Lesson 2 Analysis Tools

Transcription

1 Advanced Accounting AY 2017/2018 Lesson 2 Analysis Tools Università degli Studi di Trieste D.E.A.M.S. Paolo Altin 15

2 Analysis Tools 1. Comparative financial statement analysis (or horizontal analysis) 2. Common-size financial statement analysis (or vertical analysis) 3. Ratio Analysis 4. Cash flow analysis Università degli Studi di Trieste D.E.A.M.S. Paolo Altin 16

3 Horizontal and Vertical Analysis Three main ways to analyze financial statements Horizontal analysis Year-to-year comparison Vertical analysis Compare different companies Using industry averages Compare company s performance against the industry averages Università degli Studi di Trieste D.E.A.M.S. Paolo Altin 17

4 Horizontal Analysis This analysis is conducted by reviewing consecutive balance sheets, income statements, or statements of cash flows from period to period. The most important information revealed is trend. Two techniques are popular: year-to-year change analysis and index-number trend analysis. Università degli Studi di Trieste D.E.A.M.S. Paolo Altin 18

5 Year-to-Year Change Analysis 1) When a negative amount appears in the base and a positive amount in the next period (or vice versa), we cannot compute a meaningful percentage change. 2) When there is no amount for the base period, no percentage change is computable. 3) When the base period amount is small, a percentage change can be computed but the number must be interpreted with caution. This is because it can signal a large change merely because of the small base amount used in computing the change. 4) When an item has a value in the base period and none in the next period, the decrease is 100%. 19

6 Year-to-Year Change Analysis The study of percentage changes in comparative statements Compute dollar changes Compute percentage changes 20

7 Example: Income Statement Step 1 Step 2 21 Copyright Pearson Education, Inc

8 Example: Balance Sheet (partial) 22 Copyright Pearson Education, Inc

9 Exercise: Horizontal Analysis - Income Statement MARINER DESIGNS, INC. Comparative Income Statement Years Ended December 31, 2012 and Net sales revenue $ 431,000 $ 372,350 Expenses: Cost of goods sold $ 200,000 $ 187,550 Selling and general expenses 99,000 91,050 Other expense 8,350 6,850 Total expenses $ 307,350 $ 285,450 Net income $ 123,650 $ 86, Prepare a horizontal analysis of the comparative income statement of Mariner Designs, Inc. Round percentage changes to one decimal place. 23 Copyright Pearson Education, Inc

10 Exercise: Horizontal Analysis - Income Statement MARINER DESIGNS, INC. Comparative Income Statement Years Ended December 31, 2012 and 2011 Increase (Decrease) Amount Percent Net sales revenue $ 431,000 $ 372,350 $ 58, % Expenses: Cost of goods sold $ 200,000 $ 187,550 $ 12, % Selling and general expenses 99,000 91,050 7, % Other expense 8,350 6,850 1, % Total expenses $ 307,350 $ 285,450 21, % Net income $ 123,650 $ 86,900 $ 36, % 24 Why did 2012 net income increase by a higher percentage than net sales revenue?

11 Colgate s Comparative Income Statements Change % Change Net sales Cost of sales Gross profit SG&A expenses Other (income) expense Operating profit Interest expense, net Income before income taxes Provisions for income taxes Net income including non controlling inter Less: Net income attributable to noncontrol Net income attributable to Colgate-Palmo

12 Colgate s Comparative Income Statements Università degli Studi di Trieste D.E.A.M.S. Paolo Altin 26

13 Index-Number Trend Analysis Form of horizontal analysis Indicates business direction How have things changed over the years? Select a period of three to five years Base year is the earliest year and a normal year; Base year is selected and set equal to 100%; Subsequent years expressed as a percentage of the base period. 27

14 Colgate s Index Number Trend 28

15 Vertical Analysis Is also referred to as common-size financial statement analysis. Shows relationship of each item to a base amount on financial statements; Income statement: each item expressed as percentage of net sales Balance sheet: each item expressed as percentage of total assets or total liabilities and equity. Remember total assets = total liabilities and equity 29

16 Vertical Analysis Useful in understanding the internal makeup of financial statements; In analyzing a balance sheet, it stresses two factors: 1) Source of financing 2) Composition of assets Especially useful for intercompany comparisons. 30

17 Example: Income Statement Base amount Percentage of the base amount Copyright Pearson Education, Inc 31

18 Example: Balance Sheet Base amount Percentage of base 32 Copyright Pearson Education, Inc

19 Vertical Analysis Short Exercise Tri-State Optical Company reported the following amounts on its balance sheet at December 31, 2012 and 2011: Cash and receivables $ 54,530 $ 46,860 Inventory 42,435 32,670 Property, plant, and equipment, net 108,035 85,470 Total assets $ 205,000 $ 165,000 Prepare a vertical analysis of Tri-State assets for 2012 and Copyright Pearson Education, Inc

