Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER 19 FINANCIAL STATEMENT ANALYSIS BASICS OF FINANCIAL STATEMENT ANALYSIS • Analysing financial statements involves evaluating three characteristics of a company: its liquidity its profitability its solvency COMPARATIVE ANALYSIS • Three types of comparisons: – Intracompany basis – Intercompany basis – Industry averages COMPARATIVE ANALYSIS • Three tools: – Horizontal analysis – Vertical analysis – Ratio analysis HORIZONTAL ANALYSIS Change since base period ANY COMPANY INC Assumed Net Sales For the Year Ended December 31 (in millions) 2003 2002 2001 2000 1999 $ 6,562.8 $ 6,295.4 $ 6,190.6 $ 5,786.6 $ 5,181.4 127% 121% 119% 112% 100% VERTICAL ANALYSIS • Expresses each item in a financial statement as a percent of a base amount (total assets or net sales) ANY COMPANY, INC Condensed Balance Sheets (Partial) December 31 (in millions) 2002 Assets Current assets Capital assets Other assets Total assets Amount $1,496.5 2,888.8 666.2 $5,051.5 2001 Percent 29.6 57.2 13.2 100.0% Amount $1,467.7 2,733.3 636.6 $4,837.6 Percent 30.1 56.9 13.0 100.0% RATIO ANALYSIS Liquidity Ratios Measure short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash Revenues - Expenses Since 1892 Profitability Ratios = Net Income Measure the income or operating success of an enterprise for a given period of time Solvency Ratios XYZ Co Measure the ability of the enterprise to survive over a long period of time LIQUIDITY RATIOS • • • • • • • Current ratio Acid test ratio Cash current debt coverage ratio Receivables turnover Collection period Inventory turnover Days sales in inventory CURRENT RATIO • Measures short-term debt-paying ability Current ratio = Current assets Current liabilities (Discussed in Chapter 4) RETURN ON ASSETS • Measures overall profitability of assets Return on assets = Net income Average total assets (Discussed in Chapter 10) RETURN ON COMMON SHAREHOLDERS’ EQUITY • Measures profitability of common shareholders’ investment Return on common shareholders’ equity = Net income Average common shareholders’ equity (Discussed in Chapter 14) BOOK VALUE PER SHARE • Measures the equity (net assets) per common share Book value per share = Common shareholders’ equity Number of common shares (Discussed in Chapter 14) CASH FLOW PER SHARE • Measures the net cash flow per common share Cash flow per share = Net cash provided by all activities Number of common shares (Discussed in Chapter 18) EARNINGS PER SHARE (EPS) • Measures net income earned on each common share Earnings per share = Net income Number of common shares (Discussed in Chapter 15) PRICE-EARNINGS (PE) RATIO • Measures relationship between market price per share and earnings per share Price-earnings ratio = Share price Earnings per share (Discussed in Chapter 15) PAYOUT RATIO • Measures % of earnings distributed in the form of cash dividends Payout ratio = Cash dividends Net income (Discussed in Chapter 15) DIVIDEND YIELD • Measures rate of return earned from dividends Dividend yield = Cash dividends per share Share price (Discussed in Chapter 15) SOLVENCY RATIOS • • • • Debt to total assets Interest coverage Cash interest coverage Cash total debt coverage DEBT TO TOTAL ASSETS • Measures % of total assets provided by creditors Debt to total assets = Total liabilities Total assets (Discussed in Chapter 16) INTEREST COVERAGE • Measures ability to meet interest payments as they come due Interest coverage = Income before interest expense and income tax expense (EBIT) Interest expense (Discussed in Chapter 16) CASH INTEREST COVERAGE • Measures cash available to meet interest payments as they come due (cash basis) Cash interest coverage = Income before interest expense, income tax expense, and amortization expense (EBITDA) Interest expense (Discussed in Chapter 16) CASH TOTAL DEBT COVERAGE • Measures long-term debt-paying ability (cash basis) Cash total debt coverage ratio = Net cash provided by operating activities Average total liabilities (Discussed in Chapter 18) LIMITATIONS OF FINANCIAL ANALYSIS • Estimates • Historical cost • Alternative accounting methods • Atypical data • Diversification COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd All rights reserved Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd The purchaser may make back-up copies for his / her own use only and not for distribution or resale The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein ... For the Year Ended December 31 (in millions) 2003 2002 2001 2000 199 9 $ 6,562.8 $ 6,295.4 $ 6 ,190 .6 $ 5,786.6 $ 5,181.4 127% 121% 119% 112% 100% VERTICAL ANALYSIS • Expresses each item in a financial.. .CHAPTER 19 FINANCIAL STATEMENT ANALYSIS BASICS OF FINANCIAL STATEMENT ANALYSIS • Analysing financial... (Discussed in Chapter 4) ACID TEST RATIO • Measures immediate short-term debtpaying ability Acid test ratio = Cash + temporary investments + net receivables Current liabilities (Discussed in Chapter