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FINANCIAL STATEMENT

ANALYSIS : II
Mobin Shaikh
GNLU
ANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS
FINANCIAL STATEMENT ANALYSIS
 Non-accounting majors, especially, relate well to this topic
It looks at accounting information from users’ perspective
 What is financial statement analysis?
”Tearing apart” the financial statements

and looking at the relationships


FINANCIAL STATEMENT ANALYSIS
Information is available from 627 628
 Published annual reports
(1) Financial statements
(2) Notes to financial statements
(3) Letters to stockholders
(4) Auditor’s report (Independent accountants)
(5) Management’s discussion and analysis
 Reports filed with the government
FINANCIAL STATEMENT ANALYSIS
Information is available from 627 628
 Other sources
(1) Newspapers (e.g., Wall Street Journal )
(2) Periodicals (e.g. BS, Forbes, Fortune)
(3) Financial information organizations such

as: Moody’s, Standard & Poor’s, SEBI Reports,


Investopedia, Individual Research Agencies
(4) Other business publications
METHODS OF FINANCIAL
STATEMENT ANALYSIS

Horizontal Analysis

Vertical Analysis

Common-Size Statements
Trend Percentages
Ratio Analysis
HORIZONTAL ANALYSIS

Using
Using comparative
comparative financial
financial
statements
statements to to calculate
calculate Rupee
Rupee
or
or percentage
percentage changes
changes inin aa
financial
financial statement
statement item
item from
from
one
one period
period to
to the
the next
next
HORIZONTAL ANALYSIS
 Comparison of absolute data or percentage of two or
more years.
 It is a comparative analysis of increase or decrease in
percentages between the corresponding items in financial
statements of previous year and current year. Item wise
figures are compared between the statements of two
periods, the increase or decrease is noted down and the
percentage is calculated keeping the previous year’s
figure as the base.
HORIZONTAL ANALYSIS
 If the horizontal analysis includes three or more year’s
figures for item wise comparison, the percentage
increase or decrease may be calculated keeping figures
of the earliest year as the base for comparing all the later
year figures or each year’s item-wise figures may be
compared with immediately preceding year’s figures.
HORIZONTAL ANALYSIS EXAMPLE
The management of Xerox Corporation provides you
with comparative balance sheets of the years ended
March 31, 2010 and 2011. Management asks you to
prepare a horizontal analysis on the information.
XEROX CORPORATION
Comparative Balance Sheets
March 31, 2010 and 2011

Increase (Decrease)
2011 2010 Amount %
Assets
Current assets:
Cash ₹ 12,000.00 ₹ 23,500.00
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets ₹ 315,000.00 ₹ 289,700.00
HORIZONTAL ANALYSIS EXAMPLE
Calculating Change in Rupee Amounts

Rupee Current Year Base Year


Change = Figure – Figure
HORIZONTAL ANALYSIS EXAMPLE
Calculating Change in Rupee Amounts

Rupee Current Year Base Year


Change = Figure – Figure

Since we are measuring the amount of the


change between 2010 and 2011, the rupee
amounts for 2010 become the “base” year
figures.
HORIZONTAL ANALYSIS EXAMPLE
Calculating Change as a Percentage

Percentage Rupee Change


Change = Base Year Figure × 100%
HORIZONTAL ANALYSIS EXAMPLE
XEROX CORPORATION
Comparative Balance Sheets
March 31, 2010 and 2011
Increase (Decrease)
2010 2011 Amount %
Assets
Current assets:
Cash ₹ 12,000.00 ₹ 23,500.00 ₹ -11,500.00
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment: 12,000 –23,500 = (11,500)
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets ₹ 315,000.00 ₹ 289,700.00
HORIZONTAL ANALYSIS EXAMPLE

