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KE1013 Chapter Seven 1
Chapter Seven
FINANCIAL
STATEMENT
ANALYSIS
KE1013 Chapter Seven 2
Outline
• Users of financial statement
• The importance of financial statement analysis
• Types of analysis:– Percentage Analysis:
• Vertical
• Horizontal
– Ratio Analysis• Liquidity
• Profitability
• Efficiency
• Solvency
KE1013 Chapter Seven 3
Users of financial statement
• Managers
• Investors / Shareholders
• Potential Investors
• Creditors
• Regulatory Agencies
• Inland Revenue
• Consumers
KE1013 Chapter Seven 4
The importance of financial statement analysis
• Helps interested users in making economic decisions:– Provide the trend of the business for a certain
period of time.– Provide comparability among companies in the
same industry.
• Helps in forecasting the business’s future performance
KE1013 Chapter Seven 5
Financial Analysis: Comparison Basis
1 intracompany basis
2 industry averages
Year 1 Year 2
Company XYZ
Co. A
Co. B
Co. D Co. E
Co. C
Co. ABC Co. XYZ
3 intercompany basis
KE1013 Chapter Seven 6
Types of analysis
FinancialStatementAnalysis
Percentage Ratio
Horizontal Analysis
Vertical Analysis
Liquidity Ratio
Profitability Ratio
Efficiency Ratio
Solvency Ratio
KE1013 Chapter Seven 7
Horizontal analysis
Also known as trend analysis.
Evaluates a series of financial statement data
over a period of time.
Purpose: to determine the increase or decrease that has taken place This change may be expressed as either an amount or a percentage.
KE1013 Chapter Seven 8
Horizontal analysis
Evaluates:Income Statement
Balance Sheet
Formula: Current Year Amount – Base Year AmountBase Year Amount
KE1013 Chapter Seven 9
Selamat CompanyComparative Balance Sheet As At Dec. 31, 2001 and 2002
Fixed Asset:Office Equipment (net) 55,000 63,000Current Asset:Cash 7,000 9,700Accounts Receivable 10,000 18,000
Current LiabilitiesCurrent Liabilities:Accounts Payable 9,000 7,000
2001 2002 Inc. (Dec) Amount %
63,000 83,700
Owner’s Equity 63,000 83,700
63,000 83,700
8,000 14.5
2,700 38.68,000 80.0
(2,000) (22.2)
20,700 32.9
20,700 32.9
20,700 32.9
KE1013 Chapter Seven 10
Selamat CompanyComparative Income Statement For the Years
Ended Dec. 31, 2001 and 2002
2001 2002 Inc. (Dec) Amount %
Net Sales 99,000 115,000
Cost of Goods Sold 44,500 57,700
Gross Profit 54,500 57,300
Selling Expenses 16,800 15,000
Admin Expenses 12,000 20,900
Net Income 25,700 21,400
16,000 16.2
13,200 29.7
2,800 5.1
(1,800) (10.7)
8,900 74.2
(4,300) (16.7)
KE1013 Chapter Seven 11
Vertical Analysis
Evaluates financial statement data expressing
each item in a financial statement as a percent
of a base amount.
Vertical analysis enables you to compare companies of different sizes.
KE1013 Chapter Seven 12
Selamat CompanyComparative Balance Sheet As At Dec. 31, 2001 and 2002
Fixed Asset:Office Equipment (net) 55,000 63,000Current Asset:Cash 7,000 9,700Accounts Receivable 10,000 18,000
Current LiabilitiesCurrent Liabilities:Accounts Payable 9,000 7,000
63,000 83,700
Owner’s Equity 33,000 38,700
63,000 83,700
2001 2002
Amt % Amt %
Long Term Liabilities 30,000 45,000
100
87.3
11.115.9
14.3
100
100
100
47.652.4
75.3
11.621.5
8.4
53.846.2
KE1013 Chapter Seven 13
Selamat CompanyComparative Income Statement For the Years
Ended Dec. 31, 2001 and 2002
2001 2002
Amt % Amt %Net Sales 99,000 115,000
Cost of Goods Sold 44,500 57,700
Gross Profit 54,500 57,300
Selling Expenses 16,800 15,000
Admin Expenses 12,000 20,900
Net Income 25,700 21,400
100 100
45.0
55.0
17.0
12.0
26.0
50.2
49.8
13.0
18.2
18.6
KE1013 Chapter Seven 14
Ratio Analysis
Expresses the relationship among selected items
of financial statement data.
