Financial accounting the impact on decision makers 9e chapter 13

Analysis of Comparative Statements:Horizontal Analysis  Comparison of financial statement items over a period of time LO 2... Example 13.3—Preparing and Reading Comparative Statements

Chapter 13

Financial Statement Analysis

Limitations and Considerations in

Financial Statement Analysis

 Watch for alternative accounting principles

 Selection of a inventory valuation method

 Changes in accounting method

 Take care when making comparisons

 Recognizing trends in ratios

 Extra caution for extraordinary items and gains and losses from discontinued operations

LO 1

Limitations and Considerations in Financial Statement Analysis (continued)

 Understand the possible effects of inflation

 Financial statements are based on historical costs and are not adjusted for the effects of increasing prices

Analysis of Comparative Statements:

Horizontal Analysis

 Comparison of financial statement items over a period

of time

LO 2

Example 13.1—Preparing and Reading Comparative Balance Sheets—Horizontal Analysis

Example 13.2—Preparing and Reading Comparative Statements of

Income and Retained Earnings—Horizontal Analysis

Example 13.3—Preparing and Reading Comparative Statements of Cash Flows—Horizontal Analysis

Analysis of Common-Size Statements:

Vertical Analysis

 Comparison of various financial statement

items within a single period with the use of

common-size statements

 Common-size statements recast items as a

percentage of a selected item

LO 3

Example 13.4—Preparing and Reading

Common-Size Balance Sheets—Vertical Analysis

Example 13.5—Preparing and Reading Common-Size Income Statements—Vertical Analysis

Liquidity Analysis

 A relative measure of the nearness to cash of the

assets and liabilities of a company

LO 4

Working Capital

 The excess of current assets over current liabilities at a point in time

Current Ratio

 The ratio of current assets to current liabilities

 One of the most widely used financial statement ratios

Acid-Test Ratio

 A stricter test of liquidity than the current ratio

 Excludes inventory and prepayments from the numerator

Cash Flow from Operations to Current

Liabilities

 A measure of the ability to pay current debts from

operating cash flows

Accounts Receivable Analysis

 Accounts receivable turnover ratio: a measure of the number of times accounts receivable are collected in a period

 Number of days’ sales in receivables: a measure of the average age of accounts receivable

Cash-to-Cash Operating Cycle

 The length of time from the purchase of inventory to the collection of any receivable from the sale

Solvency Analysis

 The ability of a company to remain in business over

the long term

 The ability of the firm to stay financially healthy over the period of time that existing debt (short- and

long-term) is outstanding

LO 5

Times Interest Earned Ratio

 Indicates the company’s ability to meet the current year’s interest payments out of the current year’s earnings

Debt Service Coverage Ratio

 Measure of the amount of cash that is generated from operating activities during the year and that is

available to repay interest due and any maturing

principal amounts

Cash Flow from Operations to Capital

Expenditures Ratio

 A measure of the ability of a company to finance term asset acquisitions with cash from operations

Rate of Return on Assets

 A measure of a company’s success in earning a return for all providers of capital

Components of Return on Assets

 Return on sales ratio: a variation of the profit margin ratio

 Measures earnings before payments to creditors

 Asset turnover ratio: the relationship between net sales and average total assets

Return on Common Stockholders’

Equity Ratio

 A measure of a company’s success in earning a return for the common stockholders

 The use of borrowed funds and amounts contributed

by preferred stockholders to earn an overall return higher than the cost of these funds

Earnings per Share

 A company’s bottom line stated on a per-share basis

Dividend Ratios

 Dividend payout ratio: the percentage of earnings paid out as dividends

 Dividend yield ratio: the relationship between

dividend and the market price of a company’s stock

Reporting and Analyzing Other Income

 Reported separately to call the reader’s attention to

their unique nature

LO 7

Extraordinary Items

 Reflect any gains or losses that arise from an event that is both unusual in nature and infrequent in

occurrence

End of Chapter 13