(11,500 ÷ 23,500) × 100% = 48.9%


HORIZONTAL ANALYSIS EXAMPLE
XEROX CORPORATION
Comparative Balance Sheets
March 31, 2011 and 2010
Increase (Decrease)
2011 2010 Amount %
Assets
Current assets:
Cash ₹ 12,000.00 ₹ 23,500.00 ₹ -11,500.00 (48.9)
Accounts receivable, net 60,000 40,000 20,000 50.0
Inventory 80,000 100,000 (20,000) (20.0)
Prepaid expenses 3,000 1,200 1,800 150.0
Total current assets 155,000 164,700 (9,700) (5.9)
Property and equipment:
Land 40,000 40,000 - 0.0
Buildings and equipment, net 120,000 85,000 35,000 41.2
Total property and equipment 160,000 125,000 35,000 28.0
Total assets ₹ 315,000.00 ₹ 289,700.00 ₹ 25,300.00 8.7
HORIZONTAL ANALYSIS EXAMPLE

Let’s apply the same


procedures to the
liability and stockholders’
equity sections of the
balance sheet.
ZEROX CORPORATION
Comparative Balance Sheets
December 31, 2011 and 2010
Increase (Decrease)
2011 2010 Amount %
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ₹ 67,000.00 ₹ 44,000.00 ₹ 23,000.00 52.3
Notes payable 3,000 6,000 (3,000) (50.0
Total current liabilities 70,000 50,000 20,000 40.0
Long-term liabilities:
Bonds payable, 8% 75,000 80,000 (5,000) (6.3
Total liabilities 145,000 130,000 15,000 11.5
Stockholders' equity:
Preferred stock 20,000 20,000 - 0.0
Common stock 60,000 60,000 - 0.0
Additional paid-in capital 10,000 10,000 - 0.0
Total paid-in capital 90,000 90,000 - 0.0
Retained earnings 80,000 69,700 10,300 14.8
Total stockholders' equity 170,000 159,700 10,300 6.4
Total liabilities and stockholders' ₹ 315,000.00 ₹ 289,700.00 ₹ 25,300.00 8.7
equity
HORIZONTAL ANALYSIS EXAMPLE

Now, let’s apply the


procedures to the
income statement.
XEROX CORPORATION
Comparative Income Statements
For the Years Ended Marchr 31, 2011 and 2010
Increase (Decrease)
2011 2010 Amount %
Net sales ₹ 520,000.00 ₹ 480,000.00 ₹ 40,000.00 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income ₹ 17,500.00 ₹ 22,400.00 ₹ -4,900.00 (21.9)
XEROX CORPORATION
Comparative Income Statements
For the Years Ended March 31, 2011 and 2010
Increase (Decrease)
2011 2010 Amount %
Net sales ₹ 520,000.00 ₹ 480,000.00 ₹ 40,000.00 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense
Sales increased by 8.3% while6,400 7,000
net income decreased by (600) (8.6)
Net income 21.9%.
before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income ₹ 17,500.00 ₹ 22,400.00 ₹ -4,900.00 (21.9)
There were increases in both cost of goods sold (14.3%) and operating
expenses (2.1%). These increased costs more than offset the increase in
sales, yielding an overall decrease in net income.
XEROX CORPORATION
Comparative Income Statements
For the Years Ended March 31, 2011 and 2010
Increase (Decrease)
2011 2010 Amount %
Net sales ₹ 520,000.00 ₹ 480,000.00 ₹ 40,000.00 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income ₹ 17,500.00 ₹ 22,400.00 ₹ -4,900.00 (21.9)
VERTICAL ANALYSIS

