Transcript Chapter 24 Comparative Financial Statements Interpreting a Firm’s Accounting Information • Owners, employers, managers, and creditors are interested in the financial position and the results of.

Chapter 24
Comparative
Financial Statements
Interpreting a Firm’s
Accounting Information
• Owners, employers, managers, and creditors
are interested in the financial position and the
results of operations of a business.
Areas of Particular Concern
– Solvency
• An enterprise’s ability to pay its debts
– Profitability
• An enterprise’s ability to earn a reasonable profit
on the owners’ investment
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Types of Comparison
• A company’s financial statements are
meaningful only if you analyze them on a
comparative basis.
Compare results to previously established financial
standards/objectives.
Compare company to company in the same industry.
Compare a company’s year to year results.
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Horizontal Analysis
Comparison of the same item in a company’s
financial statements for two or more periods
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Steps in Horizontal Analysis
1. Determine the difference for each item on
the financial statement between the two
periods.
2. Express the difference as a percentage of
the base period.
Base Year
The year used as a basis for comparison
Usually the earlier year
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Horizontal Analysis with a
Sample Simplified Financial Statement
Trips & Travel Co.
Comparative Income Statement
For Years Ended June 30, 2008 and June 30, 2007
2008
2007
INCREASE OR (DECREASE)
Amount
Revenues:
Income from Services
Expenses:
Wages Expense
Advertising Expense
Telephone Expense
Supplies Expense
Utilities Expense
Total Expenses
Net Income
Percent
$
176,529.60 $
150,880.00 $
25,649.60
17.0
$
75,062.40 $
19,023.75
5,100.00
4,730.00
2,592.00
106,508.15 $
70,021.45 $
67,020.00 $
20,025.00
5,100.00
4,300.00
2,400.00
98,845.00 $
52,035.00 $
8,042.40
(1,001.25)
430.00
192.00
7,663.15
17,986.45
12.0
(5.0)
10.0
8.0
7.8
34.6
$
$
How was the percentage change for Supplies
Expense from year 2007 to 2008 calculated?
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Calculate the Percentage Change for
Supplies Expense from Year 2007 to 2008
Ending Year Amount – Base Year Amount
Base Year Amount
2008 Supplies – 2007 Supplies
2007 Supplies
Amount
Now, Add a
Without a
x 100 =
Percent
Percent
Sign
Sign
Amount
Now, Add a
Without a
x 100 =
Percent
Percent
Sign
Sign
2008 Supplies - 2007 Supplies =
Increase (Decrease)
$4,730.00 $4,300.00 =
$430.00
Decimal Amount
Increase (Decrease) ÷ 2007 Supplies =
$ 430.00 ÷
$4,300.00 =
0.100
Decimal Amount x
100
= Amount for Statement
100
0.100 x
=
10.0%
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What Does the Analysis Tell You?
• In percentage terms, Trips & Travel managed to
increase revenue by 17 percent, while the
increase in wages expense was only 12 percent
and there was actually a decrease in advertising
expense.
• Perhaps it is managing its existing customers
more efficiently.
• This analysis does not tell the whole story, but it
gives financial statement users an idea of what
areas to investigate further.
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Balance Sheet Comparisons
Selected Line Items
Bill's Bike Shop, Inc.
Comparative Balance Sheet
December 31, 2008 and December 31, 2007
Cash
Merchandise Inventory
Accounts Payable
2008
$21,800
348,400
70,100
Increase or (Decrease)
2007
Amount
Percent
$38,700 ($16,900)
(43.7)
206,500
141,900
68.7
29,000
41,100
141.7
• Management can use this analysis to identify potential
problems.
• For example, the fact that Cash is down 43.7 percent
while Accounts Payable is up 141.7 percent may
indicate a pending financial crisis.
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What Is Vertical Analysis?
Portraying items in a financial statement as
percentages (or proportional parts) of a given
item on the same financial statement
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Why Choose Vertical Analysis?
• You can see in a single statement the relationship
of each part to the whole.
• You can quickly see the relative importance of
each item in the statement.
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Base Amount
Income Statement
• The base amount is
net sales (the whole).
