13 1 3 Analyzing and Interpreting Financial Statements

13 -1 (3) Analyzing and Interpreting Financial Statements 1

Basics of Analysis Application of analytical tools Reduces uncertainty Involves transforming data

Purpose of Analysis Financial statement analysis helps users make better decisions. Internal Users External Users Managers Officers Internal Auditors Shareholders Lenders Customers

Building Blocks of Analysis Ability to meet short-term obligations and to efficiently generate revenues Ability to provide financial rewards sufficient to attract and retain financing Liquidity and Efficiency Solvency Market Profitability Prospects Ability to generate future revenues and meet long-term obligations Ability to generate positive market expectations

Information for Analysis Income Statement Balance Sheet Statement of Changes in Stockholders’ Equity Statement of Cash Flows Notes

Standards for Comparison ŒIntracompany Competitor Ž Industry Guidelines

Financial Statement Analysis Horizontal Analysis Comparing a company’s financial condition and performance across time Vertical Analysis Comparing a company’s financial condition and performance to a base amount

Tools of Analysis Using key relations among financial statement items

Horizontal Analysis CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Assets Current assets: Cash and equivalents Accounts receivable, net Inventory Prepaid expenses Total current assets Property and equipment: Land Buildings and equipment, net Total property and equipment Total assets 2003 $ 12, 000 $ 23, 500 60, 000 40, 000 80, 000 100, 000 3, 000 1, 200 $ 155, 000 $ 164, 700 40, 000 120, 000 85, 000 $ 160, 000 $ 125, 000 $ 315, 000 $ 289, 700 Dollar Change Percent Change

Comparative Statements Calculate Change in Dollar Amount Dollar Change = Analysis Period Amount – Base Period Amount Since we are measuring the amount of the change between 2003 and 2004, the dollar amounts for 2003 become the “base” period amounts.

Comparative Statements Calculate Change as a Percent Change = Dollar Change Base Period Amount × 100%

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 2003 Dollar Change Percent Change* Assets Current assets: Cash and equivalents $ 12, 000 $ 23, 500 $ (11, 500) (48. 9) Accounts receivable, net 60, 000 40, 000 Inventory 80, 000 100, 000 Prepaid expenses 3, 000 1, 200 1, 800 $12, 000 – $23, 500 = $(11, 500) Total current assets $ 155, 000 $ 164, 700 Property and equipment: ($11, 500 ÷ $23, 500) × 100%- = 48. 9% 0. 0 Land 40, 000 Buildings and equipment, net 120, 000 85, 000 Total property and equipment $ 160, 000 $ 125, 000 Total assets $ 315, 000 $ 289, 700 * Percent rounded to first decimal point.

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Assets Current assets: Cash and equivalents $ 12, 000 Accounts receivable, net 60, 000 Inventory 80, 000 Prepaid expenses 3, 000 Total current assets $ 155, 000 Property and equipment: Land 40, 000 Buildings and equipment, net 120, 000 Total property and equipment $ 160, 000 Total assets $ 315, 000 * Percent rounded to first decimal point. 2003 Dollar Change Percent Change* $ 23, 500 $ (11, 500) 40, 000 20, 000 100, 000 (20, 000) 1, 200 1, 800 $ 164, 700 $ (9, 700) (48. 9) 50. 0 (20. 0) 150. 0 (5. 9) 40, 000 85, 000 35, 000 $ 125, 000 $ 35, 000 $ 289, 700 $ 25, 300 0. 0 41. 2 28. 0 8. 7

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Notes payable Total current liabilities Long-term liabilities: Bonds payable, 8% Total liabilities Shareholders' equity: Preferred stock Common stock Additional paid-in capital Total paid-in capital Retained earnings Total shareholders' equity Total liabilities and shareholders' equity * Percent rounded to first decimal point. 2003 Dollar Change $ 67, 000 $ 44, 000 $ 23, 000 6, 000 (3, 000) $ 70, 000 $ 50, 000 $ 20, 000 75, 000 $ 145, 000 80, 000 (5, 000) $ 130, 000 $ 15, 000 20, 000 60, 000 10, 000 $ 90, 000 80, 000 69, 700 10, 300 $ 170, 000 $ 159, 700 $ 10, 300 $ 315, 000 $ 289, 700 $ 25, 300 Percent Change* 52. 3 (50. 0) 40. 0 (6. 3) 11. 5 0. 0 14. 8 6. 4 8. 7

