COM670 Chapter 5
COM670 Chapter 5
COM670 Chapter 5
Chapter 5, Slide #1
Ratio Analysis
Liquidity (Ch.6)
Measures a firms ability to meet its current obligations
Profitability (Ch. 8)
Measures the earning ability of a firm
Investor-focused (Ch. 9)
Chapter 5, Slide #2
Ratio Analysis
Interpreted in comparison with
Prior ratios Competitor ratios Industry ratios Predetermined standards
Chapter 5, Slide #3
Investors
Analysis of past and present information to project the future prospects of the entity
Creditors
Short-term: focus is on current resources Long-term: consider the future prospects of the firm
Chapter 5, Slide #4
Eliminate cyclical or seasonal variations Capture changes that occur unevenly throughout the year
Chapter 5, Slide #5
Common-Size Analysis
The use of percentages is usually preferable to the use of absolute amounts Vertical analysis
All amounts of a year expressed as a percentage of a base amount (e.g., net sales revenue, total assets)
Horizontal analysis
Amounts for comparative years are expressed as a percentage of the base year amount
Chapter 5, Slide #6
Vertical Analysis
Melcher Company Income Statement For the Years Ended December 31 2007 2006 Sales revenue Cost of goods sold Gross profit Operating expenses: Selling expense General expense Total operating expense Operating Income before taxes Taxes related to operations Net Income $ $ 100,000 65,000 35,000 14,000 16,000 30,000 5,000 1,500 3,500 100.0% 65.0% 35.0% 14.0% 16.0% 30.0% 5.0% 1.5% 3.5% $ 95,000 60,800 34,200 11,400 15,200 26,600 7,600 2,280 $ 5,320 100.0% 64.0% 36.0% 12.0% 16.0% 28.0% 8.0% 2.4% 5.6% 2005 $91,000 56,420 34,580 10,000 13,650 23,650 10,930 3,279 $ 7,651 100.0% 62.0% 38.0% 11.0% 15.0% 26.0% 12.0% 3.6% 8.4%
Horizontal Analysis
Melcher Company Income Statement For the Years Ended December 31 2007 2006 2005 Sales revenue Cost of goods sold Gross profit Operating expenses: Selling expense General expense Total operating expense Operating Income before taxes Taxes related to operations Net Income $ $ 100,000 65,000 35,000 14,000 16,000 30,000 5,000 1,500 3,500 $ 95,000 60,800 34,200 11,400 15,200 26,600 7,600 2,280 $ 5,320 $ 91,000 56,420 34,580 10,000 13,650 23,650 10,930 3,279 $ 7,651 2007 109.9% 115.2% 101.2% 140.0% 117.2% 126.8% 45.7% 45.7% 45.7% 2006 104.4% 107.8% 98.9% 114.0% 111.4% 112.5% 69.5% 69.5% 69.5% 2005 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Each financial statement element is presented as a percentage of a base amount from a selected year.
Chapter 5, Slide #8
Chapter 5, Slide #9
Industry Variations
Financial components vary by type of industry Merchandising (retail-wholesale)
Inventory is a principal asset Sales may be primarily for cash or on credit
Service
Inventory is low or nonexistent
Manufacturing
Large inventory holdings Substantial investment in plant assets
Descriptive Information
Narrative data
Annual report Trade periodicals Industry reviews
Further explains the financial position of a firm Management Discussion & Analysis
Comparisons
Provides context for analysis of ratios and financial data Common types
Trend analysis SIC: Standard Industrial Classification NAICS: North American Industry Classification System Industry averages; competitor comparisons
Highlight
Effective management Evidence of problems
129,000
103,000 0
26,000 10,000
25.2% N/M
8,130
(1,400)
9,530
N/M
2011
Cash
2010
$ 6,330 19,330
Increase/(D ecrease)
$ 620 (763)
Percent Change
9.8% (3.9%)
$ 6,950
Sales
Rent Expense Net Income (Loss)
129,000
10,000 8,130
103,000
0 (1,400)
26,000
10,000 9,530
25.2%
N/M N/M
Classifies business by industry Defines industries in accordance with the composition and structure of the economy Coding structure
Division Major group Industry group Industry
Comparisons: Industry
Industry comparison complicated by highly diversified companies Financial services
Base their analysis on industry placement Provide composite industry data
Comparisons: Caution
Ratios are subject to variance from: Differing data Inconsistent formula construction Optional (elective) accounting treatment Different fiscal year-ends Varying financial policies Inconsistent basis (before or after tax)
Chapter 5, Slide #17
Information to use?
Absolute: amplifies comparison difficulty as firm size differences increase Common-size: eliminates some of the difficulty, but comparisons are still subject to issues above
Chapter 5, Slide #18
Reference
Gibson, C.H. (2009). Financial Reporting & Analysis: Using Financial Accounting Information. 11th ed. Norwalk, Connecticut: South-Western Cengage Learning.