1. Chapter Seven FINANCIAL STATEMENT ANALYSIS

5. Financial Analysis: Comparison Basis 1 intracompany basis 2 industry averages Year 1 Year 2 Company XYZ Co. A Co. B Co. D Co. E Co. C Co. ABC Co. XYZ 3 intercompany basis

6. Types of analysis Financial Statement Analysis Percentage Ratio  Horizontal Analysis  Vertical Analysis  Liquidity Ratio  Profitability Ratio  Efficiency Ratio  Solvency Ratio

7. Horizontal analysis  Also known as trend analysis .  Evaluates a series of financial statement data over a period of time.  Purpose: to determine the increase or decrease that has taken place This change may be expressed as either an amount or a percentage.

8. Horizontal analysis Evaluates: Income Statement Balance Sheet Formula: Current Year Amount – Base Year Amount Base Year Amount

11. Vertical Analysis  Evaluates financial statement data expressing each item in a financial statement as a percent of a base amount.  Vertical analysis enables you to compare companies of different sizes.

14. Ratio Analysis  Expresses the relationship among selected items of financial statement data.  Classifications: Liquidity Ratios Profitability Ratios Efficiency Ratios Solvency Ratios

15. Liquidity Ratios The ratios are:  Current Ratio / Working capital ratio  Acid test ratio / quick ratio Measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.

17. Eg: Current Assets 20,500 26,700 Current Liabilities 17,200 29,600 2001 2002 Current ratio = 20,500 17,200 26,700 29,600 = 1.19 : 1 = 0.90 : 1

18. Liquidity Ratio – Acid Test Ratio / Quick Ratio  is a measure of a company’s short-term liquidity . Acid test ratio = Quick Assets Current Liabilities  Quick asset includes cash, marketable securities and accounts receivable.

19. Eg: Current Assets Current Liabilities 17,200 29,600 2001 2002 Acid test ratio = 17,700 17,200 20,700 29,600 = 1.03 : 1 = 0.70 : 1 Cash 7,900 8,700 Accounts Receivable 9,800 12,000 Inventories 2 ,800 6,000 20,500 26,700

20. Profitability Ratios The ratios are:  Profit margin  Gross profit margin  Return on Assets  Return on Equity  Return on Common Equity  Earnings Per Share  Price - Earnings ratio Measures of the income or operating success of a company for a given period of time.

21. Profitability Ratio – Profit Margin  is a measure of the percentage of each dollar of sales that results in net income . Profit margin = Net income Net sales

22. Eg: Net Sales 45,000 52,700 Less: Cost of Goods Sold 20,200 23,600 2001 2002 Profit margin = 10,600 45,000 14,500 52,700 = 23.56% = 27.51% 24,800 29,100 Less: Operating Expenses 14,200 14,600 Net income 10,600 14,500

23. Profitability Ratio – Gross Profit Margin  is a measure of the percentage of each dollar of sales that results in gross profit . Gross profit margin = Gross Profit Net Sales

24. Eg: Net Sales 45,000 52,700 Less: Cost of Goods Sold 20,200 23,600 2001 2002 Gross profit margin = 24,800 45,000 29,100 52,700 = 55.11% = 55.22% Gross Profit 24,800 29,100 Less: Operating Expenses 14,200 14,600 Net income 10,600 14,500

25. Profitability Ratio – Return on Assets  To assess the ability of the company in using its assets to earn net income without consideration in the financing of such assets. Return on assets = Net income + Interest expense Average total assets  Average total assets = Total assets year 1 + total assets year 2 2

26. Eg: 2001 2002 Return on Assets = = 15.89% Net income 10,600 14,500 Interest Expense 910 760 Total Assets (2000 = 69,900) 75,000 82,000 10,600 + 910 (69,900 + 75,000 ) / 2 14,500 + 760 (75,000 + 82,000 ) / 2 = 19.44%

27. Profitability Ratio – Return on Equity  To assess the ability of the company in managing the investments by shareholders to earn income. Return on equity = Net income Average total stockholders’ equity  Average total stockholders’ equity = Total equity year 1 + total equity year 2 2

28. Eg: 2001 2002 Return on Equity ( year 2002 ) = Net income 10,600 14,500 Total Equities: 14,500 (100,000 + 106,000 ) / 2 = 14.08% Common Shares 80,000 86,000 Preference Shares 20,000 20,000 100,000 106,000

