FSA1 Introduction

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FINANCIAL STATEMENTS

ANALYSIS


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Financial Statement Analysis

Who analyzes financial statements?

Internal users

i.e., Management, Shareholders, Internalauditors, Budget Analyst,

External users Examples?

Investors, creditors, regulatory agencies & stock market analysts, Business analysts, Financial

Analyst, Investment Analyst and

auditors


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What do internal users use it for?

Planning, evaluating and controlling company

operations

What do external users use it for?

Assessing past performance and current financial

position and making predictions about the future

profitability and solvency of the company as wellas evaluating the effectiveness of management


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Information is available from

Published annual reports

(1) Financial statements

(2) Notes to financial statements

(3) Letters to stockholders

(4) Auditors report (Independent accountants)

(5) Managements discussion and analysis

Reports filed with the government

Taxation Department, SECP.


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Information is available from

Other sources (1) Newspapers (e.g., The News)

(2) Periodicals (e.g. The Economist, Fortune)

(3) Financial information organizations

(4) Other business publications


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Methods of


Horizontal Analysis

Vertical Analysis

Common-Size Statements

Trend Percentages

Ratio Analysis


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Horizontal Analysis


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Vertical Analysis


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Common-Size Statements


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Trend Percentages


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Ratio Analysis


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Horizontal Analysis Example

The management of ABC Company provides you with

comparative balance sheets of the years ended

December 31, 2009 and 2010. Management asks

you to prepare a horizontal analysis on theinformation.


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ABC CORPORATION

Comparative Balance Sheets

December 31, 2009 and 2010

2010 2009

Assets

Current assets:

Cash 12,000$ 23,500$Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000

Prepaid expenses 3,000 1,200

Total current assets 155,000 164,700

Property and equipment:

Land 40,000 40,000

Buildings and equipment, net 120,000 85,000

Total property and equipment 160,000 125,000

Total assets 315,000$ 289,700$


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Calculating Change in Dollar Amounts

Since we are measuring the amount of thechange between 2010 and 2009, the dollar

amounts for 2009 become the base year

figures.

Dollar

Change

Current Year

Figure

Base Year

Figure=


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Calculating Change as a Percentage

Percentage

Change

Dollar Change

Base Year Figure 100%=


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ABC CORPORATIONComparative Balance Sheets


Increase (Decrease)

2010 2009 Amount %

Assets

Current assets:Cash 12,000$ 23,500$ (11,500)$

Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000



Property and equipment:Land 40,000 40,000



Total assets 315,000$ 289,700$

$12,000 $23,500 = $(11,500)



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Increase (Decrease)

2010 2009 Amount %

Assets

Current assets:Cash 12,000$ 23,500$ (11,500)$ (48.9)

Accounts receivable, net 60,000 40,000

Inventory 80,000 100,000



Property and equipment:Land 40,000 40,000



Total assets 315,000$ 289,700$

($11,500 $23,500) 100% = 48.9%



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Increase (Decrease)

2010 2009 Amount %

Assets

Current assets:Cash 12,000$ 23,500$ (11,500)$ (48.9)

Accounts receivable, net 60,000 40,000 20,000 50.0

Inventory 80,000 100,000 (20,000) (20.0)

Prepaid expenses 3,000 1,200 1,800 150.0

Total current assets 155,000 164,700 (9,700) (5.9)

Property and equipment:Land 40,000 40,000 - 0.0

Buildings and equipment, net 120,000 85,000 35,000 41.2

Total property and equipment 160,000 125,000 35,000 28.0

Total assets 315,000$ 289,700$ 25,300$ 8.7



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Lets apply the same

procedures to the

liability and stockholders

equity sections of the

balance sheet.



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ABC CORPORATION

Comparative Balance Sheets


Increase (Decrease)2010 2009 Amount %

Liabilities and Stockholders' Equity

Current liabilities:

Accounts payable 67,000$ 44,000$ 23,000$ 52.3

Notes payable 3,000 6,000 (3,000) (50.0)

Total current liabilities 70,000 50,000 20,000 40.0

Long-term liabilities:

Bonds payable, 8% 75,000 80,000 (5,000) (6.3)

Total liabilities 145,000 130,000 15,000 11.5

Stockholders' equity:

Preferred stock 20,000 20,000 - 0.0

Common stock 60,000 60,000 - 0.0Additional paid-in capital 10,000 10,000 - 0.0

Total paid-in capital 90,000 90,000 - 0.0

Retained earnings 80,000 69,700 10,300 14.8

Total stockholders' equity 170,000 159,700 10,300 6.4

Total liabilities and stockholders' equity 315,000$ 289,700$ 25,300$ 8.7


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Now, lets apply the

procedures to the

income statement.



