Review Analyzing Financial Statements3 methods to analyze financial

statements

1. Comparative Analysis

2. Common-Size Analysis

3. Trend Analysis

1. Comparative Analysis Comparing financial statements for 2

consecutive years (increase/ decrease)

Percentage Change = Difference/ Base Year *100

Refer to Exercise #1 page 266 (t), page 187 (w) (took up as a class on Friday)

2. Common-Size Analysis Financial Statements are based on a

common percentage

Income statement: Revenue represents 100%, all other accounts will be compared to this figure and analyzed

Balance Sheet: Total Assets represent 100%, the % of each asset will be compared to Total Assets %. Total Liabilities & Owner’s Equity will represent 100% and liability and owner’s equity figures will be compared to Total Liabilities & Owner’s Equity

Common-size Example Example: Exercise #5 page 268 (t), page 190 (w)

Company A Company B

Revenue

Sales $197 000 100 % $421 000 100 %

Expenses

Automotive Expense $ 40 200 20.4% $ 80 270 19.1%

Bank Interest Expense 3 500 1.8% 27 050 6.4%

Rent Expense 12 000 6.1% 30 000 7.1%

Wages Expense 86 750 44.0% 214 860 51.0%

Other Expenses 1 800 0.91% 10 900 2.6%

Total Expenses $144 250 73.2% $363 080 86.2%

Net Income $ 52 750 26.8% $ 57 920 13.8%

3. Trend Analysis Shows financial data (as figures and

percentages) over a number of consecutive periods

Exercise #2 page 267 (t), page 188 (w)

Year 1 Year 2 Year3 Year 4 Year 5

Sales $20 700

$22 356

$23 184 $23 805

$24 219

Percent of Year 1

100 % 108 % 112 % 115 % 117 %

Increase in Percentage

8 %

Trend Analysis ExampleExample: Exercise #3, page 267

(t), 188 (w)

Year 1

%* Year 2

%* Year 3

%* Year 4

%* Year 5

%*

Sales $57 000

100%

$58 254

102.2

$58 767

103.1

$59 223

103.9

$59 451

104.3

Expenses $35 000

100%

$36 050

103%

$36 575

104.5

$36 785

105.1

$37 520

107.2

Net Income

$22 000

100%

$22 204

100.9

$22 192

100.9

$22 438

102 $21 931

99.7

*% of first year

Key Ratio & Percentage AnalysisNovember 07, 2011

Now that we have worked with percentage changes in comparative, common-size, and trend analysis, let’s apply these changes as ratios and percentages that will help to interpret the financial statements of a business

DefineSolvency:

◦A company’s ability to pay its debt

Liquidity:◦How quickly assets can be converted

into cash

Ratios divided into 2 groupsA. Liquidity or solvency ratios:

◦ Used to decide how easily a company can pay its debts

B. Profitability ratios:◦ Used to evaluate a company’s

ability to ear profit

Ratio Formula Purpose of Ratio

Current Ratio or Working Capital Ratio

Ex. 1.5:1

Current Assets Current Liabilities

to calculate a company’s ability to pay current debtfor ever $1 of CL, CA has $1.50 to pay off

Debit Ratio

40% Total Liabilities

Total Assets

How much of total assets are financed by borrowed money?

Equity Ratio 60% Total Owner’s

Equity Total Assets

How much of total assets are financed by owner’s investment?

Rate of Return on Sales Net Income

Revenue (Sales)

For every $1 sold, how much profit is made OR% remaining after expenses deducted

Rate of Return on Owner’s Equity (Beginning + Ending

Capital)2

Net IncomeAverage O.E

Shows how well company performs using owner’s investment (return for owner investment)

* 100

*100

* 100

* 100

Saturn Sales CompanyRatio Formula/ Calculations Comment

Current Ratio CA = 65 370 = 1.52:1CL 42 970

Good, for ever $1 of debit, Saturn has $1.52 to pay = .52cents of working capital

Debit Ratio Total L *100 = 108 670 *100Total A 309 370 = 35 %

Very good, only 35% of assets are financed by borrowed money

Equity ratio Total OE*100 = 200 700 *100Total A 309 370 = 65 %

65% financed by owner’s investment

Return on Sales Net Income*100 = 30 805 *100Sales 343 342 = 8.97 %

Fair; for every $1 sold, Saturn earned 9% profit

Return on Owner’s Equity

Net Income*100 Average OE = 30 805*100(100 000 +200700/2) = 20.49%

Very Good, for ever $1 investment earned 20 cents return on investment.

Ratio Exercises to be markedCalculate the five ratios for

Exercise 1 page 618-619 (t) & 5 page 621-623 (t) on a blank sheet of paper

Be sure to include the formula, numbers used to calculate the ratio, and a brief explanation of whether the ratio calculation is poor, fair, good, or very good

Hand-in when completed

When Done complete the following:Complete exercises from Friday

(back of Friday’s Handout)Exercise 3a&b, 4a,b,c, and 6a&b

p. 277-279 (t), p. 194-198 (w)Exercise 1,2,3,4 p. 296-299 (t), p.

213-215 (w)Review questions #1-5 p. 266 (t),

p.186 (w), #8-13 p. 275(t), p.192 (w), #1-14 p. 282 (t), p.198 (w)