29. Profitability Ratio – Return on Common Equity  To assess the ability of the company in managing the investments by common shareholders to earn its net income. Return on common equity = Net income Average common stockholders’ equity  Average common stockholders’ equity = Common equity year 1 + common equity year 2 2

30. Eg: 2001 2002 Return on Common Equity ( year 2002 ) Net income 10,600 14,500 Total Equities: 14,500 (80,000 + 86,000 ) / 2 = 17.47% Common Shares 80,000 86,000 Preference Shares 20,000 20,000 100,000 106,000 =

31. Profitability Ratio – Earnings Per Share  a measure of net income earned on each share of common stock. Earnings Per Share / EPS Net income average common shares outstanding (unit) =

32. Eg: 2001 2002 Earnings per share ( year 2002 ) Net income 10,600 14,500 Total Equities: 14,500 (80,000 + 86,000 ) / 2 = RM0.17 per share Common Shares (RM1.00 per share) 80,000 86,000 =

33. Profitability Ratio – Price Earnings Ratio  M easures the ratio of the market price of each share of common stock to the earnings per share. Price Earnings Ratio / PE Ratio = Market price of common stock Earnings Per Share

34. Eg: 2001 2002 Average market price for common stock RM3.25 RM4.62 Earnings Per Share RM0.11 RM0.17 Price Earnings Ratio / PE Ratio = RM3.25 RM4.62 RM0.11 RM0.17 = 30 times = 27 times

35. Efficiency Ratios The ratios are:  Inventory Turnover  Asset Turnover  Debtors Turnover / Receivable Turnover Measures of the efficiency and the ability of the company in managing its resources.

36. Efficiency Ratio – Inventory Turnover  measures the number of times, on average, the inventory is sold during the period .  P urpose : to measure the liquidity of the inventory. Inventory Turnover = Cost of goods sold Average inventory  Average inventory = Opening inventory + closing inventory 2

37. Eg: 2001 2002 = Cost of goods sold 20,200 23,600 Inventories 2 ,800 6,000 Inventory turnover (2002) 23,600 ( 2,800 + 6,000 ) / 2 = 5.4 times

38. Efficiency Ratio – Assets Turnover  measures how efficiently a company uses its assets to generate sales . Assets turnover = Net sales Average total assets  Average assets = Total assets year 1 + total assets year 2 2

39. Eg: 2001 2002 = Assets turnover (2002) 52,700 ( 75,000 + 82,000 ) / 2 = 0.67 times Net Sales 45,000 52,700 Total Assets 75,000 82,000

40. Efficiency Ratio – Receivables Turnover  U sed to assess the liquidity of the receivables.  It measures the number of times , on average , receivables are collected during the period . Receivables turnover = Net credit sales Average net receivables  Average net receivables = A. R year 1 + A. R year 2 2

41. Eg: 2001 2002 = Receivables turnover (2002) 45,700 ( 9,800 + 12,000 ) / 2 = 4.2 times Net Credit Sales 3 5,000 45,700 Accounts Receivable 9,800 12,000

42. Solvency Ratios The ratios are:  Debt ratio  Equity ratio  Times Interest Earned Measures of the ability of the company to survive over a long period of time.

43. Solvency Ratio – Debt Ratio  measures the percentage of total assets provided by creditors. Debt ratio = Total liabilities Total assets

44. Eg: 2001 2002 Total assets 75 ,000 82,000 Total liabilities 39,000 52,000 Debt ratio = 39,000 75,000 = 52 % 52,000 82,000 = 63 %

45. Solvency Ratio – Equity Ratio  measures the percentage of total assets provided by shareholders. Equity ratio = Total owner’s equity Total assets

46. Eg: 2001 2002 Total assets 75 ,000 82,000 Equity ratio = 69,000 75,000 = 92 % 69,000 82,000 = 84 % Total equities 69,000 69,000

47. Solvency Ratio – Times Interest Earned  provides an indication of the company’s ability to meet interest payments as they come due. Times interest earned = Income before tax and interest expense Interest expense

48. Eg: 2001 2002 Income before tax and interest 10,600 14,500 = 11.65 times Interest Expense 910 760 Times interest earned = 10,600 910 14,500 760 = 19.1 times

49. Thank you