14 Financial Statement Analysis FINANCIAL ACCOUNTING 2 ND

14 Financial Statement Analysis FINANCIAL ACCOUNTING 2 ND EDITION BY DUCHAC, REEVE, & WARREN Power. Point Presentation by Gail B. Wright Professor of Accounting Bryant University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. 1

LG 1 HORIZONTAL, VERTICAL ANALYSES • Basic financial statement analysis begins with – Evaluating relative size of changes in account balances (horizontal) – Evaluating relative size of account balances (vertical) 2

HORIZONTAL ANALYSIS: Assets Largest $ increase Largest % increase Total assets increased $273 million (27. 2%) 3

HORIZONTAL ANALYSIS: Equity 4

LG 1 VERTICAL ANALYSIS • On the balance sheet – Each item is expressed as a % of total assets • On the income statement – Each item is expressed as a % of net sales 5

LG 1 COMMON-SIZED STATEMENTS • Starts with horizontal, vertical analysis – Shows comparisons in percentages – Shows 2 or more years of data – Allows for $ & % comparisons 6

LG 2 PROFITABILITY ANALYSIS • Rate earned on stockholders’ equity – Stockholders’ rate of return • Rate earned on total assets – Rate of return earned by what is invested in assets • Comprehensive profitability analysis – Detailed analysis of rate of return on stockholders’ equity 7

LG 2 RATE EARNED ON STOCKHOLDERS’ EQUITY Return on Stockholders’ Equity (ROE) = Net Income / Ave. Stockholders’ Equity 8

LG 2 PIXAR vs. DREAMWORKS: ROE Net Income Beginning Stockholders Equity Ending Stockholders Equity ROE Pixar Dreamworks $141. 7 $333 940. 5 <12. 4> 1, 220. 1 13. 1% 826. 9 ? Pixar ROE: 141. 7 / {(940. 5 + 1220. 1)/2} 9

LG 2 RATE EARNED ON TOTAL ASSETS Return on Total Assets (ROA) = Net Income / Ave. Total Assets 10

LG 2 PIXAR vs. DREAMWORKS: ROA Beginning Total Assets Pixar Dreamworks $141. 7 $333 1, 002. 0 681. 4 Ending Total Assets 1275. 0 Net Income ROA ? 1, 200. 0 35. 4% Dreamworks ROA: 333 / {(681. 4 + 1200. 0)/2} 11

LG 2 COMPREHENSIVE ROE Rate Earned on Stockholders’ Equity (ROE) = ROA * Leverage {Net Income/ Ave TA} * {Ave TA/Ave Stockholders’ Equity} 12

LG 2 PIXAR vs. DREAMROWKS: Comprehensive ROE = ROA Leverage Pixar 13. 1% 12. 4% 1. 05 Dreamworks 81. 8% 35. 4% 2. 31 13

LG 3 MARGIN & ASSET EFFICIENCY ANALYSIS • Margin & efficiency analyses examine – Profit margins – Efficient use of assets 14

LG 3 DUPONT FORMULA ROA = Profit Margin * Asset Turnover = Net Income/Ave TA = Net Income/Net Sales * Net Sales/Ave TA 15

LG 3 EXHIBIT 6 $1 assets generates $x sales $1 sales generates x cents profits 16

LG 3 PIXAR vs. DREAMROWKS: Dupont Analysis Pixar 12. 4% Profit Margin 51. 8% Dreamworks 35. 4% 30. 9% ROA = Asset Turnover 0. 24 1. 15 17

LG 3 ASSET EFFICIENCY: Components • Asset efficiency – Examine major asset accounts • Accounts receivable turnover • Inventory turnover • Fixed asset turnover 18

LG 3 ACCOUNTS RECEIVABLE ANALYSIS • Measures efficiency of collection • Reflects liquidity Accounts receivable turnover = Net Sales / (Ave. AR) Days sales in Receivables = Ave AR/Ave Daily Sales 19

LG 3 PIXAR vs. DREAMWORKS: Accounts Receivable Turnover Pixar $273. 5 204. 9 Dreamworks $1078. 2 132. 3 Ending AR 82. 0 386. 1 Accounts Receivable Turnover 1. 91 4. 16 Net Sales Beginning AR Pixar Turnover: 273. 5 / {(204. 9 + 82. 0)/2} 20

LG 3 Dreamworks collects its accounts receivable more than twice as fast as Pixar measured in terms of the number of times receivables are collected within the year. 21

LG 3 PIXAR vs. DREAMWORKS: Days Sales in Receivables Beginning AR Pixar 204. 9 Dreamworks 132. 3 Ending AR 82. 0 386. 1 Average AR $143. 45 $259. 20 Net Sales $273. 5 $1078. 2 Average daily sales (Sales/365) $0. 75 $2. 95 Days Sales in Receivables 191. 3 87. 9 22

LG 3 Dreamworks collects its accounts receivable more than twice as fast as Pixar measured in days receivables have been outstanding. 23

LG 3 INVENTORY ANALYSIS • Measures inventory efficiency – Avoid tying up funds in inventory – Avoid obsolescence • Reflects liquidity Inventory Turnover = CGS / (Ave. Inventory) Days Sales in Inventory = Ave Inventory/ (CGS/365) 24

