10 Thom Fina7c PP Ch10

Financial Accounting
Seventh Canadian Edition
Chapter 10
Financial Statement Analysis
Copyright © 2021 Pearson Canada Inc. 10 - 1

Learning Objective One
Perform a horizontal analysis

Horizontal Analysis
• Study of percentage changes from year-to-year
• Two steps:
– 1. Compute dollar amount of change
– 2. Divide dollar amount of change by base-period amount

Horizontal Analysis - Example (1 of 2)
Empire Company Limited
Comparative Income Statements
For the Years Ended May 5, 2018 and May 6, 2017
2018 2017 $ Change % Change
Sales 1.7%
$24,214.6 $23,806.2 $408.4
STEP 1
Compute the dollar amount of change in sales from 2017 to 2018:
2018 − 2017 = Increase
$24,215 − $23,806 = $409

Horizontal Analysis - Example (2 of 2)
Empire Company Limited

Comparative Income Statements
For the Years Ended May 5, 2018 and May 6, 2017
2018 2017 $ Change % Change
Sales $24,215 $23,806 $409 1.7%
STEP 2
Divide the dollar amount of change by the base-period amount. This
computes the percentage change for the period:

Trend Percentages (1 of 2)
• Form of horizontal analysis
• Base year selected and set equal to 100%
– Amount of each following year stated as a percent of base

Trend Percentages (2 of 2)
Trend percentages are computed by selecting a base year
whose amount is set equal to 100%.
Trend % = Any year $ ÷ Base year $
2018 2017 2016 2015 2014*

Operating income $346.5 $333 ($2,418.5) $743.6 $328.5
105% 101% (736)% 226% 100%
*2014 is the base year

Learning Objective Two
Perform a vertical analysis

Vertical Analysis
• Shows relationship of a financial-statement item to its base
– For Income Statement, total revenue is the base
– For Balance Sheet, total assets is the base

Learning Objective Three
Prepare common-size financial statements

Common-Size Statements
• Report only vertical analysis percents
– No dollar amounts
• Help in the comparison of different companies
– Financial results in terms of a common denominator

Benchmarking
• Compares company to a standard set by others
– Often a key competitor
• Facilitated by common-size statements
• Has goal of improvement

Learning Objective Four
Analyze the statement of cash flows

Cash-Flow Signs of Healthy Company
Operations are Investing includes

major source of more purchases
cash than sales
Financing not
dominated by
borrowing

Learning Objective Five
Use ratios to make business decisions

Ratio Categories
Measuring ability to pay current liabilities
Measuring turnover and cash conversion
Measuring leverage
Measuring profitability
Analyzing stock as an investment

Ability to Pay Current Liabilities
Working capital Current ratio
Quick (Acid-test)
ratio

Working Capital and Current Ratio
Working Current Current

 
capital assets liabilities
Current Current Current

 
ratio assets liabilities

Quick (Acid-Test) Ratio

Data for Calculations (1 of 2)
Apple Inc.
Consolidated Balance Sheets (USD $)
As at September 29, 2018 and September 30, 2017
(in millions) Sept. 29, 2018 Sept. 30, 2017
Current assets:
Cash and cash equivalents $ 25,913 $ 20,289
Short-term marketable securities 40,388 53,892
Accounts receivable, net 23,186 17,874
Inventories 3,956 4,855
Vendor non-trade receivables 25,809 17,799
Other current assets 12,087 13,936
Total current assets 131,339 128,645
Long-term marketable securities 170,799 194,714
Property, plant, and equipment, net 41,304 33,783
Other non-current assets 22,283 18,177
Total assets 365,725 375,319

Data for Calculations (2 of 2)
Current liabilities:
Accounts payable 55,888 44,242
Other current liabilities 32,687 30,551
Deferred revenue 7,543 7,548
Commercial paper 11,964 11,977
Term debt 8,784 6,496
Total current liabilities 116,866 100,814
Deferred revenue-non-current 2,797 2,836
Term debt 93,735 97,207
Other non-current liabilities 45,180 40,415
Total liabilities 258,578 241,272
Commitments and contingencies
Shareholders’ equity:
Share capital 40,201 35,867
Retained earnings 70,400 98,330
Accumulated other comprehensive income/(loss) (3,454) (150)
Total shareholders’ equity 107,147 134,047
Total liabilities and shareholders’ equity $ 365,725 $ 375,319

