
36
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Master
title style
Mercu
Tanda Sdn Bhd
a. Cost of goods sold
Inventories:
2008
$1,043,000
6-4
2007
$ 820,000
Beginning of year $ 283,000

$ 311,000
End of year
264,000
283,000
Inventory turnover (a/b)
$ 594,000
Total $ 547,000
3.8
2.8
$ 273,500
$ 297,000 37
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Number of Days Sales in Inventories
6-4
The number of days sales in

inventories is an estimate of the length
of time (in days) required to sell the
inventories. This ratio provides
information on the efficiency in
converting
Formula: inventories to sales.
Average inventories
average daily COGS
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Number of Days Sales in Inventory
6-4
Mercu Tanda Sdn Bhd
a. Average (Total/2)
Cost of goods sold
b. Average daily cost of goods
sold (COGS/365 days)
Number of days sales in
inventory (a/b)
2008
$ 273,500
$1,043,000
2007
$ 297,000
$ 820,000
$2,858
$2,247
95.7
132.2
39
40
6-4
Ratio of Fixed Assets to Long-Term Liabilities
The ratio of fixed assets to long-term

liabilities is a solvency measure that
indicates the margin of safety of the note
holders or bondholders. It also indicates
the ability of the business to borrow
additional funds on a long-term basis.
Formula:
Fixed assets (net)

long term liabilities
40
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Master
title
style
Mercu Tanda Sdn Bhd
6-4
2008
2007
a. Fixed assets (net) $444,500 $470,000
b. Long-term liabilities $100,000 $200,000
Ratio of fixed assets to
long-term liabilities (a/b)
4.4
2.4
41
42
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Master title
RatioClick
of Liabilities
to Stockholders
Equitystyle
6-4
The relationship between the total

claims of the creditors and ownersthe
ratio of liabilities to stockholders equity
is a solvency measure that indicates
the margin of safety for creditors.
Formula:
total liabilities
total stockholders equity
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6-4
Mercu Tanda Sdn Bhd
a. Total liabilities
b. Total stockholders equity
Ratio of liabilities to
stockholders equity (a/b)
2008
$310,000
$829,500
2007
$443,000
$787,500
0.4
0.6
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44
6-4
Number of Times Interest Charges Earned
Corporations in some industries normally

have high ratios of debt to stockholders
equity. For such corporations, the relative
risk of the debt-holders is normally
measured as the number of times interest
charges are earned (during the year),
sometimes
Formula: called the fixed charge coverage
ratio.
(Income before tax + interest expense)

44
interest expense
45
6-4
Mercu Tanda Sdn Bhd
2008
2007
$162,500 $134,600
6,000

a. Add interest expense
12,000
b. Amount available to meet
interest charges
$168,500 $146,600
Number of times interest
charges earned (b/a)
28.1
12.2
45
46
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Master
Objective
55 title style
Objective
6-4
Apply financial statement

analysis to assess the
profitability of a business
46
47
Profitability is the ability of an entity

to earn profits.
This ability to earn profits depends
on the effectiveness and efficiency
of operations as well as resources
available as reported in the balance
sheet.
Profitability analysis focuses
primarily on the relationship
between operating results reported
in the income statement and
resources reported in the balance
6-4
47
48
6-4
Ratios used to assess the profitability of a business

include:
Ratio of Net Sales to Assets
Rate Earned on Total Assets
Rate Earned on Stockholders Equity
Leverage
Rate Earned on Common Stockholders Equity
Earnings per Share on Common Stock
Price earning ratio
Dividends per Share
Dividend yield
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Ratio of Net Sales to Assets
6-4
The ratio of net sales to assets is a

profitability measure that shows how
effectively a firm utilizes its assets.
Formula:
Net sales
average total asset *
(*exclude long term investment)
49
50
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Master
title
style
Mercu Tanda Sdn Bhd
a. Net sales
Total assets:
Beginning of year
End of year
Total
2008
$1,498,000
2007
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
6-4
Excludes
Excludes long-term
long-term investments
investments
50
51
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Master
title style
Mercu
Tanda Sdn Bhd
a. Net sales
Total assets:
Beginning of year
End of year
Total
Ratio of net sales to assets (a/b)
2008
$1,498,000
2007
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
1.4
6-4
1.2
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Rate Earned on Total Assets
6-4
The rate earned on total assets

measures the profitability of total
assets, without considering how the
assets are financed.
Formula:
Net income + interest expense
Average total assets
52
53
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title
style
Mercu Tanda Sdn Bhd
Net income
Plus interest expense
a. Total
Total assets:
Beginning of year
End of year
Total
Rate earned on total
assets (a/b)
2008
$ 91,000
6,000
$ 97,000
2007
$ 76,500
12,000
$ 88,500
$1,230,500
1,139,500
$2,370,000
$1,185,000
$1,187,500
1,230,500
$2,418,000
$1,209,000
8.2%
6-4
53
7.3%
54
6-4
Rate Earned on Stockholders Equity
The rate earned on stockholders

