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Managerial Accounting Weygandt • Kieso • Kimmel Financial Statement Analysis: The Big Picture. Chapter 14. Chapter 14 Financial Statement Analysis: The Big Picture. After studying Chapter 14, you should be able to: Describe and apply horizontal analysis.

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managerial accounting weygandt kieso kimmel financial statement analysis the big picture

Managerial AccountingWeygandt • Kieso • KimmelFinancial Statement Analysis: The Big Picture

Chapter 14

chapter 14 financial statement analysis the big picture
Chapter 14Financial Statement Analysis: The Big Picture

After studying Chapter 14, you should be able to:

  • Describe and apply horizontal analysis.
  • Describe and apply vertical analysis.
  • Identify and compute ratios used in analyzing a company’s liquidity, solvency, and profitability.
  • Understand the concept of quality of earnings.
financial statement analysis
Financial Statement Analysis

Three basic tools are used in financial statement analysis :

  • Horizontal analysis
  • Vertical analysis
  • Ratio analysis
horizontal analysis
Horizontal Analysis
  • Is a technique for evaluating a series of financial statement data over a period of time.
  • Purpose is to determine whether an increase or decrease has taken place.
  • The increase or decrease can be expressed as either an amount or a percentage.
horizontal analysis of net sales
Horizontal Analysis of Net Sales

Current period sales expressed as a percentage of the base period using 1997 as the base period:

Kellogg Company

Net Sales (in millions) Base Period 1997

20012000199919981997

$8,853.3 $6,954.7 $6,984.2 $6762.1 $6,830.1

129.62% 101.82 % 102.26% 99% 100.0%

horizontal analysis of a balance sheet
Horizontal Analysis of a Balance Sheet

KELLOGG COMPANY, INC.

Condensed Balance Sheets

December 31

(In millions)

Increase (Decrease)

during 2001

20012000AmountPercent

Assets

Current Assets $ 1,902.0 $1,617.1 $ 284.9 17.6

Plant assets 2,952.8 2,526.9 425.9 16.9

Other assets 5,513.8 742.04,771.8643.1

Total assets $10,368.6$4,886.0$5,482.6112.2

slide8

Horizontal Analysis of a Balance Sheet

Increase (Decrease)

during 2001

20012000AmountPercent

Liabilities and

Stockholders' Equity

Current liabilities $ 2,207.6 $2,482.3 $ (274.7) (11.1)

Long-term liabilities 7,289.5 1,506.2 5,783.3384.0

Total liabilities 9,497.1 3,988.5 5,508.6 138.1

Stockholders' equity

Common stock 195.3 205.8 (10.5) (5.1)

Retained earnings

and other 1,013.3 1,065.7 (52.4) (4.9)

Treasury stock (337.1) (374.0) 36.99.9

Total stockholders'

equity 871.5 897.5 (26.0) (2.9)

Total liabilities and

stockholders' equity $10,368.6$4,886.0$5,482.6112.2

slide9

KELLOGG COMPANY, INC.

Condensed Income Statement

For the Years Ended December 31

(In millions)

Increase (Decrease)

during 200120012000AmountPercent

Net sales $ 8,853.3 $6,954.7 $1,898.6 27.3

Cost of goods sold 4,128.5 3,327.0 801.524.1

Gross profit 4,724.8 3,627.7 1,097.1 30.2

Selling & Admin. 3,523.6 2,551.4 972.2 38.1

Nonrecurring charges 33.3 86.5 (53.2) (61.5)

Income from operations 1,167.9 989.8 178.1 18.0

Interest expense 351.5 137.5 214.0 155.6

Other income

(expense), net (12.3) 15.4 (27.7) (179.9)

Income before taxes 804.1 867.7 (63.6) (7.3)

Income tax expense 322.1 280.0 42.115.0

Net income $ 482.0 $ 587.7 $ (105.7) (18.0)

vertical analysis
Vertical Analysis
  • Is a technique for evaluating financial statement data that expresses each item in a financial statement as a percent of a base amount.
  • Total assets is always the base amount in vertical analysis of a balance sheet.
  • Net sales is always the base amount in vertical analysis of an income statement.
slide11
KELLOGG COMPANY, INC.

