Accounting - Exam 2 (Chapter 17)

Horizontal Analysis utilizes:

A. Comparative Statements 1. Reports where financial amounts for more than one period are placed side by side in columns on a single statement. 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.

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.

Liquidity

availability of resources to meet short-term cash requirements.

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.

Current ratio

current assets divided by current liabilities; describes a company's ability to pay its short-term obligations.

Efficiency

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

Return

judged by assessing earnings relative to the level and sources of financing

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

Return on total assets

net income divided by average total assets; a summary measure of operating efficiency, comprises profit margin and total asset turnover

Profit margin

net income divided by net sales; describes the ability to earn a net income from sales.

Return on common stockholders' equity

net income less preferred dividends divided by average common stockholders' equity; measures the success of a company in earning net income for its owners.

Total asset turnover

net sales divided by average total assets; describes the ability to use assets to generate sales.

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

Profitability

refers to a company's ability to generate an adequate return on invested capital

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.

Capital structure

refers to a company's sources of financing

Common-Size Statements

reveal changes in the relative importance of each financial statement item by redefining each in terms of common-size percents. 1. Base amount is commonly defined as 100%. Usually a key aggregate figure is the base (Examples: revenue is the income statement base and total assets is the balance sheet base). 2. Sum of individual items is 100%. 3. Common-size percentage equals (Analysis amount divided by Base amounts) multiplied by 100.

Acid-test ratio

similar to current ratio but focuses on quick assets (i.e., cash, short-term investments, current receivables, and notes receivable) rather than current assets. Calculated as quick assets divided by current liabilities.

Working capital

the excess of current assets less current liabilities

Financial leveraging

the inclusion of debt, can increase return to stockholders.

External users (shareholders, lenders, and suppliers) rely on financial statement analysis:

to make informed decisions in pursuing their own goals.

Debt-to-equity ratio

total liabilities divided by total equity

Equity ratio

total stockholders' equity divided by total assets; compliment of debt ratio.

Market measures

useful for analyzing corporations with publicly traded stock and they use stock price in their computation.

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:

Days' sales uncollected

(accounts receivable divided by net credit sales) multiplied by 365 days; measures how frequently a company collects its accounts receivable

Vertical Analysis

(also called common-size analysis) Comparing financial condition and performance to a base amount.

Days' sales in inventory

(ending inventory divided by cost of goods sold) multiplied by 365; measures how many days it will take to convert the inventory on hand at the end of the period into accounts receivable or cash.

horizontal analysis (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.

Tools of Analysis

1. Horizontal analysis 2. Vertical analysis 3. Ratio analysis

Most users conduct analysis using general purpose financial statements that include

1. Income statement 2. Balance sheet 3. Statement of stockholders' equity (or statement of retained earnings) 4. Statement of cash flows 5. Notes related to the statements 6. Other useful financial data—10K/other SEC filings, news releases, shareholders' meetings, forecasts, management letters, auditor's report, and analyses published in annual reports.

Standards (benchmarks) can include the following types of comparisons:

1. Intracompany—based on prior performance and relations between its financial items. 2. Competitor—competitors provide standards for comparisons. 3. Industry—published industry statistics (available from services like Dun & Bradstreet, Standard and Poor's, and Moody's) provide standards for comparisons. 4.Guidelines (rules-of-thumb)—standards of comparisons developed from experience.

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.

Common-Size Graphics

Graphical analysis (ex. pie charts and bar charts) of common-size statements that visually highlight comparison information.

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.

Purpose of Analysis

To help users (both internal and external) make better business decisions.

Horizontal Analysis

Tool to evaluate changes in financial statement data across time

Debt ratio

Total liabilities divided by total assets. Represents the portion of total assets financed by debt, rather than by equity capital.

Basics of Analysis

Transforming data into useful information.

3. The common goal of all users is to evaluate:

a. Past and current performance. b. Current financial position. c.Future performance and risk.