Working Capital
2018 $14,473 = $131,339 – $116,866
2017 $27,831 = $128,645 - $100,814

Current Ratio
2018 1.12 = $131,339 ÷ $116,866
2017 1.27 = $128,645 ÷ $100,814

Quick Ratio

Measuring Turnover and the Cash
Conversion Cycle
Accounts
Inventory
receivable
turnover
turnover
Accounts
payable
turnover

Inventory Turnover
(Beginning inventory + Ending inventory)/2)

Measuring Ability to Sell Inventory
Apple’s inventory turnover: 2018

$163,756 ÷ $4,405.5.5 = 37.2
Competitor’s was 89.6
A high number indicates an ability to
sell inventory quickly.

Accounts Receivable Turnover
(Beginning net receivables + Ending net receivables)/2)
Days’ sales outstanding (DSO) = 365/Turnover

Measuring Ability to Collect Receivables
(1 of 2)
Apple’s accounts receivable turnover: 2018

$265,595 ÷ $20,530 = 12.9 times
Competitor’s was 6.8
The higher the ratio, the better.

Measuring Ability to Collect Receivables
(2 of 2)
Days’ sales in receivable (DSO):

$365 ÷ 12.9 = 28.3 or 28 days
The competition was 54 days.

Accounts Payables Turnover

Cash Conversion Cycle
DIO  DSO  DPO
DIO = Days’ Inventory Outstanding

DSO = Days’ Sales Outstanding
DPO = Days’ Payables Outstanding

Measuring Leverage: Overall Ability to Pay
Debts
Times-interest-
Debt ratio
earned

Debt ratio

Times-Interest-Earned

Measuring Profitability
Gross profit Operating income

Return on sales
percentage percentage
Asset turnover Return on assets Leverage ratio
Return on equity Earnings per share

Gross Profit and Operating Income
Percentages

Return (Net Profit Margin) on Sales

Asset Turnover

Return on Total Assets

Leverage (Equity Multiplier) Ratio

Return on Common Shareholders Equity

Earnings per Share

Analyzing Shares as an Investment
Price/Earnings ratio Dividend yield
Book value per

common share

Price/Earnings Ratio

Dividend Yield

Book Value

Red Flags in Financial Statement Analysis
• Earnings problems
• Decreased cash flow
• Too much debt
• Inability to collect receivables
• Buildup of inventories
• Trends of sales, inventory and receivables

End of Chapter Ten

10 Thom Fina7c PP Ch10

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Financial Accounting

Seventh Canadian Edition

Copyright © 2021 Pearson Canada Inc. 10 - 1

Copyright © 2021 Pearson Canada Inc. 10 - 2

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Copyright © 2021 Pearson Canada Inc. 10 - 4

Empire Company Limited

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2018 2017 2016 2015 2014*

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– For Balance Sheet, total assets is the base

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Operations are Investing includes

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Measuring ability to pay current liabilities

Measuring turnover and cash conversion

Analyzing stock as an investment

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Working capital Current ratio

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Working Current Current

Current Current Current

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2018 $14,473 = $131,339 – $116,866

2017 $27,831 = $128,645 - $100,814

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2018 1.12 = $131,339 ÷ $116,866

2017 1.27 = $128,645 ÷ $100,814

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(Beginning inventory + Ending inventory)/2)

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Apple’s inventory turnover: 2018

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(Beginning net receivables + Ending net receivables)/2)

Days’ sales outstanding (DSO) = 365/Turnover

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Apple’s accounts receivable turnover: 2018

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Days’ sales in receivable (DSO):

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DIO  DSO  DPO

DIO = Days’ Inventory Outstanding

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Gross profit Operating income

Asset turnover Return on assets Leverage ratio

Return on equity Earnings per share

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