Thursday, June 30, 2016
Monday, June 27, 2016
FINANCIAL STATEMENT ANALYSIS (Part 1)
Financial statement analysis is defined as the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss account. (analyze finance data)
*Since we are measuring the change between 2001 and 2002, the dollar amounts for 2001 become the base figure for expressing these changes in percentage form. For example, cash decreased by figures $1,150 between 2001 and 2002. This decrease expressed in percentage form is computed as follows:
There are various methods or techniques that are used in analyzing financial statements, such as comparative statements, schedule of changes in working capital, common size percentages, funds analysis, trend analysis, and ratios analysis.
Financial statements are prepared to meet external reporting obligations and also for decision making purposes. They play a dominant role in setting the framework of managerial decisions. But the information provided in the financial statements is not an end in itself as no meaningful conclusions can be drawn from these statements alone. However, the information provided in the financial statements is of immense use in making decisions through analysis and interpretation of financial statements.
TOOLS AND TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS:
Following are the most important tools and techniques of financial statement analysis:
- Horizontal and Vertical Analysis
- Ratios Analysis
1: Trend Analysis / Horizontal Analysis in financial Statements
Comparison of two or more year's financial data is known as horizontal analysis, or trend analysis.
Horizontal analysis is facilitated by showing changes between years in both dollar and percentage form as has been done in the example below. Showing changes in dollar form helps the analyst focus on key factors t hat have affected profitability or financial position. Observe in the example that sales for 2002 were up $4 million over 2001, but that this increase in sales was more than negated by a $4.5 million increase in cost of goods sold. Showing changes between years in percentage form helps the analyst to gain perspective and to gain a feel for the significance of the changes that are taking place. For example a $1 million increase in sales is much more significant if the prior year's sales were $2 million than if the prior year's sales were $20 million. In the first situation, the increase would be 50% that is undoubtedly a significant increase for any firm. In the second situation, the increase would be 5% that is just a reflection of normal progress.
Example of Horizontal or Trend Analysis:
Balance Sheet:
Comparative Balance Sheet
December 31, 2002, and 2001 (dollars in thousands) | ||||
Increase (Decrease) | ||||
2002 | 2001 | Amount | Percent | |
Assets
| ||||
Current Assets: | ||||
Cash | $1,200 | $2,350 | $(1,150)* | (48.9)% |
Accounts receivable | 6,000 | 4,000 | 2000 | 50% |
Inventory | 8,000 | 10,000 | (2000) | (20.0)% |
Prepaid Expenses | 300 | 120 | 180 | 150.0% |
---------- | ----------- | ---------- | ---------- | |
Total current assets | $15,500 | $16,470 | (970) | (5.9)% |
----------- | ----------- | ---------- | --------- | |
Property and equipment: | ||||
Land | 4,000 | 4,000 | 0 | 0% |
Building | 12,000 | 8,500 | 3,500 | 41.2% |
----------- | ----------- | ---------- | ||
Total property and equipment | 16,000 | 12,500 | 3,500 | 28% |
---------- | ----------- | ---------- | --------- | |
Total assets | 31,500 | 28,970 | 2,530 | 8.7% |
====== | ====== | ====== | ====== | |
Liabilities and Stockholders' Equity
| ||||
Current liabilities: | ||||
Accounts payables | $5,800 | $4,000 | 1800 | 45% |
Accrued payables | 900 | 400 | 500 | 125% |
Notes payables | 300 | 600 | (300) | (50%) |
---------- | ---------- | ----------- | --------- | |
Total current liabilities | 7,000 | 5,000 | 2,000 | 40% |
---------- |
----------
|
----------
|
-----------
| |
Long term liabilities: | ||||
Bonds payable 8% | 7,500 | 8,000 | (500) | (6.3)% |
---------- |
----------
|
----------
|
----------
| |
Total long term liabilities | 7,500 |
8,000
|
(500)
|
6.3%
|
---------- |
----------
|
----------
|
----------
| |
Total Liabilities | $14,500 |
13,000
|
1,500
|
(11.5)%
|
Stock holders equity: | ||||
Preferred stock, 100 par, 6%, $100 liquidation value | $2,000 | $2,000 | 0 | 0% |
Common stock, $12 par | 6,000 | 6,000 | 0 | 0% |
Additional paid in capital | 1,000 | 1,000 | 0 | 0% |
---------- | ---------- | --------- | -------- | |
Total paid in capital | 9,000 |
9,000
|
0
|
0%
|
Retained earnings | 8,000 | 6,970 | 1,030 | 14.8% |
---------- | ---------- | ---------- | ---------- | |
Total stockholders' equity | 17,000 | 15,970 | 1,030 | 6.4% |
---------- | ---------- | ---------- | --------- | |
Total liabilities and stockholders' equity | $31,500 | $28,970 | $2,530 | 8.7% |
===== | ====== | ====== | ====== |
$1,150 ÷ $2,350 = 48.9%
Other percentage figures in this example are computed by the same formula.Income Statement:
Comparative income statement and reconciliation of retained earnings
For the year ended December 31, 2002, and 2001 (dollars in thousands) | ||||
Increase (Decrease)
| ||||
2002 | 2001 | Amount | Percent | |
Sales | $52,000 | $48,000 | $4,000 | 8.3% |
Cost of goods sold | 36,000 | 31,500 | 4,500 | 14.3% |
------------ | ------------ | ------------ | ----------- | |
Gross margin | 16,000 | 16,500 | (500) | (3.0)% |
------------ | ------------ | ------------ | ------------ | |
Operating expenses: | ||||
Selling expenses | 7,000 | 6,500 | 500 | 7.7% |
Administrative expense | 5,860 | 6,100 | (240) | (3.9)% |
------------ | ------------ | ------------ | ------------ | |
Total operating expenses | 12,860 | 12,600 | 260 | 2.1% |
------------ | ------------ | ------------ | ------------ | |
Net operating income | 3,140 | 3,900 | (760) | (19.5)% |
Interest expense | 640 | 700 | (60) | (8.6)% |
------------ | ------------ | ------------ | ------------ | |
Net income before taxes | 2,500 | 3,200 | (700) | (21.9)% |
Less income taxes (30%) | 750 | 960 | (210) | (21.9)% |
------------ | ------------ | ------------ | ------------ | |
Net income | 1,750 | 2,240 | $ (490) | 21.9% |
====== | ||||
Dividends to preferred stockholders, $6 per share (see balance sheet above) | 120 | 120 | ||
------------ | ------------ | |||
Net income remaining for common stockholders | 1,630 | 2,120 | ||
Dividend to common stockholders, $1.20 per share | 600 | 600 | ||
------------ | ------------ | |||
Net income added to retained earnings | 1,030 | 1,520 | ||
Retained earnings, beginning of year | 6,970 | 5,450 | ||
------------ | ------------ | |||
Retained earnings, end of year | $ 8,000 | $ 6,970 | ||
======= | ======= |
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