Condensed Balance Sheets

December 31

(In millions)

2001 2000 z

AssetsAmountPercentAmountPercent

Current Assets $ 1,902.0 18.3 $1,617.1 33.1

Property Assets 2,952.8 28.5 2,526.9 51.7

Other assets 5,513.8 53.2 742.015.2

Total assets $10,368.6 100.0% $4,886.0 100.0%

slide12

KELLOGG COMPANY, INC.

Condensed Balance Sheets

December 31

(In millions)

20012000

Liabilities andAmountPercent*AmountPercent*

Stockholders' Equity

Current liabilities $ 2,207.6 21.3 $2,482.3 50.8

Long-term liabilities 7,289.570.3 1,506.230.8

Total liabilities 9,497.191.6 3,988.5 81.6

Stockholders' equity

Common stock 195.3 1.9 205.8 4.2

Retained earnings

and other 1,013.3 9.8 1,065.7 21.8

Treasury stock (337.1) (3.3) (374.0) (7.6)

Total stockholders'

equity 871.5 8.4 897.5 18.4

Total liabilities and

stockholders' equity $10,368.6100.0$4,886.0100.0

*Percentages may be rounded up or down

slide13

KELLOGG COMPANY, INC.

Condensed Income Statement

For the Years Ended December 31

(In millions)

2001 2000 AmountPercent*AmountPercent*

Net sales $8,853.3 100.0 $6,954.7 100.0

Cost of goods sold 4,128.5 46.6 3,327.0 47.8

Gross profit 4,724.8 53.4 3,627.7 52.2

Selling & admin. 3,523.6 39.8 2,551.4 36.7

Nonrecurring chgs. 33.3 0.4 86.5 1.3

Income operations 1,167.9 13.2 989.8 14.2

Interest expense 351.5 4.0 137.5 2.0 Other income

(expense),net (12.3) (0.1) 15.4 0.2

Income before

income taxes 804.1 9.1 867.7 12.4

Income tax ex. 322.1 3.6 280.0 4.0

Net income $ 482.0 5.5 $ 587.7 8.4

*Percentages may be rounded up or down

condensed income statements for the year ended december 31 2001 in millions
Condensed Income StatementsFor the Year Ended December 31, 2001(in millions)

Kellogg Company, Inc. General Mills,Inc

Amount Percent* Amount Percent*

Net sales $8,853.3 100.0 $7,949.0 100.0

Cost of goods sold 4,128.5 46.6 4,767.0 60.0

Gross profit 4,724.8 53.4 3,182.0 40.0

Selling and administrative

expenses 3,523.6 39.8 1,909.0 24.0

Nonrecurring charges 33.3 0.4 190.0 2.4

Income from operations 1,167.9 13.2 1,083.0 13.6

Other expenses and

revenues (including

income taxes) 685.9 7.7 622.0 7.8

Net income $ 482.0 5.5 $ 461.0 5.8

*Percentages may be rounded up or down

ratios
Ratios
  • Three types:
      • Liquidity ratios
      • Solvency ratios
      • Profitability ratios
  • Can provide clues to underlying conditions that may not be apparent from an inspection of the individual components.
  • Single ratio by itself is not very meaningful.
liquidity ratios
Liquidity Ratios

Measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.

WHO CARES?

Short-term creditors such as bankers and suppliers

slide18

Liquidity Ratios

  • Working capital
  • Current ratio
  • Current cash debt coverage ratio
  • Inventory turnover ratio
  • Days in inventory
  • Receivables turnover ratio
  • Average collection period
working capital
Working Capital

Indicates immediate short-term debt-paying ability

Current Assets - Current Liabilities

current ratio
Current Ratio

Indicates short-term debt-paying ability

Current Assets

Current Liabilities

current cash debt coverage ratio
Current Cash Debt Coverage Ratio

Indicates short-term debt-paying ability (cash basis)

Cash provided by operations Average current liabilities

days in inventory
Days in Inventory

Indicates liquidity of inventory and inventory management

365 days

Inventory Turnover Ratio

receivables turnover ratio
Receivables Turnover Ratio

Indicates liquidity of receivables

Net Credit Sales

Average Gross Receivables

average collection period
Average Collection Period

Indicates liquidity of receivables and collection success.

