Financial Statement Analysis Chapter 17 Student Version These Theseslides slidesshould shouldbe beviewed viewedusing usingthe thepresentation presentation mode mode(click (clickthe the icon icontotostart startpresentation) presentation) © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Prepared by: C Douglas Cloud Professor Emeritus of Accounting Pepperdine University Learning Objective 1 Describe basic financial statement analytical methods © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Horizontal Analysis The percentage analysis of increases and decreases in related items in comparative financial statements is called horizontal analysis © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Horizontal Analysis Horizontal Analysis: Difference Base year (2011) $17,000 $533,000 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use = 3.2% LO Horizontal Analysis Horizontal Analysis: Difference $25,800 Base year (2011) $64,700 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use = 39.9% LO Horizontal Analysis Horizontal Analysis: Difference $296,500 Base year (2011) $1,234,000 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use = 24.0% LO Horizontal Analysis Horizontal Analysis: Difference $37,500 Base year (2011) $ 100,000 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use = 37.5% LO Vertical Analysis A percentage analysis used to show the relationship of each component to the total within a single financial statement is called vertical analysis  In a vertical analysis of the balance sheet, each asset item is stated as a percent of the total assets  Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Vertical Analysis Vertical Analysis: Current Assets $550,000 Total Assets $ 1,139,500 = 48.3% © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Vertical Analysis Vertical Analysis: Selling expenses Net sales $191,000 $1,498,000 = 12.8% © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Rate Earned on Common Stockholders’ Equity Lincoln Company had $150,000 of 6% preferred stock outstanding on December 31, 2012 and 2011 Thus, preferred dividends of $9,000 ($150,000 x 6%) are deducted from net income Lincoln’s common stockholders’ equity is determined as follows: (continued) © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Rate Earned on Common Stockholders’ Equity Net income 76,500 Less preferred dividends 9,000 Total 67,500 Common stockholders’ equity: Beginning of year 600,000 RateEnd earned on common of year stockholders’ equity 637,500 Total $82,000 $1,237,500 Average (Total ÷ 2) $658,500 618,750 2012 $ 2011 91,000 $ 9,000 $ 82,000 $ $ 637,500 $ 679,500 12.5% 10.9% $1,317,000 $67,500 $618,750 $ 658,500 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use $ LO Earnings per Share on Common Stock Earnings per share (EPS) on common stock measures the share of profits that are earned by a share of common stock GAAP requires the reporting of earnings per share in the income statement It is computed as follows: Net Income – Preferred Dividends Earnings per Share (EPS) = on Common Stock Shares of Common Stock Outstanding © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Earnings per Share on Common Stock EPS for Lincoln Company is computed below Net income $76,500 Less preferred dividends 9,000 Total Earnings $67,500 per share on common stock Shares of common stock $82,000 50,000 50,000 2012 $91,000 2011 9,000 $82,000 $1.64 50,000 $67,500 50,000 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use $1.35 LO Price-Earnings Ratio Another profitability measure quoted by the financial press is the price-earnings (P/E) ratio on common stock The price-earnings ratio on common stock measures a company’s future earnings prospects The price-earnings ratio is computed as follows: Market Price per Share of Common Stock Price-earnings (P/E) ratio = Earnings per Share on Common Stock © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Price-Earnings Ratio The P/E ratio for Lincoln Company is computed below 2012 Market price per share of common stock $27.00 Earnings per share on common stock Price-earnings ratio on $1.35 common stock 2010 $41.00 ÷ $1.64÷ 25 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use 20 LO Dividends per Share Dividends per share can be reported with earnings per share to indicate the relationship between dividends and earnings Comparing these two per-share amounts measures the extent to which earnings are being distributed to common shareholders The calculations for dividends per share are at the top of the next slide (continued) © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Dividends per Share Dividends per Share = Dividends Shares of Common Stock Outstanding The dividends per share for Lincoln Company are computed below Dividends on common stock $30,000 Shares of common stock outstanding Dividends per share of common stock 50,000 2011 $0.80 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use 2012 $40,000 ÷ 50,000 ÷ $0.60 LO Dividend Yield The dividend yield on common stock measures the rate of return to common stockholders from cash dividends It is of special interest to investors whose objective is to earn dividends from their investment It is computed as follows: Dividends per Share of Common Stock Dividend Yield = Market Price per Share of Common Stock © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Dividend Yield The dividend yield for Lincoln Company is computed below 2012 Dividends per share of common stock $ 0.60 Market price per share of common stock Dividend yield on common stock $27.00 $0.80 20119 $ 0.80 $41.00 2.0% 2.2% $0.60 $41 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use $27 Learning Objective Describe basic financial statement analytical methods Use financial statement analysis to assess the solvency of a business Use financial statement analysis to assess the profitability of a business Describe the contents of corporate annual reports © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Corporate Annual Reports In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections:  Management discussion and analysis  Report on internal control  Report on fairness of the financial statements © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Report on Internal Control The Sarbanes-Oxley Act of 2002 requires a report stating management’s responsibility for establishing and maintaining internal control In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report It also requires a public accounting firm to verify management’s conclusions on internal control © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Report on Fairness of Financial Statements All publicly held corporations are required by the Sarbanes-Oxley Act of 2002 to have an independent audit (examination) of their financial statements The CPA firm that conducts the audit renders an opinion on the fairness of the statements © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Financial Statement Analysis The End Student Version Prepared by: C Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ... password-protected website for classroom use Learning Objective Describe basic financial statement analytical methods Use financial statement analysis to assess the solvency of a business © 2011 Cengage... classroom use LO Solvency Analysis All users of financial statements are interested in the ability of a company to the following:  Meet its financial obligations (debts), called solvency ... turnover Accounts 260,000 $1,498,000 Average (Total ÷ 2) $ 117, 500 130,000 2012 2011 $1,498,000 $ 120,000 $ 115,000 12.7 $ 235,000 9.2 $1,200,000 $ 117, 500 $130,000 © 2011 Cengage Learning All Rights