Vertical analysis is used to reveal patterns in data covering two or more successive periods.
Presentation on theme: "Analysis of Financial Statements"— Presentation transcript: 1 Analysis of Financial Statements Show
2 Basics of Analysis C 1 Reduces uncertainty Application of analytical tools Involves transforming data Financial
statement analysis helps users make better decisions. Financial statement analysis applies analytical tools to general-purpose financial statements and related data for making business decisions. It provides us an effective and systematic basis for making business decisions. These techniques help us to better understand the company and reduce uncertainty associated with financial information. Financial statement analysis is used by many people within the organization.
Managers find financial analysis helpful in planning and controlling operations. External users of financial statements are also interested in the results of comprehensive financial analysis. Shareholders, creditors, and customers all want to learn as much as possible about the financial health of a company. The goals include evaluating (1) past and current performance, (2) current financial position, and (3) future performance and risk. Internal Users Managers Officers
Internal Auditors External Users Shareholders Lenders Customers 3 Building Blocks of Analysis 4 Information for Analysis 5 Standards for Comparison
6 Tools of Analysis Horizontal Analysis Vertical Analysis Ratio Analysis
7 Horizontal Analysis P 1 Horizontal analysis refers to examination of financial statement data across time. The term horizontal analysis arises from the left-to-right (or right-to-left) movement of our eyes as we review comparative financial statements across time. Comparing amounts for two or more successive
periods often helps in analyzing financial statements. This comparison of the asset section of the Balance Sheet for Research in Motion’ illustrates horizontal analysis. 8 Comparative Statements 9 Comparative Statements
10 Horizontal Analysis $1,550,861 – $835,546 = $715,315
11 Horizontal Analysis $14,953,224 – $11,065,186 = $3,888,038
12 Analysis Period Amount 13 Research in
Motion Income Statement Information 14 Trend Analysis P 1 Some managers prefer to review trend information in chart
form. Using Excel is an easy way to develop charts from our data. Here is the chart of the trend percentages. We can use the trend percentages to construct a graph so we can see the trend over time. 15 Common-Size Statements 16 Common-Size Balance
Sheet 17 Common-Size Income
Statement 18 Common-Size Graphics P 2 19 Liquidity and efficiency 20 Liquidity and Efficiency
21 Working Capital P 3 Working capital represents current assets
financed from long-term capital sources that do not require near-term repayment. Current assets – Current liabilities = Working capital Working capital is defined as current assets minus current liabilities. It is a critical measure for all types of businesses. Positive working capital means the company will have enough assets converted into cash within the next year to pay its current obligations. More
working capital suggests a strong liquidity position and an ability to meet current obligations. 22 Current Ratio Current Assets Current Ratio = Current Liabilities 23 Acid-Test Ratio Cash + Short-term investments +
Current receivables 24 Accounts Receivable Turnover
25 (Beginning inventory + Ending inventory) 26 Days’ Sales Uncollected 27 Days’ Sales in
Inventory
28 (Beginning assets + Ending assets)
29 Pledged Assets to Secured Liabilities 30 Debt and Equity Ratios P 3 Amount Ratio Total
liabilities $ 8,000,000 66.7% [Debt ratio] Total equity 4,000,000 33.3% [Equity ratio] Total liabilities and equity $ 12,000,000 100.0% $8,000,000 ÷ $12,000,000 = 66.7% This debt ratio measures what portion of a company’s assets are contributed by creditors. A larger debt ratio implies less opportunity to expand through use of debt financing.
The debt ratio expresses total liabilities as a percent of total assets. The equity ratio provides complementary information by expressing total equity as a percent of total assets. The debt ratio expresses total liabilities as a percent of total assets. The equity ratio provides complementary information by expressing total equity as a percent of total assets.
31 Debt-to-equity ratio =
32 Times Interest Earned Income before interest and taxes 33 Return on Common Stockholders’ Equity
34 Profit Margin Profit margin = Net income Net sales
35 Return on Total Assets Return on total asset = Net income
36 Return on Common Stockholders’ Equity
37 Market Prospects Price-Earnings Ratio Dividend Yield P 3 38 Price-Earnings Ratio Price-earnings ratio = 39 Annual cash dividends per share 40 Horizontal and Vertical Analysis
41 Analysis Reporting Executive Summary Analysis Overview 42 Appendix 17A: Sustainable Income
43 End of Chapter 17 End of Chapter 17. What is a vertical analysis used for?Vertical analysis is an accounting tool that enables proportional analysis of documents, such as financial statements. While performing a vertical analysis, every line item on a financial statement is entered as a percentage of another item.
Is used to reveal patterns in data covering successive periods?Horizontal analysis is used to reveal patterns in data covering successive periods. A company with a high inventory turnover requires a smaller investment in inventory than one producing the same sales with a lower turnover.
What is vertical analysis also known as?Vertical analysis is also known as common size financial statement analysis. 3. For example, the vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales.
What is the difference between vertical and horizontal analysis?Horizontal analysis is performed horizontally across time periods, while vertical analysis is performed vertically inside of a column. Horizontal analysis represents changes over years or periods, while vertical analysis represents amounts as percentages of a base figure.
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