Analysis of Financial Statements

Chapter 13

Wild and Shaw

Financial and Managerial Accounting
8th Edition
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Chapter 13 Learning Objectives
CONCEPTUAL
C1 Explain the purpose and identify the building blocks of analysis. List & explain what they measure
C2 Describe standards for comparisons in analysis. List & explain source

ANALYTICAL
A1 Summarize and report results of analysis. Be able to calculate
A2 Appendix 13A Explain the form and assess the content of a complete income statement. Limited

PROCEDURAL
P1 Explain and apply methods of horizontal analysis.
P2 Describe and apply methods of vertical analysis.
P3 Define and apply ratio analysis.
You do not need to know formula
You do need to know what they measure

© McGraw-Hill Education  2
 Analysis of Financial Statements
• What is it?
• Purpose?
– Internal Users
– External Users
– Other Users
• Tools of Analysis
– Horizontal Analysis,
– Vertical Analysis
– Financial Ratio Analysis [Building Blocks (4 categories of
ratios)]
• New Terms
– Working Capital
– Working Capital Ratio
3
 Learning Objective C1

Explain the purpose and

identify the building blocks of
analysis.

© McGraw-Hill Education  4
 Purpose of Analysis
17 - 5

Apply analytical tools to transform data into useable information to reduce

uncertainty and therefore make better decisions.

Common goal of financial statement analysis for

both external and internal users is evaluate
company performance and financial condition
and to assist in evaluating:
1. Past and current performance
2. Current financial position
3. Future performance and risk
Internal Users External Users
Managers Shareholders
Officers Lenders
Internal Auditors Suppliers
© McGraw-Hill Education  5
Learning Objective C1: Explain the purpose and identify the building blocks of analysis.
 Building Blocks of Analysis 17 - 6

Raw Materials Turnover

Ability to meet
short-term 7 ratios & 1 definition 4 ratios Ability to
obligations generate future
and to revenues and
Liquidity
efficiently meet long-term
and Solvency
generate obligations
efficiency
revenues

Ability to 5 ratios & 1 definition 2 ratios Ability to

provide generate
financial positive
rewards Market market
Profitability
sufficient to prospects expectations
attract and
retain
Book Value per common share
financing
Know the definitions associated with the titles of the 4 blocks

http://www.accountingtools.com/articles-summary-metrics/
C1 6
Learning Objective C1: Explain the purpose and identify the building blocks of analysis. © McGraw-Hill Education 
 17 - 7

Information for Analysis

1. Income Statement
2. Balance Sheet
3. Statement of
Stockholders’ Equity
4. Statement of Cash Flows
5. Notes to the Financial
Statements
Financial reporting refers to the communication of financial information useful for making investment, credit, and other
business decisions. Financial reporting includes not only general-purpose financial statements but also information from
SEC 10-K or other filings, press releases, shareholders’ meetings, forecasts, management letters, auditors’ reports, and
webcasts.

© McGraw-Hill Education  7
Learning Objective C1: Explain the purpose and identify the building blocks of analysis.
Learning Objective C2

Describe standards for

comparisons in analysis.

© McGraw-Hill Education  8
 17 - 9

Standards for Comparison

When we interpret our analysis, it is essential
to compare the results we obtained to other
standards or benchmarks.

• Intracompany Good

• Competitors Best

• Industry Good

• Guidelines OK

© McGraw-Hill Education  9
Learning Objective C2: Describe standards for comparisons in analysis.
 17 - 10

Tools of Analysis
Horizontal Analysis
Comparing the financial condition and
performance across time.

Vertical Analysis
Comparing the financial condition and
performance to a base amount.

Ratio Analysis
Measurement of key relations between financial
statement items.
© McGraw-Hill Education 10
Learning Objective C2: Describe standards for comparisons in analysis.
 Learning Objective P1

Explain and apply methods of

horizontal analysis.

© McGraw-Hill Education 11
 17 - 12

Horizontal Analysis
Horizontal analysis refers to examination of
financial statement data across time.
Horizontal analysis is the review
of financial statement data
across time.