For
For aa single
single financial
financial
statement,
statement, eacheach item
item
is
is expressed
expressed as as aa
percentage
percentage of of aa
significant
significant total,
total,
e.g.,
e.g., all
all income
income
statement
statement items
items areare
expressed
expressed as as aa
percentage
percentage of of sales
sales
Vertical
Vertical analysis
analysis helps
helps the
the
management
management to to compare
compare
the
the percentage
percentage ofof different
different
components
components with
with
competitive
competitive enterprises
enterprises
percentages
percentages or
or industry
industry
average
average percentages.
percentages.
VERTICAL ANALYSIS EXAMPLE
The management of Sample Company asks you to
prepare a vertical analysis for the comparative
balance sheets of the company.
VERTICAL ANALYSIS EXAMPLE
Sample Company
Balance Sheet (Assets)
At December 31, 1999 and 1998
% of Total Assets
1999 1998 1999 1998
Cash ₹ 82,000.00 ₹ 30,000.00 17% 8%
Accts. Rec. 120,000 100,000 25% 26%
Inventory 87,000 82,000 18% 21%
Land 101,000 90,000 21% 23%
Equipment 110,000 100,000 23% 26%
Accum. Depr. (17,000) (15,000) -4% -4%
Total ₹ 483,000.00 ₹ 387,000.00 100% 100%
VERTICAL ANALYSIS EXAMPLE
Sample Company
Balance Sheet (Assets)
At December 31, 1999 and 1998
% of Total Assets
1999 1998 1999 1998
Cash ₹ 82,000.00 ₹ 30,000.00 17% 8%
Accts. Rec. 120,000 100,000 25% 26%
Inventory 87,000 82,000 18% 21%
Land 101,000 90,000 21% 23%
82,000 ÷ 483,000
Equipment = 17% rounded
110,000 100,000 23% 26%
30,000
Accum. ÷ 387,000
Depr. = 8% rounded
(17,000) (15,000) -4% -4%
Total ₹ 483,000.00 ₹ 387,000.00 100% 100%
VERTICAL ANALYSIS EXAMPLE
Sample Company
Balance Sheet (Liabilities & Stockholders' Equity)
At December 31, 1999 and 1998
% of Total Assets
1999 1998 1999 1998
Acts. Payable ₹ 76,000.00 ₹ 60,000.00 16% 16%
Wages Payable 33,000 17,000 7% 4%
Notes Payable 50,000 50,000 10% 13%
76,000
Common Stock÷ 483,000 = 16% rounded
170,000 160,000 35% 41%
Retained Earnings 154,000 100,000 32% 26%
Total ₹ 483,000.00 ₹ 387,000.00 100% 100%
TREND PERCENTAGES

Show
Show changes
changes over
over time
time in
in
given
given financial
financial statement
statement items
items
(can
(can help
help evaluate
evaluate financial
financial
information
information of
of several
several years)
years)
TREND PERCENTAGES EXAMPLE
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a trend
analysis.
Wheeler, Inc.
Operating Data
1999 1998 1997 1996 1995
Revenues ₹ 2,405.00 ₹ 2,244.00 ₹ 2,112.00 ₹ 1,991.00 ₹ 1,820.00
Expenses 2,033 1,966 1,870 1,803 1,701
Net income ₹ 372.00 ₹ 278.00 ₹ 242.00 ₹ 188.00 ₹ 119.00
TREND PERCENTAGES EXAMPLE
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a trend
analysis.
Wheeler, Inc.
Operating Data
1999 1998 1997 1996 1995
Revenues ₹ 2,405.00 ₹ 2,244.00 ₹ 2,112.00 ₹ 1,991.00 ₹ 1,820.00
Expenses 2,033 1,966 1,870 1,803 1,701
Net income ₹ 372.00 ₹ 278.00 ₹ 242.00 ₹ 188.00 ₹ 119.00

1,991 - 1,820 = $171


TREND PERCENTAGES EXAMPLE
Using 1995 as the base year, we develop the
following percentage relationships.
Wheeler, Inc.
Operating Data
1999 1998 1997 1996 1995
Revenues 132% 123% 116% 109% 100%
Expenses 120% 116% 110% 106% 100%
Net income 313% 234% 203% 158% 100%

1,991 - 1,820 = 171


171 ÷ 1,820 = 9% rounded
Trend line
140 for Sales
130
% of 100 Base

120

110

100

90
1995 1996 1997 1998 1999
Sales
Years
Expenses
COMMON-SIZE STATEMENTS

Financial
Financial statements
statements that
that show
show
only
only percentages
percentages and
and nono
absolute
absolute Rupee
Rupee amounts
amounts