Trend Analysis Trend analysis is used to reveal patterns in data covering successive periods. Trend Analysis Period Amount = Percent Base Period Amount × 100%

Trend Analysis Berry Products Income Information For the Years Ended December 31, Item Revenues Cost of sales Gross profit 2004 $ 400, 000 285, 000 115, 000 2003 $ 355, 000 250, 000 105, 000 2002 $ 320, 000 225, 000 95, 000 2001 $ 290, 000 198, 000 92, 000 2000 is the base period so its amounts will equal 100%. 2000 $ 275, 000 190, 000 85, 000

Trend Analysis Berry Products Income Information For the Years Ended December 31, Item Revenues Cost of sales Gross profit 2004 $ 400, 000 285, 000 115, 000 2003 $ 355, 000 250, 000 105, 000 2002 $ 320, 000 225, 000 95, 000 Item Revenues Cost of sales Gross profit 2004 2003 2002 2001 $ 290, 000 198, 000 92, 000 2001 105% 104% 108% 2000 $ 275, 000 190, 000 85, 000 2000 100%

Trend Analysis Berry Products Income Information For the Years Ended December 31, Item Revenues Cost of sales Gross profit 2004 $ 400, 000 285, 000 115, 000 2004 145% 150% 135% 2003 $ 355, 000 250, 000 105, 000 2003 129% 132% 124% 2002 $ 320, 000 225, 000 95, 000 2002 116% 118% 112% 2001 $ 290, 000 198, 000 92, 000 2001 105% 104% 108% 2000 $ 275, 000 190, 000 85, 000 2000 100%

Common-Size Statements Calculate Common-size Percent = Analysis Amount Base Amount × 100% Financial Statement Base Amount Balance Sheet Total Assets Income Statement Revenues

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 2003 Common-size Percents* 2004 2003 Assets Current assets: Cash and equivalents $ 12, 000 $ 23, 500 3. 8% 8. 1% Accounts receivable, net 60, 000 40, 000 Inventory 80, 000 100, 000 Prepaid expenses 3, 000 1, 200 ($12, 000 ÷ $315, 000) 100% = 3. 8% Total current assets $ 155, 000× $ 164, 700 Property and equipment: Land 40, 000 12. 7% ($23, 50040, 000 ÷ $289, 700) × 100% = 8. 1% Buildings and equipment, net 120, 000 85, 000 Total property and equipment $ 160, 000 $ 125, 000 Total assets $ 315, 000 $ 289, 700 * Percent rounded to first decimal point.

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Notes payable Total current liabilities Long-term liabilities: Bonds payable, 8% Total liabilities Shareholders' equity: Preferred stock Common stock Additional paid-in capital Total paid-in capital Retained earnings Total shareholders' equity Total liabilities and shareholders' equity * Percent rounded to first decimal point. $ 2003 44, 000 6, 000 50, 000 21. 3% 1. 0% 22. 2% 15. 2% 2. 1% 17. 3% 80, 000 $ 130, 000 23. 8% 46. 0% 27. 6% 44. 9% 20, 000 60, 000 10, 000 $ 90, 000 80, 000 69, 700 $ 170, 000 $ 159, 700 $ 315, 000 $ 289, 700 6. 3% 19. 0% 3. 2% 28. 6% 25. 4% 54. 0% 100. 0% 6. 9% 20. 7% 3. 5% 31. 1% 24. 1% 55. 1% 100. 0% $ 67, 000 $ 3, 000 70, 000 $ Common-size Percents* 2004 2003 75, 000 $ 145, 000