© McGraw-Hill Education 12
Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 13

Comparative Statements:
Dollar Change
Dollar Analysis period Base period
change = amount – amount

• When measuring the amount of the change in

dollar amounts, compare the analysis period to the
base period.
• The analysis period refers to the financial
statements under analysis.
• The base period refers to the financial statements
used for comparison.

© McGraw-Hill Education 13
Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 14

Comparative Statements:
Percent Change
Analysis
Analysis period
period amount
amount –– Base
Base period
period amount
amount
%
%
change
=
Base
Base period
period amount
amount
× 100
100
change

When calculating the change as a percentage,

divide the amount of the dollar change by the base
period amount, and then multiply by 100 to convert
to a percentage.

© McGraw-Hill Education 14
Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 15

Comparative Balance Sheets

Exhibit
13.1

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Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 16

Comparative Income Statements

Exhibit
13.2

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Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 17

Trend Analysis
Trend analysis is used to reveal patterns in data
across periods.

Trend
Analysis period amount
Percent =
Base period amount × 100
(%)

© McGraw-Hill Education 17
Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 18

Trend Analysis (continued)

Exhibit
13.3

Using the number reported 4 years ago as the base

year, we will get the following trend percentages:

Exhibit
13.4

© McGraw-Hill Education 18
Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 19

Line Graph of Trend Percents

Exhibit
13.5

We can use the trend percentages to construct a

graph so we can see the trend over time.

© McGraw-Hill Education 19
Learning Objective P1: Explain and apply methods of horizontal analysis.
 17 - 20
In Class Exercise
Compute trend percents for the following accounts, using 20X1 as the base year (round percents to whole
numbers). State whether the situation as revealed by the trends appears to be favorable or unfavorable for
each account.

($ in millions) 20X4 20X3 20X2 20X1

Sales $500 $350 $250 $200
Cost of goods sold 400 175 100 50

Sales trend percents 250% 175% 125% 100%

$500/$200 $350/$200 $250/$200 $200/$200

Cost of goods sold trend percents 800% 350% 200% 100%

$400/$50 $175/$50 $100/$50 $50/$50

Dollar Trends Trend Percentages

© McGraw-Hill Education  20
Learning Objective P1: Explain and apply methods of horizontal analysis. Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objective P2

Describe and apply methods of

vertical analysis.

© McGraw-Hill Education 21
 17 - 22

Vertical Analysis
Common-Size Statements

Common-size Analysis amount

Percent (%)
= Base amount × 100

Financial Statement Base Amount

Balance Sheet Total Assets
Income Statement Revenues

© McGraw-Hill Education 22
Learning Objective P2: Describe and apply methods of vertical analysis.
 17 - 23

Common-Size Balance Sheet

Exhibit
13.8

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Learning Objective P2: Describe and apply methods of vertical analysis.
 17 - 24

Common-Size Income Statement

Exhibit
13.9

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Learning Objective P2: Describe and apply methods of vertical analysis.
 17 - 25

Common-Size Graphics Exhibit

Common-Size Graphic of 13.12
Exhibit
Asset Components
13.10

Common-Size Graphic of
Income Statement

© McGraw-Hill Education 25
Learning Objective P2: Describe and apply methods of vertical analysis.
 17 - 26
NEED-TO-KNOW 13-2
Express the following comparative income statements in common-size percents and assess whether or not
this company’s situation has improved in the most recent year (round percents to whole numbers).
($ in millions) 20X2 20X1
Sales $800 $500
Total expenses 560 400
Net income $240 $100

Common-size percents Each item is expressed as a % of current year’s sales

Sales 100% 100%
($800/$800) ($500/$500)
Total expenses 70% 80%
($560/$800) ($400/$500)
Net income 30% 20%
($240/$800) ($100/$500)

© McGraw-Hill Education  26
Learning Objective P2: Describe and apply methods of vertical analysis. Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objective P3

Working Capital plus

Define and apply ratio analysis.

© McGraw-Hill Education 27
 Working Capital
17 - 28

Working capital is a measure of both a company's operational efficiency

and its short-term financial health. The working capital ratio (current
assets/current liabilities), or current ratio, indicates whether a
company has enough short-term assets to cover its short-term debt..

