Prepared by Debby Bloom-Hill CMA, CFM. Slide 14-2 CHAPTER 14 Analyzing Financial Statements: A Managerial Perspective Analyzing Financial Statements:

Prepared by Debby Bloom-Hill CMA, CFM

Slide 14-2

CHAPTER 14CHAPTER 14

Analyzing Financial Statements:

A Managerial Perspective

Analyzing Financial Statements:

A Managerial Perspective

Learning objective 1: Explain why managers analyze financial statements

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Why Managers Analyze Financial Statements

Why Managers Analyze Financial Statements

Managers analyze financial statements for a variety of reasons including:1. To control operations2. To assess the financial stability of

vendors, customers, and other business partners

3. To assess how their companies appear to investors and creditors


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Control of OperationsControl of Operations

Managers analyze financial statements to gain insight into whether their goals have been achieved or plans implemented successfully Managers expect that a successful

implementation of their plans will be reflected in financial information If financial information is inconsistent with a successful implementation an investigation will be launched


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Assessment of Vendors, Customers, and Other Partners

Assessment of Vendors, Customers, and Other Partners Another important reason for

analyzing financial statements is to review the financial stability of vendors, customers, and other strategic partners Increasingly companies are

establishing strong relationships with a small number of vendors willing to commit to high quality levels and short lead times


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Assessment of Vendors, Customers, and Other Partners

Assessment of Vendors, Customers, and Other Partners Managers want to be confident that

the vendor will be stable and continue in existence over the foreseeable future Companies analyze customers to

assess whether they will be able to pay the amounts they owe

Companies do not want to enter into partnerships with firms in financial difficulty


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Assessment of Appearance to Investors and Creditors

Assessment of Appearance to Investors and Creditors

Investors and creditors carefully analyze a company’s financial statements Managers should anticipate how

their financial information will appear to stakeholders Managers can explain differences in the notes to the financial statements, or avoid transactions which cause differences


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Why do managers analyze financial statements?

a. To control operationsb. To assess vendors, customers and

other business partnersc. To assess appearance to investors

and creditorsd. All of the above

Answer: dAll of the above

Learning objective 2: Perform horizontal and vertical analyses of the balance sheet and the income statement

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Horizontal and Vertical Analyses


Horizontal analysis Analysis of the dollar value and

percentage changes in financial statement amounts across time The dollar value of the change is the new value minus the old value for each financial statement amount

The percentage change is the dollar value of the change divided by the old value for each financial statement amount


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Vertical analysis Also called common size analysis Analyze financial statement

amounts in comparison to a base amount Divide each financial statement amount by total assets for the balance sheet

Divide each financial statement amount by net sales for the income statement

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Analysis of the Balance SheetAnalysis of the Balance Sheet

The results of a partial horizontal analysis of the balance sheet are presented on the next slide What can we conclude?

HGW is expanding (increases in land, buildings, furniture and fixtures, and equipment)

Funded by debt and internally generated funds (retained earnings)


Horizontal Analysis of the Balance Sheet

Horizontal Analysis of the Balance Sheet


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Analysis of the Balance SheetAnalysis of the Balance Sheet

A vertical analysis of the balance sheet is presented on the next slide The primary asset accounts are

merchandise inventory, land, and buildings All account balances are greater than 20 percent of total assets


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Vertical Analysis of the Balance Sheet

Vertical Analysis of the Balance Sheet


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Analyzing the Income Statement

Analyzing the Income Statement

A horizontal and vertical analysis of the balance sheet is presented on the next two slides Both net sales and cost of goods

sold have increased from 2013 to 2014 Gross profit has increased 43%

The vertical analysis shows that net income has declined from 6.5% of sales to 5.6% of sales


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Horizontal AnalysisHorizontal Analysis


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Vertical AnalysisVertical Analysis


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Horizontal analysis evaluates:a. Comparable companiesb. Changes in expenses as a percentage

of salesc. Changes in expenses as a percent of

total assetsd. Changes in balances from one year to

another

Answer: dChanges in balances from one year to another


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Vertical analysis evaluates:a. Changes in net sales as a percentage

of total assetsb. Changes in expenses as a percentage

of salesc. Financial statement amounts in

comparison to a base amountd. Changes in balances from one year to

another

Answer: cFinancial statement amounts in comparison to a base amount


Learning objective 3: Discuss earnings management and the importance of comparing net income to cash flow from operations

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Earnings ManagementEarnings Management Accounting earnings can be

manipulated to make performance appear stronger than it actually is Allegations of impropriety have

been leveled against many companies, including: Enron Kroger Lucent, and Waste Management


