Financial and Managerial Accounting, 8e
13–1
CHAPTER 13
ANALYSIS OF FINANCIAL STATEMENTS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
AA and
BTN
Conceptual objectives:
C1. Explain the purpose and identify the
building blocks of analysis.
1
13-1
13-1
BTN 13-6
C2. Describe standards for comparisons
in analysis.
2, 3
13-2
13-2
AA 13-2
Analytical objectives:
A1 Summarize and report results of
analysis.
13-14
13-15
AA 13-1, AA 13-3,
BTN 13-1, BTN 13-2,
BTN 13-5
statement. (Appendix 13A)
Procedural objectives:
P1. Explain and apply methods of
horizontal analysis.
13-3, 13-4
13-3, 13-5
13-1, 13-2
AA 13-1,
BTN 13-4,
BTN 13-5
P2. Describe and apply methods of
vertical analysis.
13-5
13-4, 13-5,
13-6
13-2
AA 13-1, AA 13-2,
BTN 13-4, BTN 13-5
P3. Define and apply ratio analysis.
4, 5, 6, 7, 8, 9,
10, 11, 12,
14,15, 16, 17
13-6, 13-7,
13-8, 13-9,
13-10, 13-11,
13-12, 13-13
13-7, 13-8
13- 9, 13-10,
13-11, 13-12,
13-13, 13–14
13-2, 13-3,
13-4, 13-5,
SP
BTN 13-2, BTN 13-3,
BTN 13-4, BTN 13-5,
BTN 13-6
Additional Information on Related Assignment Material
See Chapter 1 of the Instructor’s Resource Manual for more information on materials for this text available in
Connect.
Connect
Available on the instructor’s course-specific website, Connect:
• All numerical Quick Studies, all Exercises and Problems Set A.
o Connect also provides algorithmic versions for Quick Study, Exercises, and Problems.
Hints/Guided Examples
Please note that the Guided Examples are labeled as “Hints” in Connect assignments. The animated PowerPoints without
the video and audio functions for the Guided Examples are also available in the Connect Instructor Library and Exercise
Presentations. These are indicated in the Related Assignment Materials grid on page 1 in blue bold font.
Need-to-Know Videos
LO
Title
Time
P1
Horizontal Analysis
2:03
P2
13-2
Vertical Analysis
1:22
P3
13-3
Ratio Analysis
1:15
Concept Overview Videos
LO
Title
Time
C1
Explain the purpose and identify the building blocks of analysis.
Financial Statement Analysis
0:35
Purpose of Analysis
1:08
Building Blocks of Analysis
1:27
C2
1:35
0:30
Analysis Reporting
2:42
Complete Income Statement
3:34
Changes in Accounting Principles
1:25
Information for Analysis
1:00
P1
Explain and apply methods of horizontal analysis.
Horizontal Analysis
2:05
Computation of Dollar Changes
1:22
Computation of Percent Changes
0:45
Trend Analysis – Part 1
1:07
Trend Analysis – Part 2
0:37
P2
Describe and apply methods of vertical analysis.
Vertical Analysis
0:37
Financial and Managerial Accounting, 8e
13–3
Common-Size Statements
1:30
Computation of Common-Size Percent
0:24
Common-Size Graphics
0:29
P3
Define and apply ratio analysis.
Ratio Analysis
1:44
Liquidity and Efficiency Ratios
1:39
Liquidity and Efficiency Ratio Examples Part 1
3:03
Liquidity and Efficiency Ratio Examples Part 2
4:08
Solvency Ratios
1:02
Solvency Ratio Examples
2:33
Profitability Ratios
0:21
Profitability Ratios Examples
2:33
Synopsis of Chapter Revisions
Updated opener—Morgan Stanley and entrepreneurial assignment.
Updated data for all analyses of Apple using horizontal, vertical, and ratio analysis.
Updated comparative analysis using Google and Samsung.
Streamlined section on ratio analysis.
Streamlined the analysis reporting section.
Shortened Appendix 13A.
a single statement.
