FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTINGA USER PERSPECTIVEA USER PERSPECTIVE

Hoskin • Fizzell • Davidson

Second Canadian Edition

Financial Statement AnalysisFinancial Statement Analysis

Chapter Twelve

Time-Series Analysis

• Examine information from different time period in the life of the company

• Look for patterns in the data over time

• Assumes that there is predictability in the time series

Cross-sectional Analysis

• Compares data from one company to another for the same time period

• Usually companies in the same industry are compared

Common Size Data

• Ability to compare the relationships between line items of differing dollar amounts (raw financial data)

• Statement of earnings– All line items are expressed as

percentages of net revenues

Common Size Statement of Earnings

1999 1998Gross revenue 100% 100%Cost of goods sold 90.6% 89.1%Earnings before other items 9.4% 10.6%

Ratios

• Explain relationships among data in the financial statements

• General categories– Performance

– Short-term liquidity

– Long-term liquidity

Performance Ratios

• Return on investment (ROI)– measures investment performance

• Return on equity (ROE)– shareholders’ perspective

• Return on assets (ROA)– measures investment in assets

Return on Assets

ROA

=

Net income + [Interest expense x (1-Tax rate)]

Average total assets

= Net income before interest

Average total assets

Return on Equity

ROE = Net income - Preferred dividends

Average common shareholders’ equity

Leverage

• Financial leverage– Some of the funds obtained to invest

in assets came from debtholders rather than from shareholders

• High leverage– larger proportion of debt to equity

Performance Ratios

• Turnover ratios– Accounts receivable

– Inventory

– Accounts payable

Accounts Receivable Turnover

Accounts receivable turnover

=Sales on account

Average accounts receivable

Days to collect

=365

Accounts receivable turnover

Inventory Turnover

Inventory turnover =

Cost of goods sold

Average inventory

Days inventory held

=365

Inventory turnover

Accounts Payable Turnover

Accounts payable turnover

=Credit purchases

Average accounts payable

Days to pay

=365

Accounts payable turnover

Short-Term Liquidity Ratios

• Current ratio

• Quick ratio

Current Ratio

Current RatioCurrent Liabilities

Current Assets=

Current Ratio =$4,115,116

$2,294,778= 1.79

Quick Ratio

Quick RatioCurrent Liabilities

Current Assets - Inventory - Prepaid Expenses

=

Quick Ratio =

$4,115,116 - 2,050,703 - 433,785

$2,294,778= .71

Long-Term Liquidity Ratios

• Debt-equity ratio

• Times interest ratio

Debt-Equity Ratio

Debt/Equity =Total liabilities + shareholders’ equity

Total liabilities

Times Interest Earned

Times interest earned

=Interest

Income before interest and taxes

Earnings Per Share

Basic earnings per share

=Weighted average number of common shares outstanding

Net income - Preferred dividends

Price/Earnings Ratio

Price/ earnings =

Earnings per share

Stock market price per share