Chapter 15 Financial Statement Analysis Financial and Managerial

Chapter 15 Financial Statement Analysis Financial and Managerial Accounting 8 th Edition Warren Reeve Fess Power. Point Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electroni presentation is used with the permission of NVTech Inc.

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Objectives 1. List the basic financial statement After studying this analytical procedures. chapter, you should 2. Apply financial statement analysis to be able to: assess the solvency of a business. 3. Apply financial statement analysis to assess the profitability of a business. 4. Summarize the uses and limitations of analytical measures. 5. Describe the contents of corporate annual reports.

Horizontal Analysis What is horizontal analysis?

Horizontal Analysis It’s an analysis of the percentage increases and decreases of related items in comparative financial statements.

Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Balance Sheet Increase (Decrease) 2006 2005 Amount Percent Assets Current assets $ 550, 000 $ 533, 000 $ 17, 000 3. 2% Long-term investments 95, 000 177, 500 (82, 500) (46. 5%) Fixed assets (net) 444, 500 470, 000 (25, 500) (5. 4%) Intangible assets 50, 000 — Total assets $1, 139, 500 $1, 230, 500 $ (91, 000) (7. 4%) Liabilities Current liabilities $ 210, 000 $ 243, 000 $ (33, 000) (13. 6%) Long-term liabilities 100, 000 200, 000 (100, 000) (50. 0%) Total liabilities $ 310, 000 $ 443, 000 $(133, 000) (30. 0%) Stockholders’ Equity Preferred 6% stock, $100 par $ 150, 000 — Common stock, $10 par 500, 000 — Retained earnings 179, 500 137, 500 $42, 000 30. 5% Total stockholders’ equity $ 829, 500 $ 787, 500 $42, 000 5. 3% Total liab. & SE $1, 139, 500 $1230, 500 $(91, 000) (7. 4%)

Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Increase (Decrease) 2005 Amount Percent $ 533, 000 $ 17, 000 3. 2% 177, 500 (82, 500) 2006 Assets Current assets $ 550, 000 Long-term investments 95, 000 (46. 5%) Horizontal Analysis: Fixed assets (net) 444, 500 470, 000 (25, 500)(5. 4%) Difference Intangible assets 50, 000 $17, 000 — = 3. 2% Total assets $1, 139, 500 $1, 230, 500$ (91, 000)(7. 4%) Base year (2005) $533, 000 Liabilities Current liabilities $ 210, 000 $ 243, 000 $ (33, 000) (13. 6%) Long-term liabilities 100, 000 200, 000 (100, 000) (50. 0%) Total liabilities $ 310, 000 $ 443, 000 $(133, 000) (30. 0%) Stockholders’ Equity Preferred 6% stock, $100 par $ 150, 000 — Common stock, $10 par 500, 000 — Retained earnings 179, 500 137, 500 $42, 000 30. 5% Total stockholders’ equity $ 829, 500 $ 787, 500 $42, 000 5. 3%

Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments (46. 5%) Fixed assets (net) Intangible assets Total assets Liabilities Current liabilities (13. 6%) Long-term liabilities (50. 0%) Total liabilities (30. 0%) Stockholders’ Equity Preferred stock, $100 par Common stock, $10 par Retained earnings Total stockholders’ equity 2006 $ 550, 000 95, 000 Increase (Decrease) 2005 Amount Percent $ 533, 000 $ 17, 000 3. 2% 177, 500 (82, 500) 444, 500 470, 000 (25, 500)(5. 4%) 50, 000 — Horizontal Analysis: $1, 139, 500 $1, 230, 500$ (91, 000)(7. 4%) Difference $(82, 500) $ = (33, 000) (46. 5%) $177, 500 $ 210, 000 $ 243, 000 100, 000 $ 310, 000 200, 000 $ 443, 000 $ 150, 000 500, 000 179, 500 $ 829, 500 $ 150, 000 500, 000 137, 500 $ 787, 500 Base year (2005) (100, 000) $(133, 000) — — $42, 000 30. 5% $42, 000 5. 3%

Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Okay, go to the next slide. Increase (Decrease) 2006 2005 Amount Percent Assets and calculate the percentage Current assets $ 550, 000 $ 533, 000 $ 17, 000 3. 2% Long-term investments 95, 000 assets. 177, 500 (82, 500) change for fixed (46. 5%) Fixed assets (net) 444, 500 470, 000 (25, 500)(5. 4%) Intangible assets 50, 000 — Total assets $1, 139, 500 $1, 230, 500$ (91, 000) Horizontal Analysis: (7. 4%) Liabilities Difference ? Current liabilities $ 210, 000 $ 243, 000 $ (33, 000) = ? (13. 6%) Base year (2005) ? Long-term liabilities 100, 000 200, 000 (100, 000) (50. 0%) Total liabilities $ 310, 000 $ 443, 000 $(133, 000) (30. 0%) Stockholders’ Equity Preferred 6% stock, $100 par $ 150, 000 — Common stock, $10 par 500, 000 — Retained earnings 179, 500 137, 500 $42, 000 30. 5%

Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments (46. 5%) Fixed assets (net) Intangible assets Total assets (7. 4%) Liabilities Current liabilities (13. 6%) Long-term liabilities (50. 0%) Total liabilities (30. 0%) Stockholders’ Equity Preferred 6% stock, $100 par Common stock, $10 par Retained earnings 2006 $ 550, 000 95, 000 Increase (Decrease) 2005 Amount Percent $ 533, 000 $ 17, 000 3. 2% 177, 500 (82, 500) 444, 500 470, 000 (25, 500)(5. 4%) 50, 000 — $1, 139, 500 $1, 230, 500$ (91, 000) $ 210, 000 $ 243, 000 $ (33, 000) 100, 000 $ 310, 000 200, 000 $ 443, 000 (100, 000) $(133, 000) $ 150, 000 500, 000 179, 500 $ 150, 000 500, 000 137, 500 — — $42, 000 30. 5%

Lincoln Company Comparative Balance Sheet December 31, 2006 and 2005 Assets Current assets Long-term investments (46. 5%) Fixed assets (net) Intangible assets Total assets (7. 4%) Liabilities Current liabilities (13. 6%) Long-term liabilities (50. 0%) Total liabilities (30. 0%) Stockholders’ Equity Preferred 6% stock, $100 par Common stock, $10 par Retained earnings 2006 $ 550, 000 95, 000 Increase (Decrease) 2005 Amount Percent $ 533, 000 $ 17, 000 3. 2% 177, 500 (82, 500) 444, 500 470, 000 (25, 500)(5. 4%) 50, 000 — $1, 139, 500 $1, 230, 500$ (91, 000) (5. 4%) $ 210, 000 $ 243, 000 $ (33, 000) 100, 000 $ 310, 000 200, 000 $ 443, 000 (100, 000) $(133, 000) $ 150, 000 500, 000 179, 500 $ 150, 000 500, 000 137, 500 — — $42, 000 30. 5%

Lincoln Company Comparative Income Statement December 31, 2006 and 2005 Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other income (22. 7%) Other expense (50. 0%) Income before income tax Income tax Net income Income Statement Increase (Decrease) 2006 2005 Amount Percent $1, 530, 500 $1, 234, 000$296, 500 24. 0% 32, 500 34, 000 (1, 500)(4. 4%) $1, 498, 000 $1, 200, 000$298, 000 24. 8% 1, 043, 000 820, 000 223, 000 27. 2% $ 455, 000 $ 380, 000 $ 75, 000 19. 7% $ 191, 000 $ 147, 000 $ 44, 000 29. 9% 104, 000 97, 400 6, 600 6. 8% $ 295, 000 $ 244, 400 $ 50, 600 20. 7% $ 160, 000 $ 135, 600 $ 24, 400 18. 0% 8, 500 11, 000 (2, 500) $ 168, 500 6, 000 $ 146, 600 12, 000 $ 21, 900 14. 9% (6, 000) $ 162, 500 71, 500 $ 91, 000 $ 134, 600 58, 100 $ 76, 500 $ 27, 900 20. 7% 13, 400 23. 1% $ 14, 500 19. 0%

