Managerial accounting 6e jams jambalvo chapter 14

CHAPTER
CHAPTER 14
14

Analyzing Financial Statements:
A Managerial Perspective

Slide 14-2


Why
Why Managers
Managers Analyze
Analyze Financial
Financial Statements
Statements



Managers analyze financial statements for a variety of reasons
including:

1.
2.

To control operations
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 and perform horizontal
Slide 14-3

and vertical analyses of the balance sheet and the income statement.


Control
Control of
of Operations
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 and perform horizontal
Slide 14-4

and vertical analyses of the balance sheet and the income statement.


Assessment
Assessment of
of Vendors,
Vendors, Customers,
Customers, and
and Other
Other Partners
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 and perform horizontal
Slide 14-5

and vertical analyses of the balance sheet and the income statement.


Assessment

Assessment of
of Vendors,
Vendors, Customers,
Customers, and
and Other
Other Partners
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 and perform horizontal
Slide 14-6

and vertical analyses of the balance sheet and the income statement.


Assessment

Assessment of
of Appearance
Appearance to
to Investors
Investors and
and Creditors
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 and perform horizontal
Slide 14-7

and vertical analyses of the balance sheet and the income statement.


Test Your Knowledge 1

Why do managers analyze financial statements?

a.
b.
c.
d.

To control operations
To assess vendors, customers and other business partners
To assess appearance to investors and creditors
All of the above

Answer: d
All of the above

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-8

and vertical analyses of the balance sheet and the income statement.


Horizontal
Horizontal and
and Vertical
Vertical Analyses
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 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-9

and vertical analyses of the balance sheet and the income statement.


Horizontal
Horizontal and
and Vertical
Vertical Analyses
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

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-10

and vertical analyses of the balance sheet and the income statement.


Analysis
Analysis of
of the
the Balance
Balance Sheet
Sheet



The results of a horizontal analysis of the balance sheet are presented
on the next slides



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 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-11

and vertical analyses of the balance sheet and the income statement.


Horizontal
Horizontal Analysis
Analysis of
of the
the Balance
Balance Sheet
Sheet

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-12

and vertical analyses of the balance sheet and the income statement.


Horizontal
Horizontal Analysis
Analysis of
of the

the Balance
Balance Sheet
Sheet

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-13

and vertical analyses of the balance sheet and the income statement.


Analysis
Analysis of
of the
the Balance
Balance Sheet
Sheet



A vertical analysis of the balance sheet is presented on the next two
slides



The primary asset accounts are merchandise inventory, land, and
buildings

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

Learning objective 1: Explain why managers analyze financial statements and perform horizontal

Slide 14-14

and vertical analyses of the balance sheet and the income statement.


Vertical
Vertical Analysis
Analysis of
of the
the Balance
Balance Sheet
Sheet

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-15

and vertical analyses of the balance sheet and the income statement.


Vertical
Vertical Analysis
Analysis of
of the
the Balance
Balance Sheet
Sheet

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-16

and vertical analyses of the balance sheet and the income statement.


Analyzing
Analyzing the
the Income
Income Statement
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 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-17

and vertical analyses of the balance sheet and the income statement.

Horizontal
Horizontal Analysis
Analysis

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-18

and vertical analyses of the balance sheet and the income statement.


Vertical
Vertical Analysis
Analysis

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-19

and vertical analyses of the balance sheet and the income statement.


Test Your Knowledge 2

Horizontal analysis evaluates:

a.
b.
c.
d.

Comparable companies
Changes in expenses as a percentage of sales
Changes in expenses as a percent of total assets
Changes in balances from one year to another

Answer: d
Changes in balances from one year to another

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-20

and vertical analyses of the balance sheet and the income statement.


Test Your Knowledge 3

Vertical analysis evaluates:

a.
b.
c.
d.

Changes in net sales as a percentage of total assets
Changes in expenses as a percentage of sales
Financial statement amounts in comparison to a base amount
Changes in balances from one year to another

Answer: c
Financial statement amounts in comparison to a base amount

Learning objective 1: Explain why managers analyze financial statements and perform horizontal
Slide 14-21

and vertical analyses of the balance sheet and the income statement.


Earnings
Earnings Management
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 2: Discuss earnings management and the importance of comparing net income to cash flow from operations. Also,
understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial
Slide 14-22

performance.


Earnings
Earnings Management
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 2: Discuss earnings management and the importance of comparing net income to cash flow from operations. Also,
understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial
Slide 14-23

performance.


Earnings
Earnings Management
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 2: Discuss earnings management and the importance of comparing net income to cash flow from operations. Also,
understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial
Slide 14-24

performance.


Cash
Cash Flow
Flow versus
versus Earnings
Earnings

Learning objective 2: Discuss earnings management and the importance of comparing net income to cash flow from operations. Also,
understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial
Slide 14-25

performance.