Working capital is the amount of current assets minus current

liabilities. Working Capital Ratio is Current Assets divided by
Current Liabilities
  Current assets
– Current liabilities
= Working capital

More working capital suggests a strong

liquidity position and an ability to pay debts
or continue operating.
© McGraw-Hill Education 28
Learning Objective P3: Define and apply ratio analysis.
 17 - 29

STOP

© McGraw-Hill Education 29
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 17 - 30

Learning Objective P3

Define and apply ratio analysis.

© McGraw-Hill Education 30
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Building Blocks of Analysis 17 - 31

Raw Materials Turnover

Ability to meet
short-term 7 ratios & 1 definition 4 ratios Ability to
obligations generate future
and to revenues and
Liquidity
efficiently meet long-term
and Solvency
generate obligations
efficiency
revenues

Ability to 5 ratios & 1 definition 2 ratios Ability to

provide generate
financial positive
rewards Market market
Profitability
sufficient to prospects expectations
attract and
retain
Book Value per common share
financing
Know the definitions associated with the titles of the 4 blocks

http://www.accountingtools.com/articles-summary-metrics/
C1 31
Learning Objective C1: Explain the purpose and identify the building blocks of analysis. © McGraw-Hill Education 
 17 - 32

Liquidity and Efficiency

Current Inventory
Ratio Turnover

Acid-test Days’ Sales

Ratio Uncollected

Accounts Days’ Sales

Receivable in Inventory
Turnover

Total Asset
Turnover
© McGraw-Hill Education 32
Learning Objective P3: Define and apply ratio analysis.
 17 - 33

Current Ratio
(AKA Working Capital Ratio)
Current assets
Current ratio =
Current liabilities

• This ratio measures the short-term debt-

paying ability of the company.
• A higher current ratio suggests a strong
ability to meet current obligations.

© McGraw-Hill Education 33
Learning Objective P3: Define and apply ratio analysis.
 17 - 34

Acid-Test Ratio
Cash + Short-term investments +
Acid-test ratio = Current receivables
Current liabilities
Referred
Referred to
to as
as Quick
Quick Assets
Assets

This ratio is like the current ratio but excludes current assets
such as inventories and prepaid expenses that may be
difficult to quickly convert into cash.

© McGraw-Hill Education 34
Learning Objective P3: Define and apply ratio analysis.
 17 - 35

Accounts Receivable Turnover

Net sales
Accounts receivable =
turnover Average accounts receivable,
net
(Beg Accts. Rec. + End Accts. Rec.)
Average accounts receivable =
2

This ratio measures how

many times a company
converts its receivables
into cash.
© McGraw-Hill Education 35
Learning Objective P3: Define and apply ratio analysis.
 17 - 36

Inventory Turnover
Cost of goods sold
Inventory turnover =
Average inventory

Average inventory = (Beginning inventory + Ending inventory)

2

This ratio measures the how

long a company holds
inventory before selling it.

© McGraw-Hill Education 36
Learning Objective P3: Define and apply ratio analysis.
 17 - 37

Days’ Sales Uncollected

Accounts receivable, net
Day's sales =
× 365
uncollected
Net sales

This ratio measures how frequently a

company collects its accounts receivable.

© McGraw-Hill Education 37
Learning Objective P3: Define and apply ratio analysis.
 17 - 38

Days’ Sales in Inventory

Day's sales in = Ending inventory

× 365
Inventory
Cost of goods sold
This ratio is a useful measure in evaluating
inventory liquidity.
Used to evaluate inventory liquidity.

© McGraw-Hill Education 38
Learning Objective P3: Define and apply ratio analysis.
 17 - 39

Total Asset Turnover

Net sales
Total asset turnover =
Average total assets

(Beginning assets + Ending assets)

Average assets =
2

• This ratio measures a

company’s ability to use its
assets to generate sales.
• It is an important indication of
operating efficiency.