CLOVER CORPORATION Comparative Balance Sheets December 31, 2004 Assets Current assets: Cash and equivalents $ 12, 000 Accounts receivable, net 60, 000 Inventory 80, 000 Prepaid expenses 3, 000 Total current assets $ 155, 000 Property and equipment: Land 40, 000 Buildings and equipment, net 120, 000 Total property and equipment $ 160, 000 Total assets $ 315, 000 * Percent rounded to first decimal point. 2003 Common-size Percents* 2004 2003 $ 23, 500 40, 000 100, 000 1, 200 $ 164, 700 3. 8% 19. 0% 25. 4% 1. 0% 49. 2% 8. 1% 13. 8% 34. 5% 0. 4% 56. 9% 40, 000 85, 000 $ 125, 000 $ 289, 700 12. 7% 38. 1% 50. 8% 100. 0% 13. 8% 29. 3% 43. 1% 100. 0%

CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31, Common-size Percents* 2004 2003 Revenues $ 520, 000 $ 480, 000 100. 0% Costs and expenses: Cost of sales 360, 000 315, 000 69. 2% 65. 6% Selling and admin. 128, 600 126, 000 24. 7% 26. 3% Interest expense 6, 400 7, 000 1. 2% 1. 5% Income before taxes $ 25, 000 $ 32, 000 4. 8% 6. 7% Income taxes (30%) 7, 500 9, 600 1. 4% 2. 0% Net income $ 17, 500 $ 22, 400 3. 4% 4. 7% Net income per share $ 0. 79 $ 1. 01 Avg. # common shares 22, 200 * Rounded to first decimal point.

Common-Size Graphics This is a graphical analysis of Clover Corporation’s common-size income statement for 2004.

Liquidity and Efficiency Solvency Market Profitability Prospects Let’s use the following financial statements for Norton Corporation for our ratio analysis.

General Rule of Financial ratios • Balance sheet : One point of time • Income Statement & Cash Flows St. : A period of time If the ratio mixes a Balance Sheet account with an I/S or CF St. account then use the average of the Balance sheet account AVG= (Beginning Balance + Ending Balance) ÷ 2

NORTON CORPORATION Balance Sheet December 31, Assets Current assets: Cash Accounts receivable, net Inventory Prepaid expenses Total current assets Property and equipment: Land Buildings and equipment, net Total property and equipment Total assets 2004 2003 $ 30, 000 20, 000 12, 000 3, 000 $ 65, 000 $ 20, 000 17, 000 10, 000 2, 000 $ 49, 000 165, 000 116, 390 $ 281, 390 $ 346, 390 123, 000 128, 000 $ 251, 000 $ 300, 000

NORTON CORPORATION Balance Sheet December 31, 2004 2003 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Notes payable, short-term Total current liabilities Long-term liabilities: Notes payable, long-term Total liabilities Shareholders' equity: Common stock, $1 par value Additional paid-in capital Total paid-in capital Retained earnings Total shareholders' equity 70, 000 $ 112, 000 78, 000 $ 120, 000 27, 400 158, 100 $ 185, 500 48, 890 $ 234, 390 17, 000 113, 000 $ 130, 000 50, 000 $ 180, 000 Total liabilities and shareholders' equity $ 346, 390 $ 300, 000 $ $ 39, 000 3, 000 42, 000 $ $ 40, 000 2, 000 42, 000

NORTON CORPORATION Income Statement For the Years Ended December 31, Revenues Cost of sales Gross margin Operating expenses Net operating income Interest expense Net income before taxes Less income taxes (30%) Net income $ $ $ 2004 494, 000 140, 000 354, 000 270, 000 84, 000 7, 300 76, 700 23, 010 53, 690 $ $ $ 2003 450, 000 127, 000 323, 000 249, 000 74, 000 8, 000 66, 000 19, 800 46, 200

Liquidity and Efficiency Current Ratio Inventory Turnover Acid-test Ratio Days’ Sales Uncollected Accounts Receivable Turnover Days’ Sales in Inventory Total Asset Turnover

Liquidity and Efficiency Use this information to calculate the liquidity and efficiency ratios for Norton Corporation.

Working Capital Working capital represents current assets financed from long-term capital sources that do not require near-term repayment. Dec. 31, 2004 Current assets $ Current liabilities Working capital 65, 000 (42, 000) $ 23, 000

Current Ratio Current Assets = Ratio Current Liabilities Current = Ratio $65, 000 = 1. 55 : 1 $42, 000 This ratio measures the short-term debt-paying ability of the company.

Acid-Test Ratio Quick Assets Acid-Test = Current Liabilities Ratio Quick assets are Cash, Short-Term Investments, and Current Receivables. Acid-Test = $50, 000 = 1. 19 : 1 $42, 000 Ratio This ratio is like the current ratio but excludes current assets such as inventories and prepaid expenses that may be difficult to quickly convert into cash.

Accounts Receivable Turnover Accounts Sales on Account Receivable = Average Accounts Receivable Turnover Accounts $494, 000 Receivable = ($17, 000 + $20, 000) ÷ 2 = 26. 7 times Turnover This ratio measures how many times a company converts its receivables into cash each year.

Inventory Turnover Cost of Goods Sold = Average Inventory $140, 000 = = 12. 73 times ($10, 000 + $12, 000) ÷ 2 This ratio measures the number of times merchandise is sold and replaced during the year.

Days’ Sales Uncollected Days’ Sales Accounts Receivable = ´ 365 Uncollected Net Sales Days’ Sales $20, 000 = ´ 365 = 14. 8 days Uncollected $494, 000 This ratio measures the liquidity of receivables.

Days’ Sales in Inventory Days’ Sales = in Inventory Ending Inventory Cost of Goods Sold ´ 365 Days’ Sales $12, 000 = ´ 365 = 31. 29 days in Inventory $140, 000 This ratio measures the liquidity of inventory.

Total Asset Turnover Total Asset Net Sales = Turnover Average Total Assets Total Asset $494, 000 = = 1. 53 times Turnover ($300, 000 + $346, 390) ÷ 2 This ratio measures the efficiency of assets in producing sales.

Solvency Debt Ratio Equity Ratio

Solvency Use this information to calculate the solvency ratios for Norton Corporation.

Debt Ratio Total Liabilities Debt = Ratio Total Assets Debt = Ratio $112, 000 $346, 390 = 32. 3% This ratio measures what portion of a company’s assets are contributed by creditors.

Equity Ratio Total Equity = Ratio Total Assets Equity = Ratio $234, 390 $346, 390 = 67. 7% This ratio measures what portion of a company’s assets are contributed by owners.

Profitability Profit Margin Return on Total Assets Gross Margin Return on Common Stockholders’ Equity

Profitability Use this information to calculate the profitability ratios for Norton Corporation.

Profit Margin Profit = Margin Net Income Net Sales $53, 690 Profit = 10. 87% = Margin $494, 000 This ratio describes a company’s ability to earn a net income from sales.

Gross Margin Gross Net Sales - Cost of Sales = Margin Net Sales Gross $494, 000 - $140, 000 = 71. 66% = Margin $494, 000 This ratio measures the amount remaining from $1 in sales that is left to cover operating expenses and a profit after considering cost of sales.

Return on Total Assets Return on = Net Income Total Assets Average Total Assets Return on $53, 690 = = 16. 61% Total Assets ($300, 000 + $346, 390) ÷ 2 This ratio is generally considered the best overall measure of a company’s profitability.

Du. Pont Analysis Return on = Net Income Total Assets Average Total Assets = = Net Income Net Sales Profit Margin X X Net Sales Average Total Assets Total Asset Turnover

Return on Common Stockholders’ Equity Return on Common Net Income - Preferred Dividends = Stockholders’ Average Common Stockholders’ Equity Return on $53, 690 - 0 Common = = 25. 9% Stockholders’ ($180, 000 + $234, 390) ÷ 2 Equity This measure indicates how well the company employed the owners’ investments to earn income.

Market Prospects Price. Earnings Ratio Dividend Yield

Market Prospects Use this information to calculate the market ratios for Norton Corporation.

Price-Earnings Ratio Price-Earnings Market Price Per Share = Ratio Earnings Per Share Price-Earnings $15. 00 = = 7. 65 times Ratio $1. 96 This measure is often used by investors as a general guideline in gauging stock values. Generally, the higher the price-earnings ratio, the more opportunity a company has for growth.

Dividend Yield Dividend Annual Dividends Per Share = Yield Market Price Per Share Dividend $2. 00 = = 13. 3% Yield $15. 00 This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.