Lincoln Company Comparative Income Statement December 31, 2006 and 2005 Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other income (22. 7%) Other expense (50. 0%) Income before income tax Income tax Net income Increase (Decrease) 2006 2005 Amount Percent $1, 530, 500 $1, 234, 000$296, 50024. 0% 32, 500 34, 000 (1, 500)(4. 4%) $1, 498, 000 $1, 200, 000$298, 000 24. 8% 1, 043, 000 820, 000 223, 000 27. 2% $ 455, 000 $ 380, 000 $ 75, 000 19. 7% Horizontal Analysis: $ 191, 000 $ 147, 000 $ 44, 000 29. 9% 97, 400 6, 600 6. 8% Increase 104, 000 amount $296, 500 $ 295, 000 $ 244, 400 =$ 24. 0% 50, 600 20. 7% Base year (2005) $1, 234, 000 $ 160, 000 $ 135, 600 $ 24, 400 18. 0% 8, 500 11, 000 (2, 500) $ 168, 500 6, 000 $ 146, 600 12, 000 $ 21, 900 14. 9% (6, 000) $ 162, 500 71, 500 $ 91, 000 $ 134, 600 58, 100 $ 76, 500 $ 27, 900 20. 7% 13, 400 23. 1% $ 14, 500 19. 0%

Lincoln Company Comparative Income Statement December 31, 2006 and 2005 Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other income (22. 7%) Other expense (50. 0%) Income before income tax Income tax Net income Increase (Decrease) 2006 2005 Amount Percent $1, 530, 500 $1, 234, 000$296, 500 24. 0% 32, 500 34, 000 (1, 500)(4. 4%) $1, 498, 000 $1, 200, 000$298, 00024. 8% 1, 043, 000 820, 000 223, 000 27. 2% $ 455, 000 $ 380, 000 $ 75, 000 19. 7% $ 191, 000 $ 147, 000 $ 44, 000 29. 9% 104, 000 97, 400 6, 600 6. 8% $ 295, 000 $ 50, 600 20. 7% Horizontal Analysis: $ 244, 400 $ 160, 000 $ 135, 600 $ 24, 400 18. 0% 8, 500 11, 000 (2, 500) Increase amount $298, 000 = 24. 8% Base year (2005) $1, 200, 000 $ 168, 500 $ 146, 600 $ 21, 900 14. 9% 6, 000 12, 000 $ 162, 500 71, 500 $ 91, 000 $ 134, 600 58, 100 $ 76, 500 (6, 000) $ 27, 900 20. 7% 13, 400 23. 1% $ 14, 500 19. 0%

Vertical Analysis A percentage analysis can be used to show the relationship of each component to a total within a single statement.

Vertical Analysis The total, or 100% item, on the balance sheet is “total assets. ”

Lincoln Company Comparative Balance Sheet December 31, 2006 Amount Percent Balance Sheet December 31, 2005 Amount Percent Assets Current assets $ 550, 000 48. 3% $ 533, 000 43. 3% 48. 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% Liabilities Current liabilities $ 210, 000 18. 4% $ 243, 000 19. 7% Long-term liabilities 100, 000 8. 8 200, 000 16. 3 Vertical Total Analysis: liabilities $ 310, 000 27. 2% $ 443, 000 36. 0% Stockholders’ Equity Current assets $550, 000 Preferred stock, 6%, $100 par $ 150, 000 13. 2% $ 150, 000 = 48. 3% Total assets 12. 2% Common$1, 139, 500 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% Total liab. & SE$1, 139, 500 100. 0% $1, 230, 500 100. 0%