© McGraw-Hill Education 39
Learning Objective P3: Define and apply ratio analysis.
 17 - 40

Solvency
Debt
Ratio

Equity
Ratio

Debt-to-Equity
Ratio

Times
Interest
Earned
© McGraw-Hill Education 40
Learning Objective P3: Define and apply ratio analysis.
 17 - 41

Debt Ratio and Equity Ratio

$241,272
$241,272 ÷÷ $375,319
$375,319 == 64.3%
64.3%

• The debt ratio shows total liabilities as a percent of total

assets.
• The equity ratio shows total equity as a percent of total
assets.

© McGraw-Hill Education 41
Learning Objective P3: Define and apply ratio analysis.
 17 - 42

Debt-to-Equity Ratio
Total liabilities  
Debt-to-equity ratio =
Total equity  

This ratio measures what portion of a company’s

assets are contributed by creditors. A larger debt-to-
equity ratio implies less opportunity to expand
through use of debt financing.

© McGraw-Hill Education 42
Learning Objective P3: Define and apply ratio analysis.
 17 - 43

Times Interest Earned

Income before interest and
Times interest earned taxes  
=
Interest expense  
  Net income
+ Interest expense
+ Income taxes
= Income before interest and taxes
   

This is the most common measures a

company’s ability to pay interest.

© McGraw-Hill Education 43
Learning Objective P3: Define and apply ratio analysis.
 17 - 44

Profitability
Profit Gross Margin Return on
Margin Ratio Total Assets

Return on Book Value per Basic Earnings

Common Common Share per Share
Stockholders’
Equity

© McGraw-Hill Education 44
Learning Objective P3: Define and apply ratio analysis.
 17 - 45

Profit Margin
(AKA Profit Margin Ratio)
Net income  
Profit margin =
Net sales  

This ratio measures a company’s ability to

earn net income from each sales dollar.

© McGraw-Hill Education 45
Learning Objective P3: Define and apply ratio analysis.
 17 - 46

Gross Margin Ratio

Net Sales-CGS  
Gross Margin Ratio =
Net sales  

Gross $64,304
= = 37.62%
margin $170,910

This ratio measures the amount

remaining from $1 in sales that is left to
cover operating expenses and a profit
after considering cost of sales.
P3
46
 17 - 47

Return on Total Assets

Return on total asset = Net income  

Average total
assets  

Return on total assets measures how well

assets are utilized by the company and its
management.

© McGraw-Hill Education 47
Learning Objective P3: Define and apply ratio analysis.
 17 - 48

Return on Common
Stockholders’ Equity
Net income − Preferred dividends  
Return on common stockholders'
Average common stockholders'
equity =
equity  

This measure indicates how the company’s

ability to earn income for common
stockholders.

© McGraw-Hill Education 48
Learning Objective P3: Define and apply ratio analysis.
 17 - 49

Book Value per Common Share

Shareholders’ Equity applicable to
Common Shares  
Book Value per Common Share =
Number of common shares
ourstanding  

A measure used by owners of common

shares in a firm to determine the level of
safety associated with each individual
share after all debts are paid accordingly

P3
49
 17 - 50

Basic Earnings per Share

Net income - Preferred dividends  
Basic Earnings per Share= Weighted-Average common
shares outstanding  

This measure indicates how much

income was earned for each share of
common stock outstanding.

P3
50
 17 - 51

Market Prospects
Price-Earnings Dividend
Ratio Yield

© McGraw-Hill Education 51
Learning Objective P3: Define and apply ratio analysis.
 17 - 52

Price-Earnings Ratio
Market price per common share  
Price-earnings ratio =
Earnings per share  

This ratio measures market expectations for

future growth. It is often used by investors as a
general guideline in gauging stock values

© McGraw-Hill Education 52
Learning Objective P3: Define and apply ratio analysis.
 17 - 53

Dividend Yield
Annual cash dividends per share  
Dividend yield =
Market price per share  

This ratio is used to compare the dividend-

paying performance of different companies.

This ratio identifies the return, in terms of cash

dividends, on the current market price per share
of the company’s common stock.

© McGraw-Hill Education 53
Learning Objective P3: Define and apply ratio analysis.
 17 - 54

Summary of Ratios Exhibit

13.16

54
Learning Objective P3: Define and apply ratio analysis. © McGraw-Hill Education 
 17 - 55
Exercise
For each ratio listed, identify whether the change in ratio value from 20X1 to 20X2 is regarded as favorable or
unfavorable.