Chapter Outline
I. Basics of Analysis—Transforming data into useful information.
A. Purpose of Analysis
To help users (both internal and external) make better business decisions.
1. Internal users (managers, officers, internal auditors, consultants, budget officers, and market
researchers) make the strategic and operating decisions of a company. Purposes for these users
is to provide strategic information to improve company efficiency and effectiveness in
providing products and services.
2. External users (shareholders, lenders, and suppliers) rely on financial statement analysis to
make informed decisions in pursuing their own goals.
3. The common goal of all users is to evaluate:
a. Past and current performance.
b. Current financial position.
c. Future performance and risk.
B. Building Blocks of Analysis
The four areas of inquiry or building blocks are:
1. Liquidity and efficiency—ability to meet short-term obligations and to efficiently generate
revenues.
2. Solvency—ability to generate future revenues and meet long-term obligations.
3. Profitability—ability to provide financial rewards sufficient to attract and retain financing.
4. Market prospects—ability to generate positive market expectations.
C. Information for Analysis
Most users conduct analysis using general purpose financial statements that include:
forecasts, management letters, auditor’s report, and analyses published in annual reports.
We need standards (benchmarks) can include the following types of comparisons:
4. Guidelines (rules-of-thumb)—standards of comparisons developed from experience.
1. Horizontal analysis
2. Vertical analysis
3. Ratio analysis
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2. Dollar changes and percentage changes—usually shown in line items.
a. Dollar change = Analysis period amount minus Base period amount.
b. Percent change = (Analysis period amount minus Base period amount) divided by Base
period amount multiplied by 100. Note:
(1) When a negative amount appears in the base period and a positive amount in the
analysis period (or vice versa) a meaningful percentage change cannot be computed.
(2) When there is no value in the base period—percentage change is not computable.
(3) When an item has a value in the base period and zero in the next period—the decrease is
100 percent.
3. Comparative Balance Sheets—balance sheets from two or more periods arranged side-by-side.
Dollar and percentage changes are often shown. Analysis focuses on large changes.
4. Comparative Income Statements—also compares two or more periods presented side-by side
with dollar and percentage changes.
B. Trend analysis (also called trend percent analysis or index number trend analysis)
1. A form of horizontal analysis used to reveal patterns in data across successive periods.
2. Involves computing trend percents (or index number) as follows: Analysis period amount
divided by base period amount) multiplied by 100.
3. Often aided by graphical depiction.
to a base amount. The analysis tools include:
3. Common-size percentage equals (Analysis amount divided by Base amounts) multiplied by 100.
comparison information.
IV. Ratio Analysis—widely used in financial analysis because they help to uncover conditions and trends
difficult to detect by inspecting individual amounts. Ratios are organized into the four (A to D below)
building blocks of analysis:
A. Liquidity and Efficiency
1. Liquidity refers to the availability of resources to meet short-term cash requirements.
2. Efficiency refers to how productive a company is in using its assets. Efficiency is usually
measured relative to how much revenue is generated for a certain level of assets.
3. Ratios in this block:
a. Working capital—the excess of current assets less current liabilities.
as quick assets divided by current liabilities.
Financial and Managerial Accounting, 8e
d. Accounts receivable turnover—net sales or credit sales divided by average accounts
receivable; a measure of how long it takes a company to collect its accounts.
e. Inventory turnover—cost of goods sold divided by average inventory; the number of times a
company’s average inventory is sold during an accounting period.
B. Solvency
1. Solvency refers to a company’s long-run financial viability and its ability to cover long-term
obligations. Capital structure is one of the most important components of solvency analysis.
2. Capital structure refers to a company’s sources of financing.
3. Ratios in this block:
a. Debt ratio—total liabilities divided by total assets.
b. Equity ratio—total stockholders’ equity divided by total assets; compliment of debt ratio.
c. Debt-to-equity ratio—total liabilities divided by total equity.
stockholders.