Lincoln Company Comparative Balance Sheet December 31, 2006 Amount Percent December 31, 2005 Amount Percent Assets Current assets $ 550, 00048. 3% Long-term investments 95, 000 8. 3 Property, plant, & equip. (net) 444, 50039. 0 Intangible assets 50, 000 4. 4 Total assets $1, 139, 500 $1, 230, 500 100. 0% Liabilities Current liabilities $ 210, 00018. 4% Vertical Analysis: Long-term liabilities 100, 000 8. 8 Total liabilities 310, 00027. 2% Current$assets $533, 000 Stockholders’ Equity $1, 230, 500 Preferred 6% stock, $100 Total par assets $ 150, 00013. 2% Common stock, $10 par 500, 00043. 9 Retained earnings 179, 50015. 7 Total stockholders’ equity $ 829, 50072. 8% Total liab. & SE $1, 139, 500 $1, 230, 500 100. 0% $ 533, 00043. 3% 177, 500 14. 4 470, 000 38. 2 50, 000 4. 1 100. 0% $ 243, 000 19. 7% 200, 000 16. 3 $ 443, 000 36. 0% = 43. 3% $ 150, 000 12. 2% 500, 000 40. 6 137, 500 11. 2 $ 787, 500 64. 0% 100. 0%

Lincoln Company Comparative Balance Sheet December 31, 2006 Amount Percent Assets Current assets Long-term investments Property, plant, & equip. (net) Intangible assets Total assets $1, 230, 500 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. & SE $1, 230, 500 December 31, 2005 Amount Percent $ 550, 00048. 3% 95, 000 8. 3 444, 50039. 0 50, 000 4. 4 $1, 139, 500 100. 0% $ 533, 000 43. 3% 177, 500 14. 4 470, 000 38. 2 50, 000 4. 1 100. 0% $ 210, 00018. 4% 100, 000 8. 8 $ 310, 00027. 2% $ 243, 000 19. 7% 200, 000 16. 3 $ 443, 000 36. 0% $ 150, 00013. 2% 500, 00043. 9 179, 50015. 7 $ 829, 50072. 8% $1, 139, 500 100. 0% $ 150, 000 12. 2% 500, 000 40. 6 137, 500 11. 2 $ 787, 500 64. 0% 100. 0%

Lincoln Company Income Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Sales $1, 530, 500 102. 2% $1, 234, 000 102. 8% Sales returns 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 Net sales 68. 3 is 100. 0% Gross profit $ 455, 000 30. 4% $ 380, 00031. 7% Selling expenses $ 191, 000 12. 8% $ 147, 00012. 3% Administrative expenses 104, 000 6. 9 97, 400 8. 1 Total operating expenses $ 295, 000 19. 7% $ 244, 40020. 4% Income from operations $ 160, 000 10. 7 $ 135, 60011. 3% Other income 8, 500 0. 6 11, 000 0. 9 $ 168, 500 11. 3% $ 146, 60012. 2% Other expense 6, 000 0. 4 12, 000 1. 0 Income before income tax $ 162, 500 10. 9% $ 134, 60011. 2% Income tax expense 71, 500 4. 8 58, 100 4. 8

Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Sales $1, 530, 500 102. 2% $1, 234, 000 102. 8% Sales returns 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 12. 8% 68. 3 Gross profit $ 455, 000 30. 4% $ 380, 00031. 7% Selling expenses $ 191, 000 12. 8% $ 147, 00012. 3% Administrative expenses 104, 000 6. 9 97, 400 8. 1 Total. Vertical operating. Analysis: expenses $ 295, 000 19. 7% $ 244, 40020. 4% Income from operations $ 160, 000 10. 7 $ 135, 60011. 3% Selling expenses $191, 000 Other income 8, 500 0. 6 11, 000 0. 9 = 12. 8% Net sales $1, 498, 000 $ 168, 500 11. 3% $ 146, 60012. 2% Other expense 6, 000 0. 4 12, 000 1. 0 Income before income tax $ 162, 500 10. 9% $ 134, 60011. 2% Income tax expense 71, 500 4. 8 58, 100 4. 8

Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Sales $1, 530, 500 102. 2% $1, 234, 000 102. 8% Sales returns 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, 00031. 7% Selling expenses $ 191, 000 12. 8% $ 147, 00012. 3% Administrative expenses 104, 000 6. 9 97, 400 8. 1 Total operating expenses $ 295, 000 19. 7% $ 244, 40020. 4% Income from operations $ 160, 000 10. 7 $ 135, 60011. 3% Other income 8, 500 0. 6 11, 000 0. 9 $ 168, 500 11. 3% $ 146, 60012. 2% Other expense 6, 000 0. 4 12, 000 1. 0 Income before income tax $ 162, 500 10. 9% $ 134, 60011. 2% Income tax expense 71, 500 4. 8 58, 100 4. 8

Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Sales $1, 530, 500 102. 2% $1, 234, 000 102. 8% Sales returns 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, 00031. 7% Selling expenses $ 191, 000 12. 8% $ 147, 00012. 3% Administrative expenses 104, 000 6. 9 97, 400 8. 1 Total operating expenses $ 295, 000 19. 7% $ 244, 40020. 4% Income from operations $ 160, 000 10. 7 $ 135, 60011. 3% Other income 8, 500 0. 6 11, 000 0. 9 $ 168, 500 11. 3% $ 146, 60012. 2% Other expense 6, 000 0. 4 12, 000 1. 0 Income before income tax $ 162, 500 10. 9% $ 134, 60011. 2% Income tax expense 71, 500 4. 8 58, 100 4. 8

Lincoln Company Comparative Income Statement For the Years Ended December 31, 2006 and 2005 2006 2005 Amount Percent Sales $1, 530, 500 102. 2% $1, 234, 000 102. 8% Sales returns 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, 00031. 7% Selling expenses $ 191, 000 12. 8% $ 147, 00012. 3% Administrative expenses 104, 000 6. 9 97, 400 8. 1 Total operating expenses $ 295, 000 19. 7% $ 244, 40020. 4% Income from operations $ 160, 000 10. 7 $ 135, 60011. 3% Other income 8, 500 0. 6 11, 000 0. 9 $ 168, 500 11. 3% $ 146, 60012. 2% Other expense 6, 000 0. 4 12, 000 1. 0 Income before income tax $ 162, 500 10. 9% $ 134, 60011. 2% Income tax expense 71, 500 4. 8 58, 100 4. 8

Common Size Statements Vertical analysis with both dollar and percentage amounts is also useful in comparing one company with another or with industry averages. Such comparisons are easier to make with the use of common-size statements in which all items are expressed in percentages.

Common-Size Income Statement

Solvency Analysis § Solvency is the ability of a business to meet its financial obligations (debts) as they are due. § Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities. § This ability is normally assessed by examining balance sheet relationships.

Current Position Analysis Working Capital and Current Ratio Current assets Current liabilities Working capital Current ratio 2006 $550, 000 210, 000 $340, 000 2. 6 2005 $533, 000 243, 000 $290, 000 2. 2 Use: To indicate the ability to meet Divide currently maturing obligations. current assets by current liabilities

Current Position Analysis Quick Ratio Quick assets: Cash Marketable securities Accounts receivable (net) Total Current liabilities Quick ratio 2006 2005 $ 90, 500 75, 000 115, 000 $280, 500 $210, 000 1. 3 $ 64, 700 60, 000 120, 000 $244, 700 $243, 000 1. 0 Use: To indicate instant debt-paying ability.

Accounts Receivable Analysis Accounts Receivable Turnover Net sales on account Accounts receivable (net): Beginning of year End of year Total Average (Total ÷ 2) 2006 $1, 498, 000 2005 $1, 200, 000 $ 120, 000 115, 500 $ 235, 000 $ 117, 500 $ 140, 000 120, 000 $ 260, 000 $ 130, 000 Net sales on account Average accounts receivable

Accounts Receivable Analysis Accounts Receivable Turnover Net sales on account Accounts receivable (net): Beginning of year End of year Total Average Accounts receivable turnover 2006 $1, 498, 000 2005 $1, 200, 000 $ 120, 000 115, 500 $ 235, 000 $ 117, 500 12. 7 $ 140, 000 120, 000 $ 260, 000 $ 130, 000 9. 2 Use: To assess the efficiency in collecting receivables and in the management of credit.