20X2 20X1 Change

1. Profit margin ratio 6% 8% Unfavorable Lower % of net income in each sales dollar
2. Debt ratio 50% 70% Favorable Fewer assets are claimed by creditors
3. Gross margin ratio 40% 36% Favorable Higher % of gross margin in each sales dollar
4. Accounts receivable turnover 8.8 9.4 Unfavorable Less efficiency in collection
5. Basic earnings per share $2.10 $2.00 Favorable Higher net income per common share
6. Inventory turnover 3.6 4.0 Unfavorable Less efficient inventory management

Profit Margin Ratio = Net Income/Net Sales

Debt Ratio = Total Liabilities/Total Assets

Gross Margin Ratio = (Net Sales – Cost of Goods Sold)/Net Sales

Accounts Receivable Turnover = Net Sales/Average Accounts Receivable (net)

Basic Earnings Per Share = (Net Income – Preferred Dividends)/Number of common shares outstanding

Inventory Turnover = Cost of Goods Sold/Average Inventory

© McGraw-Hill Education  55
Learning Objective P3: Define and apply ratio analysis.. Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objective A1

Summarize and report results

of analysis.

© McGraw-Hill Education 56
 17 - 57

Analysis Reporting

1. Executive Summary
2. Analysis Overview
3. Evidential Matter
4. Assumptions
5. Key Factors
6. Inferences

© McGraw-Hill Education 57
Learning Objective A1: Summarize and report results of analysis.
 Learning Objective A2

Appendix 13-A
Explain the form and assess
the content of a complete
income statement.

© McGraw-Hill Education 58
 17 - 59

Sustainable Income
Earnings per
Changes in share
Accounting Principles (by Continuing and
Discontinued operations)

Discontinued
Segments

Continuing
Operations Net Income
© McGraw-Hill Education 59
Learning Objective A2: Explain the form and assess the content of a complete income statement.
 17 - 60

Income Statement All-inclusive

Exhibit
13A.1

© McGraw-Hill Education 60
Learning Objective A2: Explain the form and assess the content of a complete income statement.
 17 - 61
Chapter Rap-up
First section of an income statement is continuing operations and includes revenues, expenses and
income from continuing operations. Often viewed as the most important.

Business segment is part of a company’s operations that serves a particular line of business or class
of customer. Segments have assets, liabilities and results of operations. Reporting of discontinued
segments includes income or loss from operating the discontinued segment net of tax and gain or loss
from disposal of the segment's net assets net of tax. Gain or loss is reported separately. Income tax
effects are reported separately.

Flexibility of practice when applied to managerial accounting means that the design of a company's
managerial accounting system largely depends on the nature of the business and the arrangement of
the internal operations of the company.

The financial statement analysis section that includes information on the background on a company,
its industry, and its economic setting is the analysis overview.

When considering an investment in stock and you wish to assess the firm's short-term debt-paying
ability use the current ratio.

Managerial Accounting is an activity that provides financial and non-financial information to an

organization's managers and other internal decision makers.

61
 17 - 62
Chapter Rap-up
Financial reporting refers to the communication of relevant financial information to
decision makers.

Intracompany standards for financial statement analysis are often based on a

company's prior performance.

Industry standards for financial statement analysis are set by the financial
performance and condition of the company's industry.

General standards of comparisons (rules-of-thumb) are developed from past

experience.

Comparative financial statements in which each amount is expressed as a

percentage of a base amount and in which the base amount is expressed as 100%
are called common size comparative statements.

Common-size statements reveal changes in the relative magnitude of each financial

statement item.

62
 17 - 63
Chapter Rap-up
Financial statements with data for two or more successive accounting periods placed
in columns side by side, sometimes with changes shown in dollar amounts and
percentages, are referred to as comparative statements.

Don’t forget that when calculating a percent, some number is divided by another and
multiplied by 100.