• Each item will be
expressed as a
percentage of net
sales (or total net
revenues).
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Balance Sheet
• The base amount is
total assets or total
liabilities and
stockholders’ equity
(the whole).
• Each item will be
expressed as a
percentage of total
assets.
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Calculations for Vertical Analysis
Formula for expressing a part as a percentage of the whole
Amount
Now, Add a
Individual Income Statement Account Amount
Without a
x 100 =
Percent
Net Sales or Total Net Revenues
Percent
Sign
Sign
Amount
Now, Add a
Individual Balance Sheet Account Amount
Without a
x 100 =
Percent
Total Assets
Percent
Sign
Sign
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Vertical Analysis with
Simplified Financial Statements
Trips & Travel Co.
Comparative Balance Sheet
For Years Ended June 30, 2008 and June 30, 2007
2008
Amount
2007
Percent
Amount
Percent
Assets
Cash
Accounts Receivable
Prepaid Insurance
Building
Total Assets
Liabilities
Accounts Payable
Owner's Equity
L. P. Arthur, Capital
Total Liabilities and Owner's Equity
$
$
60,699.45
60,950.00
4,470.00
626,472.00
752,591.45
8.1 $
8.1
0.6
83.2
100.0 $
60,200.00
45,450.00
4,320.00
596,640.00
706,610.00
8.5
6.4
0.6
84.4
100.0
$
37,360.00
5.0 $
33,400.00
4.7
$
$
715,231.45
752,591.45
95.0 $
100.0 $
673,210.00
706,610.00
95.3
100.0
How did we calculate the 2008 Cash amount as a
percentage of 2008 total assets?
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Calculate the 2008 Cash Amount
as a Percentage of 2008 Total Assets
Formula for expressing a part as a percentage of the whole
Amount
Now, Add a
Individual Balance Sheet Account Amount
Without a
x 100 =
Percent
Total Assets
Percent
Sign
Sign
Cash
60,699.45
Amount
0.081
÷
÷
x
x
Total Assets
752,591.45
100
100.00
With % Sign
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=
=
=
=
=
Amount
0.081
Amount for Statement
8.1
8.1%
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Vertical Analysis on the Balance Sheet
• Express each item as a percentage of total
assets (or the total of liabilities and stockholders’
equity), which is the same figure.
• For Example:
=
Cash
Total Assets
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$21,800 = 3.1%
$708,200
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Trend Percentages
• Indicate the general direction that an item on the
financial statement is taking
• Calculated by dividing a specific item on an
income statement by the corresponding item on
the base year income statement
• One period or year (usually the earliest)
designated as the base period and amount for
this period set at 100 percent
• Each amount in later years expressed as a
percentage of the amount of the base period
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Trend Percentages: An Example
2004
2005
2006
2007
2008
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Trend Percentages: An Example (cont’d)
For 2005
For 2006
For 2007
For 2008
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Trend Percentages: An Example (cont’d)
2004
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2005
2006
2007
2008
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Common-Size Statement
• A financial statement using vertical analysis with
all items expressed as percentages
• Used to compare one company with another as
well as with industry averages
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Financial Ratios
• Short-term creditors and managers use the
following ratios to analyze a firm:
–
–
–
–
–
Working capital
Current ratio
Quick ratio
Accounts receivable turnover
Merchandise inventory turnover
• Banks want to know if the firm can make its
interest payments.
• Managers want to know if they have enough
money to pay the bills and buy assets.
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Working Capital
• The excess of current assets over current
liabilities
• Current Assets – Current Liabilities = Working
Capital
• Indicates the amount of capital a firm has
available to use or to work with during a normal
operating cycle
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Computing Working Capital
(2008)
(2007)
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Current Ratio
• The ratio of current assets to current liabilities
• Current Assets  Current Liabilities
• Indicates a firm’s short-term debt-paying ability,
its ability to pay current liabilities with current
assets
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Computing Current Ratio
(2008)
(2007)
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Hints About Financial Ratios
1. In calculating any ratio, we mean the ratio of one
thing to something else.
– When we write the ratio as a fraction, we put the of
part in the numerator and the to part in the
denominator.