LG 3 PIXAR vs. DREAMWORKS: Inventory Turnover Beginning Inventory Pixar $29. 9 107. 7 Dreamworks $566. 2 427. 5 Ending Inventory 140. 0 519. 9 Inventory Turnover 0. 24 1. 2 Cost merchandise sold Pixar Turnover: 29. 9 / {(107. 7 + 140. 0)/2} 25

LG 3 Dreamworks turns its inventory 5 times as fast as Pixar measured in terms of the number of times inventory turns over within the year. 26

LG 3 PIXAR vs. DREAMWORKS: Days Sales in Inventory Beginning Inventory Pixar 107. 7 Dreamworks 427. 5 Ending Inventory 140. 0 519. 9 Average Inventory $123. 85 $473. 7 Cost of goods sold $29. 9 $566. 2 Average daily COGS (Sales/365) $0. 082 $1. 55 Days Sales in Inventory 1, 510 306 27

LG 3 Dreamworks turns out its pictures more than 5 times as fast as Pixar measured in days pictures have been in production. 28

LG 3 FIXED ASSET ANALYSIS • Measures efficiency in use of fixed assets – Measures dollars sales generated by $1 fixed assets Fixed Asset Turnover = Sales / (Ave. Fixed Assets) 29

LG 3 PIXAR vs. DREAMWORKS: Fixed Asset Turnover Beginning Fixed assets Pixar $273. 5 115. 0 Dreamworks $1078. 2 89. 8 Ending Fixed assets 125. 6 86. 0 Fixed Asset Turnover 2. 27 12. 27 Net Sales Pixar Turnover: 273. 5 / {(115. 0 + 125. 6)/2} 30

LG 3 Dreamworks generates more than 5 times the sales dollars as Pixar during the year. 31

LG 4 LEVERAGE ANALYSIS • Measures liquidity, solvency – Current ratio – Quick ratio – Fixed assets to long-term liabilities – Liabilities to equity – # Times interest charges earned 32

LG 4 PIXAR vs. DREAMWORKS: Current Ratio Current assets Current liabilities Working capital (CA – CL) Current ratio Pixar $939. 0 Dreamworks $727. 8 54. 9 152. 9 $884. 1 $574. 9 17. 1 4. 76 33

LG 4 A current ratio > 2. 0 shows excellent ability to pay shortterm borrowings. Both Pixar & Dream. Works have high current ratios. 34

LG 4 PIXAR vs. DREAMWORKS: Quick Ratio Quick assets* Current liabilities Quick ratio Pixar $936. 8 Dreamworks $450. 9 54. 9 152. 9 17. 06 2. 95 *Quick assets: cash, marketable securities, & receivables 35

LG 4 If the standard measurement for the quick ratio is > 1. 0, what can you say about the quick ratio for Pixar & Dream. Works? 36

LG 4 PIXAR vs. DREAMWORKS: Fixed Assets to Long-Term Liabilities Fixed assets Long-term liabilities Fixed assets to Long-term liabilities Pixar $125. 6 Dreamworks $89. 7 0 217. 2 NA 0. 41 37

LG 4 If Dream. Works finances 41% of its fixed assets with long term debt, what can you say about how Pixar finances its fixed assets? 38

LG 4 PIXAR vs. DREAMWORKS: Liabilities to Stockholders’ Equity Total liabilities Total stockholders’ equity Ratio liabilities to stockholders’ equity Pixar $54. 9 Dreamworks $373. 1 1, 220. 1 826. 9 0. 04 0. 45 39

LG 4 Both Pixar & Dream. Works are conservative (< 1) in their use of liabilities to finance assets. 40

LG 4 PIXAR vs. DREAMWORKS: # Times Interest Charges Earned Net Income + Tax expense + Interest expense Available for interest charges # Times interest charges earned Pixar $141. 7 Dreamworks $333 79. 4 90. 3 0 15. 0 $221. 1 $438. 3 NA 29. 2 41

LG 4 Dream. Works can cover its interest charges more than 29 times. Interpret Pixar’s ratio. 42

LG 5 STOCKHOLDER RATIOS • Earnings per share • Price earnings ratio • Dividend Yield 43

LG 5 PIXAR vs. DREAMWORKS: Earnings per Share Net Income Pixar $141. 7 Dreamworks $333 Shares common stock outstanding 56. 76 81. 4 EPS $2. 50 $4. 09 44

LG 5 A share of Dream. Works stock earned more than a share of Pixar’s stock. What is the importance of trends in EPS? 45

LG 5 PIXAR vs. DREAMWORKS: Price-Earnings Ratio Market price per share C/S EPS Price-Earnings ratio Pixar $90. 06 Dreamworks $37. 44 2. 50 4. 09 36. 02 $9. 15 46

LG 5 Investors are willing to pay 36 times Pixar’s earning for a share of stock? Compare with Dream. Works. 47

LG 5 DIVIDEND YIELD • Dividend yield calculates the rate of return to common shareholders in terms of cash dividends • Neither Pixar not Dream. Works pay dividends 48

LG 6 ANALYTICAL MEASURES: Summary • Industry, capital structure, operations affect measures used • Measures of financial position, operating results assess past performance – Industry, general economic trends should be considered • Interrelationships among measures should be considered 49

LG 7 CONTENTS ANNUAL REPORTS • Corporate annual reports must include – Management Discussion & Analysis • Interprets financial statements • Assesses future of company – Report on adequacy of internal control – Report on fairness of financial statements 50

• "My great concern is not whether you have failed, but whether you are content with your failure. " - Abraham Lincoln (1809 -1865) 51