Classifications:
Liquidity Ratios
Profitability Ratios
Efficiency Ratios
Solvency Ratios
KE1013 Chapter Seven 15
Liquidity Ratios
Measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.
The ratios are:
Current Ratio / Working capital ratio
Acid test ratio / quick ratio
KE1013 Chapter Seven 16
Liquidity Ratio – Current ratio / Working capital ratio
measure for evaluating a company’s liquidity and short-term debt-paying ability.
Current ratio = Current Assets
Current Liabilities
KE1013 Chapter Seven 17
Eg:
Current Assets 20,500 26,700
Current Liabilities 17,200 29,600
2001 2002
Current ratio = 20,500
17,200
26,700
29,600
= 1.19 : 1 = 0.90 : 1
KE1013 Chapter Seven 18
Liquidity Ratio – Acid Test Ratio / Quick Ratio
is a measure of a company’s short-term liquidity.
Acid test ratio = Quick Assets
Current Liabilities
Quick asset includes cash, marketable securities and accounts receivable.
KE1013 Chapter Seven 19
Eg:
Current Assets
Current Liabilities 17,200 29,600
2001 2002
Acid test ratio = 17,700
17,200
20,700
29,600
= 1.03 : 1 = 0.70 : 1
Cash 7,900 8,700
Accounts Receivable 9,800 12,000
Inventories 2,800 6,000
20,500 26,700
KE1013 Chapter Seven 20
Profitability Ratios
Measures of the income or operating success of a company for a given period of time.
The ratios are:
Profit margin
Gross profit margin
Return on Assets
Return on Equity
Return on Common Equity
Earnings Per Share
Price - Earnings ratio
KE1013 Chapter Seven 21
Profitability Ratio – Profit Margin
is a measure of the percentage of each dollar of sales that results in net income.
Profit margin = Net income
Net sales
KE1013 Chapter Seven 22
Eg:
Net Sales 45,000 52,700
Less: Cost of Goods Sold 20,200 23,600
2001 2002
Profit margin = 10,600
45,000
14,500
52,700
= 23.56% = 27.51%
24,800 29,100
Less: Operating Expenses 14,200 14,600
Net income 10,600 14,500
KE1013 Chapter Seven 23
Profitability Ratio – Gross Profit Margin
is a measure of the percentage of each dollar of sales that results in gross profit.
Gross profit margin = Gross Profit
Net Sales
KE1013 Chapter Seven 24
Eg:
Net Sales 45,000 52,700
Less: Cost of Goods Sold 20,200 23,600
2001 2002
Gross profit margin = 24,800
45,000
29,100
52,700
= 55.11% = 55.22%
Gross Profit 24,800 29,100
Less: Operating Expenses 14,200 14,600
Net income 10,600 14,500
KE1013 Chapter Seven 25
Profitability Ratio – Return on Assets
To assess the ability of the company in using its assets to earn net income without consideration in the financing of such assets.
Return on assets = Net income + Interest expense
Average total assets
Average total assets = Total assets year 1 + total assets year 2
2
KE1013 Chapter Seven 26
Eg: 2001 2002
Return on Assets =
= 15.89%
Net income 10,600 14,500
Interest Expense 910 760
Total Assets (2000 = 69,900) 75,000 82,000
10,600 + 910
(69,900 + 75,000 ) / 2
14,500 + 760
(75,000 + 82,000 ) / 2
= 19.44%
KE1013 Chapter Seven 27
Profitability Ratio – Return on Equity
To assess the ability of the company in managing the investments by shareholders to earn income.
Return on equity = Net income
Average total stockholders’ equity
Average total stockholders’ equity
= Total equity year 1 + total equity year 2
2
KE1013 Chapter Seven 28
Eg: 2001 2002
Return on Equity ( year 2002 ) =
Net income 10,600 14,500
Total Equities:
14,500
(100,000 + 106,000 ) / 2
= 14.08%
Common Shares 80,000 86,000
Preference Shares 20,000 20,000
100,000 106,000
KE1013 Chapter Seven 29
Profitability Ratio – Return on Common Equity
To assess the ability of the company in managing the investments by common shareholders to earn its net income.
Return on commonequity
=Net income
Average common stockholders’ equity
Average common stockholders’ equity =
Common equity year 1 + common equity year 2
2
KE1013 Chapter Seven 30
Eg: 2001 2002
Return on Common Equity ( year 2002 )
Net income 10,600 14,500
Total Equities:
14,500
(80,000 + 86,000 ) / 2
= 17.47%
Common Shares 80,000 86,000
Preference Shares 20,000 20,000
100,000 106,000
=
KE1013 Chapter Seven 31
Profitability Ratio – Earnings Per Share
a measure of net income earned on each share of common stock.