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ABC CORPORATION

Comparative Income StatementsFor the Years Ended December 31, 2010 and 2009

Increase (Decrease)

2010 2009 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3

Cost of goods sold 360,000 315,000 45,000 14.3

Gross margin 160,000 165,000 (5,000) (3.0)

Operating expenses 128,600 126,000 2,600 2.1

Net operating income 31,400 39,000 (7,600) (19.5)

Interest expense 6,400 7,000 (600) (8.6)

Net income before taxes 25,000 32,000 (7,000) (21.9)

Less income taxes (30%) 7,500 9,600 (2,100) (21.9)

Net income 17,500$ 22,400$ (4,900)$ (21.9)


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ABC CORPORATION


Increase (Decrease)

2010 2009 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3


Gross margin 160,000 165,000 (5,000) (3.0)






Net income 17,500$ 22,400$ (4,900)$ (21.9)

Sales increased by 8.3% while net

income decreased by 21.9%.


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ABC CORPORATION


Increase (Decrease)

2010 2009 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3


Gross margin 160,000 165,000 (5,000) (3.0)






Net income 17,500$ 22,400$ (4,900)$ (21.9)

There were increases in both cost of goodssold (14.3%) and operating expenses (2.1%).These increased costs more than offset the

increase in sales, yielding an overalldecrease in net income.


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Vertical Analysis Example

The management of Sample Company asks you to

prepare a vertical analysis for the comparative

balance sheets of the company.


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Sample CompanyBalance Sheet (Assets)

At December 31, 1999 and 1998

% of Total Assets

1999 1998 1999 1998Cash 82,000$ 30,000$ 17% 8%

Accts. Rec. 120,000 100,000 25% 26%

Inventory 87,000 82,000 18% 21%

Land 101,000 90,000 21% 23%Equipment 110,000 100,000 23% 26%

Accum. Depr. (17,000) (15,000) -4% -4%

Total 483,000$ 387,000$ 100% 100%



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Sample CompanyBalance Sheet (Assets)


% of Total Assets

1999 1998 1999 1998Cash 82,000$ 30,000$ 17% 8%

Accts. Rec. 120,000 100,000 25% 26%

Inventory 87,000 82,000 18% 21%

Land 101,000 90,000 21% 23%Equipment 110,000 100,000 23% 26%

Accum. Depr. (17,000) (15,000) -4% -4%

Total 483,000$ 387,000$ 100% 100%

$82,000 $483,000 = 17% rounded

$30,000 $387,000 = 8% rounded


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Sample Company

Balance Sheet (Liabilities & Stockholders' Equity)


% of Total Assets

1999 1998 1999 1998Acts. Payable 76,000$ 60,000$ 16% 16%

Wages Payable 33,000 17,000 7% 4%

Notes Payable 50,000 50,000 10% 13%

Common Stock 170,000 160,000 35% 41%Retained Earnings 154,000 100,000 32% 26%

Total 483,000$ 387,000$ 100% 100%


$76,000 $483,000 = 16% rounded


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Trend Percentages Example

Wheeler, Inc. provides you with the followingoperating data and asks that you prepare a trend

analysis.

Wheeler, Inc.

Operating Data

1999 1998 1997 1996 1995

Revenues 2,405$ 2,244$ 2,112$ 1,991$ 1,820$

Expenses 2,033 1,966 1,870 1,803 1,701Net income 372$ 278$ 242$ 188$ 119$


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Wheeler, Inc. provides you with the followingoperating data and asks that you prepare a trend

analysis.

Wheeler, Inc.

Operating Data

1999 1998 1997 1996 1995

Revenues 2,405$ 2,244$ 2,112$ 1,991$ 1,820$

Expenses 2,033 1,966 1,870 1,803 1,701Net income 372$ 278$ 242$ 188$ 119$

$1,991 - $1,820 = $171


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Using 1995 as the base year, we develop the

following percentage relationships.

Wheeler, Inc.

Operating Data1999 1998 1997 1996 1995

Revenues 132% 123% 116% 109% 100%

Expenses 120% 116% 110% 106% 100%

Net income 313% 234% 203% 158% 100%

$1,991 - $1,820 = $171

$171 $1,820 = 9% rounded


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90

100

110

120

130

140

1995 1996 1997 1998 1999

%of

100Base

YearsSales

Expenses

Trend line

for Sales


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Ratios

Ratios can be expressed in three different ways:

1. Ratio (e.g., current ratio of 2:1)

2. % (e.g., profit margin of 2%)

3. $ (e.g., EPS of $2.25)

Using ratios and percentages without considering

the underlying leads to incorrect conclusions.


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Categories of Ratios

Liquidity RatiosIndicate a companys short-termdebt-paying ability

Equity (Long-Term Solvency) RatiosShow relationship between debt and equityfinancing in a company

Profitability TestsRelate income to other variables

Market TestsHelp assess relative merits of stocks in themarketplace


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Important Considerations

Need for comparable data

Data is provided by different companies.

Must compare by industry

Influence of external factors

General business conditions

Seasonal nature of business operations

Impact of inflation

FSA1 Introduction

Documents

Transcript of FSA1 Introduction