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Chapter 10

Chapter 10. Analysis of Financial Statements. General Accounting Principles. Reliability Understandability Comparability. Primary Financial Statements. The balance sheet enumerates Assets Liabilities Equity. Assets. Current: cash and equivalents, accounts receivable, and inventory

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Chapter 10

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  1. Chapter 10 Analysis of Financial Statements

  2. General Accounting Principles • Reliability • Understandability • Comparability

  3. Primary Financial Statements • The balance sheet enumerates • Assets • Liabilities • Equity

  4. Assets • Current: cash and equivalents, accounts receivable, and inventory • Long-term: land, buildings, machinery, and equipment • Hidden assets

  5. Liabilities • Current • .Accounts Payable • Accruals • Notes payable • Long-term

  6. Equity • Preferred stock • Common stock • Additional paid-in capital • Retained earnings • Book value • Book value per share

  7. The Income Statement • Enumerates • Revenues • Expenses • To determine • Income (earnings) • Earnings per share

  8. Analysis of Cash Flow: Statement of Cash Flows • Enumerates • sources of funds • uses of funds • Determines change in the cash position • Emphasis on the firm’s ability to generate cash

  9. Cash Inflows • A decrease in an asset • An increase in a liability • An increase in equity

  10. Cash Outflows • An increase in an asset • A decrease in a liability • A decrease in equity

  11. Limitations of Accounting Data • Nonmeasureable items are excluded • Aggregations • Biased estimates of data • Insufficient challenges by auditors

  12. Depreciation • Allocation of the cost of plant and equipment over time • Non-cash expense • Impact on taxes and cash flow

  13. Depreciation • Straight-line depreciation • Equal allocation each year • Accelerated depreciation • Larger proportion during the early years

  14. Modified Accelerated Cost Recovery System (MACRS) • Asset classified by years 3, 5, 7, 10, 15, 20 years • The half-year convention

  15. Corporate Losses • Offset earnings from other years • Carry back 3 years then • Carry forward

  16. Ratio Analysis • Builds on a firm's financial statements • Easy to understand • Used by both equity investors and creditors

  17. Ratio Analysis • Facilitates Comparisons • Over time: time-series analysis • Across firms: cross-sectional analysis

  18. An Application of Ratio Analysis • The following ratios use Pier I Imports 2002 financial statements

  19. Current Ratio • Current assets / current liabilities • $605.1 / $208.4 = 2.90

  20. Quick Ratio • (Current assets - inventory) / current liabilities • ($605.1 - $275.4) / $208.4 = 1.58

  21. Inventory Turnover • Sales / average inventory • $1,548.9 / $293.1 = 5.3

  22. Receivables Turnover • Sales / accounts receivable • $1,548.6 / $6,205 = 249.6 • Answer is not meaningful

  23. Receivables Turnover • For Southern Company$10,155 / $1,132 = 8.97 • Interpretation: 8.97 is about nine times a year or every six weeks.

  24. Average Collection Period(days sales outstanding) • For Southern Company • Accounts receivable / sales per day • $1,132 / $28,208 = 40 days

  25. Fixed Asset Turnover • Sales / fixed assets • $1,159 / $209.9 = 7.38

  26. Total Asset Turnover • Sales / total assets • $1,159 / $862.7 = 1.80

  27. Gross Profit Margin • (revenues - cost of goods sold) / sales • $649.8 / $1,549 = 41.96%

  28. Operating Profit Margin • Operating earnings / sales • $158.8 / $1,549 = 10.26%

  29. Net Profit Margin • Earnings after taxes / sales • $100.2 / $1,549 = 6.47%

  30. Return on Assets • Earnings after taxes / total assets • $100.2 / $862.7 = 11.6%

  31. Return on Equity • Earnings after taxes / equity • $100.2 / $585.6 = 17.1%

  32. Return on Common Equity • Adjusts for preferred stock • If no preferred, ratio is same as return on equity

  33. Basic Earning Power • EBIT / total assets • $158.8 / $862.7 = 18.47%

  34. Debt Ratio • Debt / total assets • $277.0 / $862.7 = 32.1%

  35. Debt to Equity Ratio • Debt / equity • $277.0 / $585.7 = 47.3%

  36. DuPont System of Analysis • Combines • Net profit margin • Turnover • Leverage • Helps identify source of weakness

  37. DuPont System of Analysis

  38. Times-interest-earned • Earnings before interest and taxes / interest • $158,813 / $-184 = -863.1 • Interest earned exceeded interest paid.

  39. Ratio Comparisons • Ratios of firms within an industry • tend to have similar numerical values • differences in numerical values are reasons for further analysis

  40. Problems for Interpretation • Different definitions for the same ratio • Historical data may be outmoded • Non-recurring items • Internet sources differ

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