365 days

Receivables Turnover Ratio

solvency ratios
Solvency Ratios

Measure the ability of the enterprise to survive over a long period of time

WHO CARES?

Long-term creditors and stockholders

slide27

Solvency Ratios

  • Debt to total assets ratio
  • Cash debt coverage ratio
  • Times interest earned ratio
  • Free cash flow
debt to total assets ratio
Debt to Total Assets Ratio

Indicates % of total assets provided by creditors

Total Liabilities

Total Assets

cash debt coverage ratio
Cash Debt Coverage Ratio

Indicates long-term debt-paying ability (cash basis)

Cash provided by operations

Average total liabilities

times interest earned ratio
Times Interest Earned Ratio

Indicates company’s ability to meet interest payments as they come due

Net Income Before Interest

Expense & Income Tax

Interest Expense

slide31

Free Cash Flow

Indicates cash available for paying dividends or expanding operations

Cash Provided By Operations

- Capital Expenditures

- Dividends Paid

Free Cash Flow

profitability ratios
Profitability Ratios

Measure the income or operating success of an enterprise for a given period of time

WHO CARES? Everybody

WHY? A company’s income affects:

  • its ability to obtain debt and equity financing
  • its liquidity position
  • its ability to grow
slide33

Profitability Ratios

  • Earnings per share (EPS)
  • Price-earnings ratio
  • Gross profit rate
  • Profit margin ratio
  • Return on assets ratio
  • Assets turnover ratio
  • Payout ratio
  • Return on common stockholders’ equity ratio
earnings per share eps

Net Income - Preferred Stock Dividends

Average common shares outstanding

Earnings Per Share (EPS)

Indicates net income earned on each share of common stock sales

price earnings ratio

Stock Price Per Share

Earnings Per Share

Price Earnings Ratio

Indicates relationship between market price per share and earnings per share

gross profit rate
Gross Profit Rate

Indicates margin between selling price and cost of good sold

Gross profit

Net sales

profit margin ratio

Net income

Net sales

Higher value suggests favorable return on each dollar of sales.

Profit Margin Ratio

Indicates net income generated by each dollar of sales

return on assets ratio

Higher value suggests favorable efficiency.

Return On Assets Ratio

Reveals the amount of net income generated by each dollar invested

Net income

Average total assets

asset turnover ratio
Asset Turnover Ratio

Indicates how efficiently assets are used to generate sales

Net sales

Average total assets

payout ratio
Payout Ratio

Indicates % of earnings distributed in the form of cash dividends

Cash dividends decl. on common stock

Net income

return on common stockholders equity ratio
Return on Common Stockholders’ Equity Ratio

Indicates profitability of common stockholders’ investment

Net income - preferred stock dividends

Average common stockholders’ equity

limitations of financial analysis
Limitations Of Financial Analysis
  • Horizontal, vertical, and ratio analysis are frequently used in making significant business decisions.
  • One should be aware of the limitations of these tools and the financial statements.
quality of earnings
Quality of Earnings

Indicates the level of full and transparent information that is provided to users of the financial statements.

alternative accounting methods
Alternative Accounting Methods
  • One company may use the FIFO method, while another company in the same industry may use LIFO.
  • If the inventory is significant for both companies, it is unlikely that their current ratios are comparable.
  • In addition to differences in inventory costing methods, differences also exist in reporting such items as depreciation, depletion, and amortization.
pro forma income
Pro Forma Income

A measure of the net income generated that usually excludes items that the company thinks are unusual or nonrecurring.