C. Profitability
1. Profitability refers to a company’s ability to generate an adequate return on invested capital.
2. Return is judged by assessing earnings relative to the level and sources of financing.
3. Profitability is also relevant to solvency.
4. Ratios in this block:
a. Profit margin—net income divided by net sales; describes the ability to earn a net income
D. Market Prospects
1. Market measures are useful for analyzing corporations with publicly traded stock.
2. Market measures use stock price in their computation.
3. Ratios in this block:
a. Price-earnings ratio—market price per share of common stock divided by earnings per
share; used to evaluate the profitability of alternative common stock investments.
b. Dividend yield—annual cash dividends paid per share of stock divided by market price per
share; used to compare the dividend paying performance of different investment
alternatives.
E. Summary of Ratios
Exhibit 13.16 in the text sets forth the names of each of the common ratios by category, and includes
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the formula and a description of what is measured by each ratio.
V. Decision Analysis—Analysis Reporting
Goal of financial statement analysis report is to reduce uncertainty through rigorous and sound
evaluation. A good analysis report usually consists of six sections:
1. Executive summary
2. Analysis overview
3. Evidential matter
4. Assumptions
5. Key factors
6. Inferences
VI. Sustainable Income—Appendix 13A
When a revenue and expense transactions are from normal, continuing operations, a simple income
statement is adequate. When activities include events that are not normal, it must disclose this
information by separating the income statement into different sections as follows (A-D):
B. Discontinued Segments
1. A business segment is a part of a company’s operations that serves a particular line of business or
class of customers.
2. Section reports:
a. Income (loss) from operating the discontinued business segment for the current period prior
to disposal (net of taxes).
b. Gain or loss on disposal of the segment (net of related income tax effects).
C. Earnings per Share –
1. Final section of income statement
that principle had always been used).
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Chapter 13 Alternate Demonstration Problem
Following are data from the statements of two companies selling similar products:
Current Year-End Balance Sheets
Sled
Company
Zip
Company
Cash ………………………………………………………………
$ 11,900
$ 20,000
Notes receivable—short-term …………………………
7,700
3,200
Accounts receivable, net ………………………………..
42,000
64,000
Inventory ……………………………………………………….
58,800
87,680
Prepaid expenses …………………………………………..
1,680
3,520
Plant and equipment, net ………………………………..
232,120
274,400
Total assets ……………………………………………………
$354,200
$452,800
Current liabilities ……………………………………………
$ 56,000
$ 80,000
Mortgage payable …………………………………………..
70,000
80,000
Common stock, $10 par value …………………………
140,000
160,000
Retained earnings ………………………………………….
88,200
132,800
Total liabilities and stockholders’ equity …………
$354,200
$452,800
$672,000
$880,000
Cost of goods sold …………………………………………
528,080
699,840
4,200
5,600
Net income …………………………………………………….
23,373
28,896
Inventory ……………………………………………………….
$ 85,120
Total assets ……………………………………………………
345,800
443,200
217,000
285,120
Required:
1. Calculate current ratios, acid–test ratios, inventory turnovers, and days’ sales
uncollected for the two companies. Then state which company you think is the better
short-term credit risk and why.
Financial and Managerial Accounting, 8e
13–9
Solution: Chapter 13 Alternate Demonstration Problem
Part 1
Sled Company
Zip Company
Current ratio:
$122,080
$ 56,000
= 2.18 to 1
$178,400
$ 80,000
= 2.23 to 1
$ 56,000
$ 80,000
$ 56,000
$ 86,400
$ 42,000
$ 64,000
Sled Company and Zip Company have almost equal current and acid-test ratios, so
near the same that the differences are not significant. However, Sled Company turns
its inventory and collects its accounts receivable more rapidly than Zip Company; and
on this basis it appears to be a better short-term credit risk.
Part 2
Return on total assets:
$ 23,373
$350,000
= 6.68%
$ 28,896
$448,000
= 6.45%
Return on stockholders’
equity:
$ 23,373
$222,600
= 10.5%
$ 28,896
$288,960
= 10.0%