20 Vertical Analysis Short Exercise Tri-State Optical Company reported the following amounts on its balance sheet at December 31, 2012 and 2011: Cash and receivables $ 54,530 $ 46,860 Inventory 42,435 32,670 Property, plant, and equipment, net 108,035 85,470 Total assets $ 205,000 $ 165,000 Prepare a vertical analysis of Tri-State assets for 2012 and % of total Cash and receivables $ 54,530 $ 46,860 Inventory 42,435 32,670 Property, plant, and equipment, net 108,035 85,470 Total assets $ 205,000 $ 165,000 Copyright Pearson Education, Inc 2011 % of total

21 Colgate s Common-Size Income Statements 35

22 Colgate s Common-Size Balance Sheet 36

23 Colgate s Common-Size Balance Sheet 37

24 Colgate s Common-Size Balance Sheet 38

25 Common-Size Statements Common-size statements compare one company to another Report only percentages (same as vertical analysis) Remove dollar value bias 39 Copyright Pearson Education, Inc

26 Common-Size Statements Common-size statements compare one company to another Report only percentages (same as vertical analysis) Remove dollar value bias 40 Copyright Pearson Education, Inc

27 Benchmarking Comparing a company with another leading companies Two main types: Against a key competitor Against the industry average 41

28 Common-Size Income Statement Short Exercise Data for Martinez, Inc., and Rosado, Corp., follow: Martinez Rosado Net sales $ 10,600 $ 18,600 Cost of goods sold 6,455 13,522 Other expenses 3,541 4,185 Net income $ 604 $ Prepare common-size income statements. 42 Copyright Pearson Education, Inc

29 Common-Size Income Statement Short Exercise Data for Martinez, Inc., and Rosado, Corp., follow: Martinez Rosado Net sales $ 10,600 $ 18,600 Cost of goods sold 6,455 13,522 Other expenses 3,541 4,185 Net income $ 604 $ Prepare common-size income statements. Martinez Rosado Net sales 100 % 100 % Cost of goods sold 60.9 % 72.7 % Other expenses 33.4 % 22.5 % Net income 5.7 % 4.8 % 43 Copyright Pearson Education, Inc

30 (Continued) Common-Size Income Statement Short Exercise Martinez Rosado Net sales 100 % 100 % Cost of goods sold 60.9 % 72.7 % Other expenses 33.4 % 22.5 % Net income 5.7 % 4.8 % 2. Which company earns more net income? 3. Which company s net income is a higher percentage of its net sales? 44 Copyright Pearson Education, Inc

31 (Continued) S15-4 :COMMON-SIZE INCOME STATEMENT Martinez Rosado Net sales 100 % 100 % Cost of goods sold 60.9 % 72.7 % Other expenses 33.4 % 22.5 % Net income 5.7 % 4.8 % 2. Which company earns more net income? Rosado 3. Which company s net income is a higher percentage of its net sales? Martinez 45 Copyright Pearson Education, Inc

32 The analysis short recap The goal of analyzing a financial statement is essentially to determine if the story it tells is good, bad or indifferent. In other words, to evaluate the financial health of a business. The analyst draws a few initial conditions, than puts the financial statement into context: by comparing it with income statements of earlier periods (past results ) by comparing it with income statements of other companies. 46

33 The analysis - short recap Comparative Financial Analysis: it provides a comparison of a company s financial performance over multiple periods (year-to-year analysis). It is possible to determine trends. Common-size Statement Financial Analysis: it helps to compare different companies and to provide a benchmark analysis. 47

34 Ratio Analysis Ratio analysis is among the most popular and widely used tools of financial analysis. Provide a quick and (relatively) simple means of evaluating the financial health of a business (company). Computation of a ratio is a simple arithmetic operation, its interpretation is more complex. A ratio must refer to an economically important relation, to be meaningful. 48

35 Ratio Analysis Ratios relate one figure appearing in the financial statement to some other figures appearing there (e.g., operating profit in relation to capital employed or in relation to assets) or to some other resources of the business (e.g., net profit for employee, sales revenue per square metre of selling space, etc.). Ratios are very helpful when comparing different businesses, even if involved in different scale of operations (e.g. expressing operating profit in relation to capital employed). They are one of the starting points of the analysis, not an end point! 49

36 Factors affecting ratios Economic events Industry factors Managament policies Accounting methods Reliability of the numbers Skillful of analyst in application and interpretation Any limitation in accounting measurements impact the effectiveness of ratios. 50

37 Ratio Interpretation It is not necessary to compute all possible ratios to analyze a situation. Ratios, like most techniques in financial analysis, are not relevant in isolation. They are usefully interpreted in comparison with: prior ratios predetermined standards ratios of competitors. The variability of a ratio across time is often as important as its trend. 51

38 Cash Flow Analysis It is primarily used as a tool to evaluate the sources and uses of funds. It provides insights into how a company is obtaining its financing and deploying its resources. It also is used in cash flow forecasting and as part of liquidity analysis. 52

39 Colgate s Cash Flow Statement 53

40 Colgate s Cash Flow Statement 54

41 Analysis Resources