Financial accounting 12th warren duchac chapter 17

Financial Statement Analysis

Chapter 17
Student Version
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Prepared by: C. Douglas Cloud
Professor Emeritus of
Accounting
Pepperdine University


Learning Objective 1
1. Describe basic financial statement

analytical methods.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 1

Horizontal Analysis
The percentage analysis of increases and
decreases in related items in comparative
financial statements is called horizontal
analysis.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 1

Horizontal Analysis

Horizontal
Analysis:
Difference
Base year (2011)

$17,000
$533,000

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= 3.2%


LO 1

Horizontal Analysis

Horizontal
Analysis:
Difference

$25,800

Base year (2011)

$64,700

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= 39.9%


LO 1

Horizontal Analysis

Horizontal
Analysis:
Difference

$296,500

Base year (2011)

$1,234,000

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= 24.0%


LO 1

Horizontal Analysis

Horizontal
Analysis:
Difference

$37,500

Base year (2011)

$ 100,000

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= 37.5%


LO 1

Vertical Analysis
A percentage analysis used to show the
relationship of each component to the total
within a single financial statement is called
vertical analysis.
 In a vertical analysis of the balance sheet,
each asset item is stated as a percent of the
total assets.
 Each liability and stockholders’ equity item
is stated as a percent of the total liabilities
and stockholders’ equity.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 1

Vertical Analysis

Vertical
Analysis:
Current Assets

$550,000

Total Assets

$ 1,139,500

= 48.3%

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 1

Vertical Analysis

Vertical Analysis:
Selling expenses
Net sales

$191,000
$1,498,000

= 12.8%

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 1

Common-Sized Statements
In a common-sized statement, all items are
expressed as percentages with no dollar
amounts shown.
Common-sized statements are useful for
comparing the current period with prior
periods, individual businesses with one
another, or one business with industry
averages.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


Learning Objective 2
1. Describe basic financial statement
analytical methods.
2. Use financial statement analysis to assess
the solvency of a business.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 2

Solvency Analysis
All users of financial statements are

interested in the ability of a company to do
the following:
 Meet its financial obligations (debts), called
solvency.
 Earn income, called profitability.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 2
Solvency and Current Position Analysis

Solvency analysis focuses on the ability of a
business to pay its current and noncurrent
liabilities.
Solvency and profitability are interrelated. A
company that cannot pay its debts will have
difficulty obtaining credit, which can
decrease its profitability.
 A company’s ability to pay its current
liabilities is called current position analysis.
It is of special interest to short-term
creditors.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 2

Working Capital
The excess of current assets over current
liabilities is called working capital. Working
capital is often used to evaluate a company’s
ability to pay current liabilities.
Working capital is computed as follows:
Working Capital = Current Assets – Current Liabilities

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 2

Current Ratio
The current ratio, sometimes called the
working capital ratio or bankers’ ratio, also
measures a company’s ability to pay its
current liabilities.
The current ratio is computed as follows:
Current Ratio =

Current Assets
Current Liabilities

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LO 2

Current Ratio
The current ratio for Lincoln Company is computed
below.
2012
Current assets
$533,000
Current liabilities
Current
$243,000ratio

2011
$550,000

2.6

$210,000

$550,000

$533,000

$210,000

$243,000

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2.2

LO 2

Quick Ratio
A ratio that measures the “instant” debtpaying ability of a company is called the
quick ratio, or acid-test ratio. It is computed
as follows:
Quick Ratio =

Quick Assets
Current Liabilities

Quick assets are cash
and other assets that
can be easily
converted to cash.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 2

Quick Assets
The quick ratio for Lincoln Company is computed
below.
2012
2011
Quick assets:
Cash

$ 90,500
$
64,700
Temporary Investments
75,000
60,000
Accounts receivable (net)
115,000
120,000
Quick ratio
1.3
1.0
Total quick assets
$280,500
$280,500 $244,700
$244,700
$210,000 $243,000
Current liabilities
$210,000
$243,000
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LO 2

Accounts Receivable Turnover
The relationship between sales and accounts
receivable may be stated as accounts
receivable turnover. Collecting accounts

receivable as quickly as possible improves a
company’s solvency.
The accounts receivable turnover is
computed as follows:
Accounts Receivable Turnover =

Net Sales
Average Accounts
Receivable

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.


LO 2

Accounts Receivable Turnover
The accounts receivable turnover for Lincoln
Company is computed below.
Net sales
$1,200,000
Accounts receivable (net):
Beginning of year
140,000
End of year
120,000
Total receivable turnover
Accounts
260,000
$1,498,000

Average (Total ÷ 2)
$117,500
130,000

2012
2011
$1,498,000
$ 120,000

$

115,000
12.7

$ 235,000
9.2

$1,200,000
$ 117,500
$130,000

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$
$


LO 2
Number of Days’ Sales in Receivables

The number of days’ sales in receivables is
an estimate of the length of time (in days) the
accounts receivable have been outstanding.
It is computed as follows:
Number of Days’ =
Sales in Receivables

Average Accounts
Receivable
Average Daily
Sales

Net Sales
365

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LO 2
Number of Days’ Sales in Receivables

The number of days’ sales in receivables for
Lincoln Company is computed below.
2012
Average accounts receivable
(Total accounts receivable ÷ 2)
130,000
Net sales

$1,200,000
Average daily sales
Number
of ÷
days’
(Net sales
365) sales in receivables
3,288
$117,500
$4,104

2011

$ 117,500

$

$1,498,000
28.6 $
$130,000
$3,288

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39.5 $
4,104


LO 2

Inventory Turnover
The relationship between the volume of
goods (merchandise) sold and inventory may
be stated as the inventory turnover. The
purpose of this ratio is to assess the
efficiency of a firm in managing its inventory.
The inventory turnover is computed as
follows:
Inventory Turnover =

Cost of Goods Sold
Average Inventory

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LO 2

Inventory Turnover
Lincoln’s inventory balance at the beginning of 2011
is $311,000.
2012
Cost of goods sold
$820,000
Inventories:
Beginning of year
$311,000
End of year

283,000
Total turnover
Inventory
$594,000
$1,043,000
Average (Total ÷ 2)
$273,500
$297,000

2011

$1,043,000
$ 283,000
264,000
3.8

$ 547,000
2.8

$820,000
$ 273,500
$297,000

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.