A company's sales in 2013 were $250,000 and in 2014 were $287,500. Using 2013
as the base year, the sales trend percent for 2014 is 115%.

Application of the “building blocks,” involves determining the objective of the

analysis.

63
 17 - 64

STOP

© McGraw-Hill Education 64
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 17 - 65

Chapter 13 In class exercises

© McGraw-Hill Education  65
 17 - 66

In Class Exercises
1. What ratio measures the short-term debt-paying ability of the company. A
higher ratio suggests a strong liquidity position.
Current Ratio

2. What ratio is like the current ratio but excludes current assets such as
inventories and prepaid expenses that may be difficult to quickly convert into
cash.
Acid-test Ratio

3. What ratio measures how many times a company converts its receivables into
cash each year.
Accounts Receivable Turnover

4. What ratio measure indicates how well the company employed the
stockholders’ equity to earn net income.
Return on common Stockholders’ Equity

66
 17 - 67

In Class Exercises
5. What ratio measure indicates how much income was earned for
each share of common stock outstanding.
Basic Earnings per Share

6. What measure is often used by investors as a general guideline

in gauging stock values. Generally, the higher this ratio is, the more
opportunity a company has for growth.
Price Earnings Ratio
A corporation reports the following year-end balance sheet data.
             
Cash $ 60,000  Current liabilities $ 94,000 
Accounts receivable   74,000  Long-term liabilities   22,000 
  119,00 
Inventory   79,000 Common stock  
0
164,00  142,00 
Equipment   Retained earnings  
0 0
377,00  377,00 
Total assets $ Total liabilities and equity $
0 0

What is the acid test ratio? 1.43

67
 17 - 68
In class exercises

A company's sales in Year 1 were $20,000 and in Year 2 were $57,500. Using Year 1
as the base year, the percent change for Year 2 compared to the base year is:
187.5%; {[($57,500-$20,000)/$20,000] x 100}

Birch Company reported sales of $30,000 for Year 1, $50,000 for Year 2, and
$63,000 for Year 3. Using Year 1 as the base year, what is the revenue trend percent
for Years 2 and 3?
Year 2: 167% ($50,000 / 30,000 x 100)
Year 2: 210% ($63,000 / 30,000 x 100)

A corporation reports the following year-end balance sheet data. The company's
working capital equals:
Cash $ 53,000  Current liabilities $ 88,000 
Accounts receivable   68,000  Long-term liabilities   48,000 
     
Inventory   73,000 Common stock   113,000
Equipment   158,000  Retained earnings   103,000 
Total assets $ 352,000  Total liabilities and equity $ 352,000 

$106,000 [($53,000+$68,000+$73000) – $88,000

68
 17 - 69
In class exercises

External users of financial information:

a. Are those individuals involved in managing and operating the company.
b. Include internal auditors and consultants.
c. Are not directly involved in operating the company. Correct
d. Make strategic decisions for a company.
e. Make operating decisions for a company.

Internal users of financial information:

a. Are not directly involved in operating a company.
b. Are those individuals involved in managing and operating the company. Correct
c. Include shareholders and lenders.
d. Include directors and customers.
e. Include suppliers, regulators and the press.

Financial reporting refers to:

a. The application of analytical tools to general-purpose financial statements.
b. The communication of relevant financial information to decision makers. Correct
c. Financial statements only.
d. Ratio analysis.
e. Profitability.
69
 17 - 70
In class exercises

The ability to meet short-term obligations and to generate revenues using the least
amount of resources is called:
a. Liquidity and efficiency. Correct
b. Solvency.
c. Profitability.
d. Market prospects.
e. Creditworthiness.

The ability to generate future revenues and meet long-term obligations is referred to
as:
a. Liquidity and efficiency.
b. Solvency. Correct
c. Profitability.
d. Market prospects.
e. Creditworthiness.

The ability to provide financial rewards sufficient to attract and retain financing is
called:
a. Liquidity and efficiency.
b. Solvency.
c. Profitability. Correct
d. Market prospects.
e. Creditworthiness. 70
 17 - 71
In class exercises

The ability to generate positive market expectations is called:

a. Liquidity and efficiency.
b. Liquidity and solvency.
c. Profitability.
d. Market prospects. Correct
e. Creditworthiness.