2. Once you have converted individual dollar
amounts into ratios or percentages, it becomes
more meaningful when you compare them to the
ratios or percentages for other companies or
industry averages.
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Quick Ratio
• Quick Assets:
– The sum of Cash, Current Notes Receivable, Net
Accounts Receivable, Interest Receivable, and
Marketable Securities
• Quick Ratio:
– Quick Assets  Current Liabilities
• Also called acid-test ratio
• The quick ratio is similar to the current ratio, but
it includes only assets that are more easily
converted to cash.
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Computing Quick Ratio
(2008)
(2007)
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Accounts Receivable Turnover
• Accounts receivable turnover is the number
of times charge accounts are paid off per year.
• A turnover implies a sale on account and
subsequent payment.
• If possible, use the average of the monthly
balances of Accounts Receivable.
– This allows for seasonal fluctuations.
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Computing
Accounts Receivable Turnover
(2008)
(2007)
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Use Accounts Receivable
Turnover to Determine the Number of
Days That the Receivables Were on the Books
(2008)
(2007)
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Merchandise Inventory Turnover
• Merchandise inventory turnover is the number
of times a company’s average inventory is sold
during a given year.
• If possible, use the average of the monthly
balances of merchandise inventory.
– This allows for seasonal fluctuations.
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Computing
Merchandise Inventory Turnover
(2008)
(2007)
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Use Merchandise Inventory
Turnover to Determine the Number of
Days That the Merchandise Was Kept in Stock
(2008)
(2007)
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Financial Ratios
• Long-term creditors and managers use the
following ratios to analyze a firm:
– Ratio of stockholders’ equity to liabilities
– Ratio of property and equipment to long-term
liabilities
• Long-term creditors want to know if the firm can
keep up with debt payments in the long run.
• Managers are concerned with taking care of the
company’s present obligations, as well as
preserving its credit standing, and hence its
ability to borrow in the future.
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Ratio of Stockholders’
Equity to Liabilities
• Shows how much stockholders’ equity there is
for every $1.00 of total debt
(2008)
(2007)
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Ratio of Property and
Equipment to Long-Term Liabilities
• Shows how much property and equipment there
is for every $1.00 of long-term liabilities
• Helps to determine the firm’s ability to incur
more debt
– Creditors usually demand that specific property be
pledged when debt is granted.
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Compute Ratio of Property and
Equipment to Long-Term Liabilities
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Financial Ratios
• Owners and managers use the following ratios
to analyze the firm:
–
–
–
–
Equity per share
Rate of return on common stockholders’ equity
Earnings per share of common stock
Price-earnings ratio
• Owners and managers are concerned with the
value and return on investment of the company.
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Equity per Share
Shows the net asset
value (assets minus
liabilities) of the firm per
one share of stock
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Computing Equity per Share When a Firm
Has One Class of Common Stock Outstanding
(2008)
(2007)
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Computing Equity per Share When
There Is Preferred Stock Outstanding
• Deduct the liquidating value of the preferred
stockholders’ equity, including any dividends in
arrears on cumulative preferred stock, to arrive
at the stockholders’ equity available to holders of
common stock.
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Liquidate
To wind up the affairs of a business by paying
off the creditors and selling the assets for cash
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Rate of Return on
Common Stockholders’ Equity
• Rate of return on
common stockholders’
equity helps to answer
the question:
– How good was the
investment in the firm?
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Compute Rate of Return
on Common Stockholders’ Equity
x
2008
x
2007
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Earnings per Share of Common Stock
• Measures how good or bad an investment is
• Answers the question:
– How much net income available to common
stockholders would each shareholder get for
one share if the earnings were divided up and
handed out?
• If there is preferred stock, you must first deduct
any dividends on preferred stock to arrive at
the amount available to common stock.
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Compute Earnings per
Share of Common Stock
(2008)
(2007)
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Price-Earnings Ratio
• A common measure for deciding whether a
stock’s market price is reasonable
• Calculated by dividing the market price per
share by the annual earnings per share
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Computing Price-Earnings Ratio
(2008)
(2007)
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