Earnings Per Share/ EPS
Net income
average common shares outstanding (unit)=
KE1013 Chapter Seven 32
Eg: 2001 2002
Earnings per share ( year 2002 )
Net income 10,600 14,500
Total Equities:
14,500
(80,000 + 86,000 ) / 2
= RM0.17 per share
Common Shares(RM1.00 per share) 80,000 86,000
=
KE1013 Chapter Seven 33
Profitability Ratio – Price Earnings Ratio
Measures the ratio of the market price of each share of common stock to the earnings per share.
Price Earnings Ratio/ PE Ratio =
Market price of common stock
Earnings Per Share
KE1013 Chapter Seven 34
Eg:2001 2002
Average market price forcommon stock
RM3.25 RM4.62
Earnings Per Share RM0.11 RM0.17
Price Earnings Ratio/ PE Ratio
=RM3.25 RM4.62
RM0.11 RM0.17
= 30 times = 27 times
KE1013 Chapter Seven 35
Efficiency Ratios
Measures of the efficiency and the ability of the company in managing its resources.
The ratios are:
Inventory Turnover
Asset Turnover
Debtors Turnover / Receivable Turnover
KE1013 Chapter Seven 36
Efficiency Ratio – Inventory Turnover
measures the number of times, on average, the inventory is sold during the period .
Purpose: to measure the liquidity of the inventory.
InventoryTurnover
=Cost of goods sold
Average inventory
Average inventory =Opening inventory + closing inventory
2
KE1013 Chapter Seven 37
Eg:2001 2002
=
Cost of goods sold 20,200 23,600
Inventories 2,800 6,000
Inventory turnover (2002)23,600
( 2,800 + 6,000 ) / 2
= 5.4 times
KE1013 Chapter Seven 38
Efficiency Ratio – Assets Turnover
measures how efficiently a company uses its assets to generate sales.
Assets turnover =Net sales
Average total assets
Average assets =Total assets year 1 + total assets year 2
2
KE1013 Chapter Seven 39
Eg:2001 2002
=Assets turnover (2002)52,700
( 75,000 + 82,000 ) / 2
= 0.67 times
Net Sales 45,000 52,700
Total Assets 75,000 82,000
KE1013 Chapter Seven 40
Efficiency Ratio – Receivables Turnover
Used to assess the liquidity of the receivables.
It measures the number of times, on average, receivables are collected during the period.
Receivables turnover =Net credit sales
Average net receivables
Average net receivables
=A. R year 1 + A. R year 2
2
KE1013 Chapter Seven 41
Eg:2001 2002
=Receivables turnover (2002)
45,700
( 9,800 + 12,000 ) / 2
= 4.2 times
Net Credit Sales 35,000 45,700
Accounts Receivable 9,800 12,000
KE1013 Chapter Seven 42
Solvency Ratios
Measures of the ability of the company to survive over a long period of time.
The ratios are:
Debt ratio
Equity ratio
Times Interest Earned
KE1013 Chapter Seven 43
Solvency Ratio – Debt Ratio
measures the percentage of total assets provided by creditors.
Debt ratio =Total liabilities
Total assets
KE1013 Chapter Seven 44
Eg:2001 2002
Total assets 75,000 82,000
Total liabilities 39,000 52,000
Debt ratio =39,000
75,000
= 52 %
52,000
82,000
= 63 %
KE1013 Chapter Seven 45
Solvency Ratio – Equity Ratio
measures the percentage of total assets provided by shareholders.
Equity ratio =
Total owner’s equity
Total assets
KE1013 Chapter Seven 46
Eg:2001 2002
Total assets 75,000 82,000
Equity ratio =69,000
75,000
= 92 %
69,000
82,000
= 84 %
Total equities 69,000 69,000
KE1013 Chapter Seven 47
Solvency Ratio – Times Interest Earned
provides an indication of the company’s ability to meet interest payments as they come due.
Times interest earned = Income before tax and interest expense
Interest expense
KE1013 Chapter Seven 48
Eg:2001 2002
Income before tax and interest 10,600 14,500
= 11.65 times
Interest Expense 910 760
Times interest earned =10,600
910
14,500
760
= 19.1 times
KE1013 Chapter Seven 49