Intracompany standards for financial statement analysis:

a. Are often based on a company's prior performance. Correct
b. Are often set by competitors.
c. Are set by the company's industry.
d. Are based on rules of thumb.
e. Are published in Dun and Bradstreet.

Industry standards for financial statement analysis:

a. Are based on a company's prior performance.
b. Are set by the government.
c. Are set by the financial performance and condition of the company's industry. Correct
d. Are based on rules of thumb.
e. Compare a company's income with the prior year's income.

71
 17 - 72
In class exercises

General standards of comparisons (rules-of-thumb) are developed from:

a. Industry statistics from the government.
b. Past experience. Correct
c. Analysis of competitors.
d. Relations between financial items.
e. Dun and Bradstreet.

The comparison of a company's financial condition and performance across time

is known as:
a. Horizontal analysis. Correct
b. Vertical analysis.
c. Political analysis.
d. Financial reporting.
e. Investment analysis.

The measurement of key relations among financial statement items is known as:
a. Financial reporting.
b. Horizontal analysis.
c. Investment analysis.
d. Ratio analysis. Correct
e. Risk analysis.
72
 17 - 73
In class exercises

The dollar change for a financial statement item is calculated by:

a. Subtracting the analysis period amount from the base period amount.
b. Subtracting the base period amount from the analysis period amount. Correct
c. Subtracting the analysis period amount from the base period amount, dividing the result by
the base period amount, then multiplying that amount by 100.
d. Subtracting the base period amount from the analysis period amount, dividing the result by
the base period amount, then multiplying that amount by 100.
e. Subtracting the base period amount from the analysis amount, then dividing the result by the
base amount

The percent of change for a financial statement item is calculated by:

a. Subtracting the analysis period amount from the base period amount.
b. Subtracting the base period amount from the analysis period amount.
c. Subtracting the analysis period amount from the base period amount, dividing the result by
the base period amount, then multiplying that amount by 100.
d. Subtracting the base period amount from the analysis period amount, dividing the result by
the base period amount, then multiplying that amount by 100. Correct
e. Subtracting the base period amount from the analysis amount, then dividing the result by the
base amount

73
 17 - 74

1. Examination of financial data across time is know as ....

 
Horizontal or Trend Analysis
 
 2. A statement where each general ledger amount is expressed as a percent of a base amount (either
Total Assets or Revenues) is know as....
 
Vertical or Common-size Analysis
 
 3. The ratio that describes a company’s ability to earn net income from each sales dollar is known as
the __________ ratio.
 
Profit Margin
 
 4. The measure that is often used by investors as a general guideline in gauging stock values is known
as the ______________ ratio. Generally, the higher the ratio, the more opportunity a company has for
growth.
 
Price Earnings
 
 5. The ratio that identifies the return, in terms of cash dividends, on the current market price per share
of the company’s common stock is known as the _________________ ratio.
 
Dividend Yield
 
 6. The ratio that measures the amount remaining from $1 in sales that is left to cover operating
expenses and a profit after considering cost of sales is known as the _______________ ratio.
 
Gross Margin
74
 In-Class Exercises
17 - 75

Selected comparative financial statements of Astalon Company follow:

Required
1. Express the Income Statement data in Common-Size and Trend statements.
2. Express the Balance Sheet Data in Common-Size and Trend Statements with 2008
as the base year.
 In-Class Exercises
17 - 76

Required
1. Express the Income Statement data in Common-Size and Trend statements.

(Common Size) Astalon Company

Comparative Income Statements
FYE December 31, 2010, 2009, 2008
Common- Common- Common-
2010 Size 2009 Size 2008 Size
Sales 526,304 100.00% 403,192 100.00% 279,800 100.00%
Cost of Sales 316,835 60.20% 255,624 63.40% 179,072 64.00%
Gross Profit 209,469 39.80% 147,568 36.60% 100,728 36.00%
Selling Expense 74,735 14.20% 55,640 13.80% 36,934 13.20%
Administrative Expense 47,367 9.00% 35,481 8.80% 23,223 8.30%
Total Expenses 122,102 23.20% 91,121 22.60% 60,157 21.50%
Income before Taxes 87,367 16.60% 56,447 14.00% 40,571 14.50%
Income Taxes 16,250 3.09% 11,572 2.87% 8,236 2.94%
Net Income 71,117 13.51% 44,875 11.13% 32,335 11.56%
 In-Class Exercises
17 - 77

Required
1. Express the Income Statement data in Common-Size and Trend statements.