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Earnings ManagementEarnings Management Why do managers manipulate

earnings? Managers often are evaluated and

rewarded based on the level of firm earnings If earnings are below the

specified bonus level, managers have an inventive to manipulate earnings

Managers manipulate earnings to raise the stock price and profit from exercising stock options


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Earnings ManagementEarnings Management

A red flag suggesting that accounting irregularities may be a problem is a difference between net income and operating cash flows If a firm records fictitious sales

income will increase but operating cash flows will not be affected The company does not collect cash

from fictitious sales


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Cash Flow versus EarningsCash Flow versus Earnings

Learning objective 4: Understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial performance

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Other Sources of Information on Financial Performance


A number of other information sources can be used to gain insight into a company’s financial performance Management discussion and

analysis Contained in the annual report Management provides users with explanations for financial results that are not obvious from reading the basic financial statements


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A number of other information sources can be used to gain insight into a company’s financial performance Credit reports

A number of firms sell credit reports that provide information on a company’s credit history

The ratings help managers evaluate the likelihood that a company they do business with will pay its bills on time


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A number of other information sources can be used to gain insight into a company’s financial performance News articles are another very

valuable source of financial information Lexis-Nexis is an example of a company that, for a fee, provides access to articles from major newspapers, magazines, and newswire services

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Management Discussion & Analysis (MD&A) ExampleManagement Discussion & Analysis (MD&A) Example


Learning objective 5: Calculate and interpret profitability ratios

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Ratio AnalysisRatio Analysis

Managers frequently perform financial analyses using various ratios To control operations To assess the stability of vendors,

customers, and other business partners

To assess how their companies appear to investors and creditors


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Ratio AnalysisRatio Analysis

Ratios are grouped into 3 categories1. Profitability ratios examine the

firm’s ability to generate income2. Turnover ratios reveal the

efficiency with which a company uses its assets

3. Debt related ratios relate the amount of debt a company has and its ability to repay its obligations

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Profitability RatiosProfitability Ratios


Earnings per share Amount of earnings generated per

share of common stock The more earnings per share a

company can generate, the higher its stock price

Price-earnings ratio Indicates how much investors are

willing to pay per dollar of earnings

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Profitability RatiosProfitability Ratios


Gross margin percentage Indicates how much a company earns

per dollar of sales, taking into account the cost of the items it sells

Return on total assets Indicates how profitable a company is

in relation to its assets Return on common stockholders’

equity The return a company is able to earn

on funds invested by shareholders

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Profitability Ratio FormulasProfitability Ratio Formulas


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Turnover RatiosTurnover Ratios

Learning objective 6: Calculate and interpret turnover ratios

Asset turnover Shows how efficiently assets are

used to generate sales Accounts receivable turnover

The more times accounts receivable turn over, the sooner they are collected

Days’ sales in receivables A measure of how long it will take

to collect receivables

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Turnover RatiosTurnover Ratios


Inventory turnover Indicates how many times inventory

turns over Generally, the higher the ratio, the

more efficient the management of inventory levels

Days’ sales in inventory A measure of how long it will take

to sell inventory

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Turnover Ratio FormulasTurnover Ratio Formulas


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The efficient use of assets is indicated by:

a. Turnover ratiosb. Debt-related ratiosc. The ratio of debt to equityd. The ratio of current assets to

current liabilities

Answer: aTurnover ratios


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Debt-Related RatiosDebt-Related Ratios

Learning objective 7: Calculate and interpret debt-related ratios

Current ratio A measure of a company’s ability to

pay short term obligations Acid test ratio (quick ratio)

Compared to the current ratio, a more stringent test of a company’s ability to pay short term obligations

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Debt to equity ratio A measure of the relative amount of

debt versus equity in a firm’s capital structure. Firms with relatively high values may have too much debt

Times interest earned A measure of a company’s ability to

make interest payments on its debt

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Too Much DebtToo Much Debt


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The ratio times interest earned can be used to evaluate:

a. The amount of debt versus equity financing

b. The extent to which interest income exceeds interest expense

c. The extent to which interest expense exceeds interest income

d. The likelihood that a company will be able to make required interest payments

Answer: dThe likelihood that a company will be able to make required interest payments


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Strategic PartnersStrategic Partners


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Prepared by Debby Bloom-Hill CMA, CFM. Slide 14-2 CHAPTER 14 Analyzing Financial Statements: A Managerial Perspective Analyzing Financial Statements: