Managerial accounting 5th jiambalvo ch14

Learning objective 2: Perform horizontal and vertical analyses of the balance sheet and the income statement Slide 14-9 Horizontal and Vertical Analyses Horizontal and Vertical Analyse

Prepared by

Debby Bloom-Hill CMA, CFM

Learning objective 1: Explain why managers

analyze financial statements Slide 14-3

Why Managers Analyze Financial Statements

Why Managers Analyze Financial Statements

 Managers analyze financial

statements for a variety of reasons

including:

1 To control operations

2 To assess the financial stability of

vendors, customers, and other business partners

3 To assess how their companies

appear to investors and creditors

Learning objective 1: Explain why managers

analyze financial statements Slide 14-4

Control of Operations

 Managers analyze financial

statements to gain insight into

whether their goals have been

achieved or plans implemented

successfully

 Managers expect that a successful

implementation of their plans will be reflected in financial information

 If financial information is inconsistent with a successful implementation an investigation will

be launched

Learning objective 1: Explain why managers

analyze financial statements Slide 14-5

Assessment of Vendors, Customers, and Other Partners

Assessment of Vendors, Customers, and Other Partners

 Another important reason for

analyzing financial statements is to review the financial stability of

vendors, customers, and other

strategic partners

 Increasingly companies are

establishing strong relationships with a small number of vendors willing to commit to high quality levels and short lead times

Learning objective 1: Explain why managers

analyze financial statements Slide 14-6

Assessment of Vendors, Customers, and Other Partners

Assessment of Vendors, Customers, and Other Partners

 Managers want to be confident that the vendor will be stable and

continue in existence over the

foreseeable future

 Companies analyze customers to

assess whether they will be able to pay the amounts they owe

 Companies do not want to enter into partnerships with firms in financial difficulty

Learning objective 1: Explain why managers

analyze financial statements Slide 14-7

Assessment of Appearance to

Investors and Creditors

Assessment of Appearance to

Investors and Creditors

 Investors and creditors carefully

analyze a company’s financial

statements

 Managers should anticipate how

their financial information will appear to stakeholders

 Managers can explain differences in the notes to the financial

statements, or avoid transactions which cause differences

Learning objective 1: Explain why managers

analyze financial statements Slide 14-8

Why do managers analyze financial

statements?

a To control operations

b To assess vendors, customers and

other business partners

c To assess appearance to investors

and creditors

d All of the above

Answer: d

All of the above

Test Your Knowledge 1

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement Slide 14-9

Horizontal and Vertical

Analyses

Horizontal and Vertical

Analyses

 Horizontal analysis

 Analysis of the dollar value and

percentage changes in financial statement amounts across time

 The dollar value of the change is the new value minus the old value for each financial statement

amount

 The percentage change is the dollar value of the change divided by the old value for each financial

statement amount

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement Slide 14-10

Horizontal and Vertical

Analyses

Horizontal and Vertical

Analyses

 Vertical analysis

 Also called common size analysis

 Analyze financial statement

amounts in comparison to a base amount

 Divide each financial statement amount by total assets for the balance sheet

 Divide each financial statement amount by net sales for the income statement

Slide 14-11

Analysis of the Balance Sheet

 The results of a partial horizontal

analysis of the balance sheet are

presented on the next slide

 What can we conclude?

 HGW is expanding (increases in land, buildings, furniture and fixtures, and equipment)

 Funded by debt and internally generated funds (retained

earnings)

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Horizontal Analysis of the

Balance Sheet

Horizontal Analysis of the

Balance Sheet

Learning objective 2: Perform horizontal and

vertical analyses of the balance sheet and the income statement

Slide 14-12

Analysis of the Balance Sheet

 A vertical analysis of the balance

sheet is presented on the next

slide

 The primary asset accounts are

merchandise inventory, land, and

buildings

 All account balances are greater than 20 percent of total assets

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

 A horizontal and vertical analysis

of the balance sheet is presented

on the next two slides

 Both net sales and cost of goods

sold have increased from 2013 to 2014

 Gross profit has increased 43%

 The vertical analysis shows that net income has declined from 6.5% of sales to 5.6% of sales

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Slide 14-16

Horizontal Analysis

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Slide 14-17

Vertical Analysis

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Test Your Knowledge 2

Slide 14-19

Vertical analysis evaluates:

a Changes in net sales as a percentage

of total assets

b Changes in expenses as a percentage

of sales

c Financial statement amounts in

comparison to a base amount

d Changes in balances from one year to

another

Answer: c

Financial statement amounts in

comparison to a base amount

Learning objective 2: Perform horizontal and vertical analyses of the

balance sheet and the income statement

Test Your Knowledge 3

Learning objective 3: Discuss earnings management and the importance of

comparing net income to cash flow from operations Slide 14-20

Earnings Management

 Accounting earnings can be

manipulated to make performance

appear stronger than it actually is

 Allegations of impropriety have

been leveled against many companies, including:

 Enron

 Kroger

 Lucent, and

 Waste Management

Learning objective 3: Discuss earnings management and the importance of

comparing net income to cash flow from operations Slide 14-21

Earnings Management

 Why do managers manipulate

earnings?

 Managers often are evaluated and

rewarded based on the level of firm earnings

 If earnings are below the specified bonus level, managers have an inventive to manipulate earnings

 Managers manipulate earnings to

raise the stock price and profit from exercising stock options

Learning objective 3: Discuss earnings management and the importance of

comparing net income to cash flow from operations Slide 14-22

Earnings Management

 A red flag suggesting that

accounting irregularities may be a

problem is a difference between

net income and operating cash

flows

 If a firm records fictitious sales

income will increase but operating cash flows will not be affected

 The company does not collect cash from fictitious sales

Learning objective 3: Discuss earnings management and the importance of

comparing net income to cash flow from operations Slide 14-23

Cash Flow versus Earnings

Learning objective 4: Understand how MD&A, credit reports, and news articles can be used to gain

insight into a company’s current and future financial performance Slide 14-24

Other Sources of Information

on Financial Performance

Other Sources of Information

on Financial Performance

 A number of other information

sources can be used to gain insight into a company’s financial

performance

 Management discussion and

analysis

 Contained in the annual report

 Management provides users with explanations for financial results that are not obvious from reading the basic financial statements

Learning objective 4: Understand how MD&A, credit reports, and news articles can be used to gain

insight into a company’s current and future financial performance Slide 14-25

Other Sources of Information

on Financial Performance

Other Sources of Information

on Financial Performance

 A number of other information

sources can be used to gain insight into a company’s financial

performance

 Credit reports

 A number of firms sell credit reports that provide information on a

company’s credit history

 The ratings help managers evaluate the likelihood that a company they do

business with will pay its bills on time

Learning objective 4: Understand how MD&A, credit reports, and news articles can be used to gain

insight into a company’s current and future financial performance Slide 14-26

Other Sources of Information

on Financial Performance

Other Sources of Information

on Financial Performance

 A number of other information

sources can be used to gain insight into a company’s financial

performance

 News articles are another very

valuable source of financial information

 Lexis-Nexis is an example of a company that, for a fee, provides access to articles from major

newspapers, magazines, and newswire services

Slide 14-27

Management Discussion &

Analysis (MD&A) Example

Management Discussion &

Analysis (MD&A) Example

Learning objective 4: Understand how MD&A, credit reports, and news articles can be used to gain

insight into a company’s current and future financial performance

Learning objective 5: Calculate and

interpret profitability ratios Slide 14-28

Ratio Analysis

 Managers frequently perform

financial analyses using various

ratios

 To control operations

 To assess the stability of vendors,

customers, and other business partners

 To assess how their companies

appear to investors and creditors

Learning objective 5: Calculate and

interpret profitability ratios Slide 14-29

Ratio Analysis

 Ratios are grouped into 3

categories

1 Profitability ratios examine the

firm’s ability to generate income

2 Turnover ratios reveal the

efficiency with which a company uses its assets

3 Debt related ratios relate the

amount of debt a company has and its ability to repay its obligations

Slide 14-30

Profitability Ratios

Learning objective 5: Calculate and

interpret profitability ratios

 Earnings per share

 Amount of earnings generated per

share of common stock

 The more earnings per share a

company can generate, the higher its stock price

 Price-earnings ratio

 Indicates how much investors are

willing to pay per dollar of earnings

Slide 14-31

Profitability Ratios

Learning objective 5: Calculate and

interpret profitability ratios

 Gross margin percentage

 Indicates how much a company earns per dollar of sales, taking into account the cost of the items it sells

 Return on total assets

 Indicates how profitable a company is

in relation to its assets

 Return on common stockholders’

equity

 The return a company is able to earn

on funds invested by shareholders

Slide 14-32

Profitability Ratio Formulas

Learning objective 5: Calculate and

interpret profitability ratios

  

Slide 14-33

Profitability Ratio Formulas

Learning objective 5: Calculate and

interpret profitability ratios

  

Slide 14-34

Profitability Ratio Formulas

Learning objective 5: Calculate and

interpret profitability ratios

Slide 14-35

Profitability Ratio Formulas

Learning objective 5: Calculate and

interpret profitability ratios

Slide 14-36

Turnover Ratios

Learning objective 6: Calculate and

interpret turnover ratios

 Asset turnover

 Shows how efficiently assets are

used to generate sales

 Accounts receivable turnover

 The more times accounts receivable turn over, the sooner they are

collected

 Days’ sales in receivables

 A measure of how long it will take

to collect receivables

Slide 14-37

Turnover Ratios

Learning objective 6: Calculate and

interpret turnover ratios

 Days’ sales in inventory

 A measure of how long it will take

to sell inventory

Slide 14-38

Turnover Ratio Formulas

Learning objective 6: Calculate and

interpret turnover ratios

  

Slide 14-39

Turnover Ratio Formulas

Learning objective 6: Calculate and

interpret turnover ratios

  

Slide 14-40

Turnover Ratio Formulas

Learning objective 6: Calculate and

interpret turnover ratios

c The ratio of debt to equity

d The ratio of current assets to

current liabilities

Answer: a

Turnover ratios

Test Your Knowledge 4

Learning objective 6: Calculate and

interpret turnover ratios

Slide 14-42

Debt-Related Ratios

Learning objective 7: Calculate and

interpret debt-related ratios

 Current ratio

 A measure of a company’s ability to pay short term obligations

 Acid test ratio (quick ratio)

 Compared to the current ratio, a

more stringent test of a company’s ability to pay short term obligations

Slide 14-43

Debt-Related Ratios

Learning objective 7: Calculate and

interpret debt-related ratios

 Debt to equity ratio

 A measure of the relative amount of debt versus equity in a firm’s capital structure

 Firms with relatively high values may have too much debt

 Times interest earned

 A measure of a company’s ability to make interest payments on its debt

Slide 14-44

Debt-Related Ratios

Learning objective 7: Calculate and

interpret debt-related ratios

  

Slide 14-45

Debt-Related Ratios

Learning objective 7: Calculate and

interpret debt-related ratios

Slide 14-46

Too Much Debt

Learning objective 7: Calculate and

interpret debt-related ratios

b The extent to which interest income

exceeds interest expense

c The extent to which interest expense

exceeds interest income

d The likelihood that a company will be

able to make required interest payments

Answer: d

The likelihood that a company will be able to make required interest payments

Test Your Knowledge 5

Learning objective 7: Calculate and

interpret debt-related ratios

Slide 14-48

Strategic Partners

Learning objective 7: Calculate and

interpret debt-related ratios

Slide 14-49

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