Accounts Receivable Analysis Number of Days’ Sales in Receivables 2006 Accounts receivable (net), end of year Net sales on account Average daily sales on account (sales ÷ 365) 2005 $ 115, 000 $1, 498, 000 $ 120, 000 $1, 200, 000 $ $ 4, 104 Accounts receivable, end of year Average daily sales on account 3, 288

Accounts Receivable Analysis Number of Days’ Sales in Receivables 2006 Accounts receivable (net), end of year Net sales on account Average daily sales on account (sales ÷ 365) Number of days’ sales in receivables 2005 $ 115, 000 $1, 498, 000 $ 120, 000 $1, 200, 000 $ $ 4, 104 28. 0 3, 288 36. 5 Use: To assess the efficiency in collecting receivables and in the management of credit.

Inventory Analysis Inventory Turnover Cost of goods sold Inventories: Beginning of year End of year Total Average (Total ÷ 2) Inventory turnover = 2006 $1, 043, 000 2005 $ 820, 000 $ 283, 000 264, 000 $ 547, 000 $ 273, 500 $ 311, 000 283, 000 $ 594, 000 $ 297, 000 Cost of goods sold Average inventory

Inventory Analysis Inventory Turnover Cost of goods sold Inventories: Beginning of year End of year Total Average (Total ÷ 2) Inventory turnover 2006 $1, 043, 000 2005 $ 820, 000 $ 283, 000 264, 000 $ 547, 000 $ 273, 500 3. 8 $ 311, 000 283, 000 $ 594, 000 $ 297, 000 2. 8 Use: To assess the efficiency in the management of inventory.

Inventory Analysis Number of Days’ Sales in Inventory Inventories, end of year Cost of goods sold Average daily cost of goods sold (COGS ÷ 365) Number of Days’ Sales = in Inventory 2006 $ 264, 000 $1, 043, 000 2005 $283, 000 $820, 000 $ $ 2, 858 2, 247 Inventories, end of year Average daily cost of goods sold

Inventory Analysis Number of Days’ Sales in Inventory Inventories, end of year Cost of goods sold Average daily cost of goods sold (COGS ÷ 365) Number of days’ sales in inventory 2006 $ 264, 000 $1, 043, 000 2005 $283, 000 $820, 000 $ $ 2, 858 92. 4 Use: To assess the efficiency in the management of inventory. 2, 247 125. 9

Long-Term Creditors Ratio of Fixed Assets to Long-Term Liabilities Fixed assets (net) Long-term liabilities Ratio of fixed assets to long-term liabilities 2006 $444, 500 $100, 000 4. 4 2005 $470, 000 $200, 000 2. 4 Use: To indicate the margin of safety to long-term creditors.

Long-Term Creditors Ratio of Liabilities to Stockholders’ Equity Total liabilities Total stockholders’ equity Ratio of liabilities to stockholders’ equity 2006 $310, 000 $829, 500 2005 $443, 000 $787, 500 0. 37 0. 56 Use: To indicate the margin of safety to creditors.

Long-Term Creditors Number of Times Interest Charges Earned Income before income tax Add interest expense Amount available for interest Number of Times Interest = Charges Earned 2006 2005 $ 900, 000 $ 800, 000 300, 000 250, 000 $1, 200, 000 $1, 050, 000 Income before income tax + interest expense Interest expense

Long-Term Creditors Number of Times Interest Charges Earned Income before income tax Add interest expense Amount available for interest Number of times earned 2006 2005 $ 900, 000 $ 800, 000 300, 000 250, 000 $1, 200, 000 $1, 050, 000 4. 2 Use: To assess the risk to debtholders in terms of number of times interest charges were earned.

Profitability Analysis § 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. § Profitability analysis focuses primarily on the relationship between operating results reported in the income statement and resources reported in the balance sheet.