(Trend)

Astalon Company
Comparative Income Statements
FYE December 31, 2010, 2009, 2008
TREND TREND
2010 2010 2009 2009 2008 Trend
Sales 526,304 188.10% 403,192 144.10% 279,800 100.00%
Cost of Sales 316,835 176.93% 255,624 142.75% 179,072 100.00%
Gross Profit 209,469 207.96% 147,568 146.50% 100,728 100.00%
Selling Expense 74,735 202.35% 55,640 150.65% 36,934 100.00%
Administrative Expense 47,367 203.97% 35,481 152.78% 23,223 100.00%
Total Expenses 122,102 202.97% 91,121 151.47% 60,157 100.00%
Income before Taxes 87,367 215.34% 56,447 139.13% 40,571 100.00%
Income Taxes 16,250 197.30% 11,572 140.51% 8,236 100.00%
Net Income 71,117 219.94% 44,875 138.78% 32,335 100.00%
 In-Class Exercises
17 - 78

Selected comparative financial statements of Astalon Company follow:

Required
1. Express the Income Statement data in Common-Size and Trend statements.
2. Express the Balance Sheet Data in Common-Size and Trend Statements with 2008
as the base year.
 In-Class Exercises
17 - 79

Required
2. Express the Balance Sheet Data in Common-Size and Trend Statements with 2008
as the base year.
(Common Size)
Astalon Company
Comparative Balance Sheets
December 31, 2010, 2009, 2008
Common- Common- Common-
2010 Size 2009 Size 2008 Size
Assets
Current Assets 48,242 34.30% 38,514 28.20% 51,484 45.50%
Long-term Investments - 0.00% 800 0.59% 3,620 3.20%
Plant Assets, Net 92,405 65.70% 97,259 71.21% 58,047 51.30%
Total Assets 140,647 100.00% 136,573 100.00% 113,151 100.00%

Liabilities & Equity

Current Liabilities 20,534 14.60% 20,349 14.90% 19,801 17.50%
Common Stock 69,000 49.06% 69,000 50.52% 51,000 45.07%
Other Paid-in Capital 8,625 6.13% 8,625 6.32% 5,667 5.01%
Retained Earnings 42,488 30.21% 38,599 28.26% 36,683 32.42%
Total Liabilities & Equity 140,647 100.00% 136,573 100.00% 113,151 100.00%
 In-Class Exercises
17 - 80

Required
2. Express the Balance Sheet Data in Common-Size and Trend Statements with 2008
as the base year.
(Trend)
Astalon Company
Comparative Balance Sheets
December 31, 2010, 2009, 2008
Trend Trend Trend
2010 2010 2009 2009 2008 2008
Assets
Current Assets 48,242 93.70% 38,514 74.81% 51,484 100.00%
Long-term Investments - 0.00% 800 22.10% 3,620 100.00%
Plant Assets, Net 92,405 159.19% 97,259 167.55% 58,047 100.00%
Total Assets 140,647 124.30% 136,573 120.70% 113,151 100.00%

Liabilities & Equity

Current Liabilities 20,534 103.70% 20,349 102.77% 19,801 100.00%
Common Stock 69,000 135.29% 69,000 135.29% 51,000 100.00%
Other Paid-in Capital 8,625 152.20% 8,625 152.20% 5,667 100.00%
Retained Earnings 42,488 115.82% 38,599 105.22% 36,683 100.00%
Total Liabilities & Equity 140,647 124.30% 136,573 120.70% 113,151 100.00%
 17 - 81

End of Chapter 13

© McGraw-Hill Education 81
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Informational needs
FCF = Free Cash Flows

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STOP

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