equity measure emphasizes the rate of
income earned on the amount
invested by the stockholders.
Formula:
Net income
Average stockholders equity
54
55
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Master
title style
Mercu
Tanda Sdn Bhd
a. Net income
Stockholders equity:
Beginning of year
End of year
Total
Rate earned on stockholders
equity (a/b)
2008
$ 91,000
2007
$ 76,500
$ 787,500
829,500
$1,617,000
$ 808,500
$ 750,000
787,500
$1,537,500
$ 768,750
11.3%
6-4
10.0%
55
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Leverage
6-4
The difference in the rate earned on

stockholders equity and the rate
earned on total assets is called
leverage.
Formula:
Rate earned on stockholders equity
rate earned on total asset
56
57
Click to11.3
edit Master title style
Exhibit 8
10
%
Leverage
%
8.2%
Leverage
3.1%
10.0
%
7.3%
6-4
Leverage
2.7%
5%
0%
2008
Rate earned
on total assets
2007
Rate earned on
stockholders
equity
73
57
58
6-4
Rate Earned on Common Stockholders Equity
The rate earned on common

stockholders equity focuses only on
the rate of profits earned on the
amount invested by the common
stockholders.
Formula:
Net income preferred dividend
Average common stockholders equity
58
59
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Master
title style
Mercu
Tanda Sdn Bhd
2008
$ 91,000
9,000
$ 82,000
6-4
2007
$ 76,500
9,000
$ 67,500
Net income
Less preferred dividends
a. Remaindercommon stock
Common stockholders equity:
Beginning of year
$ 637,500 $ 600,000
End of year
679,500
637,500
Total
$1,317,000 $1,237,500
$ 658,500 $ 618,750
Rate earned on common
stockholders equity (a/b)
12.5%
10.9%
59
60
6-4
Earnings per Share on Common Stock
One of the profitability measures often

quoted by the financial press is earning per
share (EPS) on common stock. It is also
normally reported in the income statement
in corporate annual reports.
Formula:
Net income preferred dividend

number of shares in common stock
60
61
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title
style
Mercu Tanda Sdn Bhd
2008
Net income
$ 91,000
Preferred dividends
9,000
a. Remainderidentified with
common stock
$ 82,000
b. Shares of common stock 50,000
Earnings per share on common
stock (a/b)
$1.64
6-4
2007
$ 76,500
9,000
$ 67,500
50,000
$1.35
61
62
Price-Earnings Ratio
6-4
Another profitability measure quoted

by the financial press is the priceearnings (P/E) ratio on common stock.
The price-earnings ratio is an
indicator of a firms future earnings
prospects.
Formula:
Share market price
earning/share of common stock
62
63
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title
style
Mercu Tanda Sdn Bhd
6-4
2008
2007
Market price per share of
common stock
$41.00$27.00
Earnings per share on common
stock
1.64 1.35
Price-earnings ratio on
common stock
25
20
63
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Dividends per Share
6-4
Dividends per share can be reported with

earnings per share to indicate the
relationship between dividends and
earnings. Comparing these two per share
amounts indicates the extent to which the
corporation is retaining its earnings for use
in operations.
64
65
Exhibit 9: Dividends and Earning per

Share of Common Stock
6-4
Mercu Tanda Sdn Bhd
$2.00
Per $1.50
share
$1.00
$1.64
$1.35
$0.8
0
$0.6
0
$0.50
$0.0
2008
Dividend
s
2007
Earnings
86
65
66
Dividend Yield
6-4
The dividend yield on common stock

is a profitability measure that shows
the rate of return to common
stockholders in terms of cash
dividends.
Formula:
Dividend per share
market price per share
66
67
6-4
Mercu Tanda Sdn Bhd
2008
Dividends per share of
common stock
Market price per share of
common stock
Dividend yield on
common stock
2007
$ 0.80
$ 0.60
41.00
27.00
2.0%
2.2%
67

PP For Chapter 6 - Financial Statement Analysis - Final

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List the users of

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Users have different expectation on financial

Management team and

Assess firms financial performance, growth, and future

Assess stability of the firm they are currently working

Evaluate credit worthiness and solvency of the firm

Inland revenue board

Compute taxable income of the company and avoiding

Facilitate investment decisions

Environmental awareness and corporate social

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Describe importance of financial

company for certain period

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List basic financial statement analytical

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The percentage analysis of

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Comparative Balance Sheets

Mercu Tanda Sdn Bhd

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Comparative Schedule of Current Assets

Mercu Tanda Sdn Bhd

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Comparative Income Statement

Mercu Tanda Sdn Bhd

Comparative Retained Earnings

$ 49,000 $ 39,000 $10,000

the relationship of each component to

sheet, each asset item is stated as a

=(Total current asset / Total asset) x 100

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Mercu Tanda Sdn Bhd

statement, each item is stated as a

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Mercu Tanda Sdn Bhd

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In a common-sized statements, all

Condensed Common-size Income Statement

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Apply financial statement

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Using measures to assess a

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Ratios used to assess current position analysis:

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The ability of a business to meet its

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Ratios used in assessing business

Ratio of Fixed Assets to Long-Term Liabilities

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The excess of current assets of a

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Mercu Tanda Sdn Bhd

Accounts receivable (net)

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The current ratio, sometimes called

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