The Common Stockholder Ratio of Net Sales to Assets Net sales Total assets: Beginning of year End of year Total Average (Total ÷ 2) 2006 $1, 498, 000 2005 $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 Excludes long-term investments

The Common Stockholder Ratio of Net Sales to Assets Net sales Total assets: Beginning of year End of year Total Average (Total ÷ 2) Ratio of net sales to assets 2006 $1, 498, 000 2005 $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 Use: To assess the effectiveness of the use of assets. 1. 2

The Common Stockholder Rate Earned on Total Assets Net income Plus interest expense Total assets: Beginning of year End of year Total Average (Total ÷ 2) Rate earned on total assets 2006 $ 91, 000 6, 000 $ 97, 000 2005 $ 76, 500 12, 000 $ 88, 500 $1, 230, 500 1, 139, 500 $2, 370, 000 $1, 185, 000 8. 2% $1, 187, 500 1, 230, 500 $2, 418, 000 $1, 209, 000 7. 3% Use: To assess the profitability of the assets.

The Common Stockholder Rate Earned on Stockholders’ Equity Net income Stockholders’ equity: Beginning of year End of year Total Average (Total ÷ 2) Rate earned on stockholders’ equity 2006 $ 91, 000 2005 $ 76, 500 $ 787, 500 829, 500 $1, 617, 000 $ 808, 500 $ 750, 000 787, 500 $1, 537, 500 $ 768, 750 11. 3% 10. 0% Use: To assess the profitability of the investment by stockholders.

Leverage 11. 3% 10. 0% Leverage 3. 1% 10% 8. 2% 7. 3% Leverage 2. 7% 5% 0% 2006 Rate earned on total assets 2005 Rate earned on stockholders’ equity

The Common Stockholder Rate Earned on Common Stockholders’ Equity Net income Less preferred dividends Remainder—common stock Common stockholders’ equity: Beginning of year End of year Total Average (Total ÷ 2) $ $ 2006 91, 000 9, 000 82, 000 $ 637, 500 679, 500 $1, 317, 000 $ 658, 500 $ $ 2005 76, 500 9, 000 67, 500 $ 600, 000 637, 500 $1, 237, 500 $ 618, 750

The Common Stockholder Rate Earned on Common Stockholders’ Equity Net income Less preferred dividends Remainder—common stock Common stockholders’ equity: Beginning of year End of year Total Average (Total ÷ 2) Rate earned on common stockholders’ equity $ $ 2006 91, 000 9, 000 82, 000 $ $ 2005 76, 500 9, 000 67, 500 $ 637, 500 679, 500 $1, 317, 000 $ 658, 500 $ 600, 000 637, 500 $1, 237, 500 $ 618, 750 12. 5% 10. 9% Use: To assess the profitability of the investment by common stockholders.

The Common Stockholder Earnings Per Share on Common Stock Net income Less preferred dividends Remainder—common stock Shares of common stock 2006 $ 91, 000 9, 000 $ 82, 000 50, 000 Earnings per share on common stock $1. 64 2005 $ 76, 500 9, 000 $ 67, 500 50, 000 $1. 35 Use: To assess the profitability of the investment by common stockholders.

The Common Stockholder Price-Earnings Ratio 2006 Market price per share of common $41. 00 Earnings per share on common ÷ 1. 64 Price-earnings ratio on common stock 25 2005 $27. 00 ÷ 1. 35 20 Use: To indicate future earnings prospects, based on the relationship between market value of common stock and earnings.

Dividends and Earnings Per Share $2. 00 $1. 64 Per share $1. 50 $1. 00 $1. 35 $0. 80 $0. 60 $0. 50 $0. 00 2006 Dividends 2005 Earnings

The Common Stockholder Dividend Yield on Common Stock Dividends per share of common Market price per share of common Dividend yield on common stock 2006 $ 0. 80 ÷ 41. 00 1. 95% 2005 $ 0. 60 ÷ 27. 00 2. 22% Use: To indicate the rate of return to common stockholders in terms of dividends.

Corporate Annual Reports In addition to financial statements, the annual report includes a management discussion analysis (MDA) and an independent auditors’ report. The MDA includes an analysis of the results of operations and discusses management’s opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition.

Corporate Annual Reports In addition to financial statements, the annual report includes a management discussion analysis (MDA) and an independent auditors’ report. Before issuing annual statements, all publicly held corporations are required to have an independent audit of their financial statements. The CPAs who conduct the audit render an opinion as to the fairness of the statements.

Chapter 15 The End