Measuring and Evaluating Financial Performance PowerPoint Author Brandy Mackintosh CA Learning Objective 131 Describe the purpose and uses of horizontal vertical and ratio analyses ID: 428367
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Slide1
Chapter 13
Measuring and EvaluatingFinancial Performance
PowerPoint
Author
:
Brandy Mackintosh, CASlide2
Learning Objective 13-1
Describe the purpose and uses of horizontal, vertical, and ratio analyses.Slide3
Horizontal, Vertical, and Ratio Analyses
Horizontal (trend) analyses are conducted to help financial statement users recognize important
financial
changes that unfold over time.
Gross Profit
in
2013
Δ in Gross Profit
$ and/or % from 2013
12/31/13
12/31/14
Gross Profit
in
2014
Trend Analysis
Vertical analyses focus on important relationships between items on the same financial statement.
Sales
Cost of Goods Sold
Gross Profit
$200,000 100%
150,000 75%
$ 50,000 25%
Amount
Percent
2014Slide4
Horizontal, Vertical, and Ratio Analyses
Ratio analyses are conducted to understand relationships among various items reported in one or more of the financial statements.
It is essential to understand that no analysis is complete unless it leads to an interpretation that helps financial statement users understand and evaluate a company’s financial results
Receivable
Turnover
Ratio
=
Net Sales Revenue
Average Net ReceivablesSlide5
Learning Objective 13-2
Use horizontal (trend) analysis to recognize financial changes that unfold over time.Slide6
Horizontal (Trend) Computations
Trend analyses are usually calculated in terms of year-to-year dollar and percentage changes.
Let’s look at an exampleSlide7
Now let’s look at the remainder of the trend analysis of the Income Statement.
Can you calculate the dollar and percentage change for Cost of Sales?
Now let’s calculate the
percentage
change in Net Sales Revenue between
fiscal 2013
and fiscal 2012.
Horizontal (Trend) Computations
Calculate the change in dollars for Net Sales Revenue between fiscal 2013 and
fiscal 2012.
$53,417
–
$50,521
$50,521
× 100Slide8
Learning Objective 13-3
Use vertical (common size) analysis to understand important relationships within financial statements.Slide9
Vertical (Common Size) Computations
Vertical, or common size, analysis focuses on important relationships
within
financial statements.
Income Statement
Balance Sheet
Sales = 100%
Total Assets = 100%
Cost of Sales
Net Sales Revenue
× 100Slide10
Learning Objective 13-4
Calculate financial ratios to assess profitability, liquidity, and solvency.Slide11
Ratio Computations
Ratio analysis compares the amounts for one or more line items to the amounts for other line items in the same year.
Ratios are classified into three categories . . .
Profitability ratios
examine a company’s
ability to generate income.
Liquidity ratios
help us determine if a
company
has
sufficient
current assets to repayliabilities when due.
Solvency ratios
examine a company’sability to payinterest and repaydebt when due.Slide12
Common Profitability RatiosSlide13
Common Liquidity RatiosSlide14
Common Solvency RatiosSlide15
Learning Objective 13-5
Interpret the results of financial analyses.Slide16
Interpreting Horizontal and Vertical Analyses
Lowe’s
assets grew only by 0.2%
in fiscal
2013.
Lowe’s began relying more on debt and less equity financing.
Total
liabilities increased 11 percent and stockholders’ equity decreased by 14.5%.Slide17
Interpreting Horizontal and Vertical Analyses
Cost of sales and operating expenses are the most important determinants of the company’s profitability.
Much of the increase in Net Income in
fiscal
2013 is
explained by
greater control of the Cost
of Sales and Operating
Expenses.Slide18
Interpreting Horizontal and Vertical Analyses
Lowe’s has experienced
a small decrease in
its
percentage of Cost
of
Sales in relation to Sales Revenue from fiscal 2012 to 2013. Decreasing cost of sales means higher Gross Profit.
Lowe’s did
a better job
of controlling its Operating Expenses
between 2012 and 2013. Slide19
Ratio
CalculationsSlide20
Ratio CalculationsSlide21
Profitability Ratios
Net Profit Margin
–
The slowly improving economy helped boost Lowe’s profits in 2013 as shown by
the
increase
in Net Profit Margin.
Gross Profit Percentage
– Lowe’s gross profit percentage indicates how much profit was made on each dollar of sales after deducting the Cost of Goods Sold. Slide22
Profitability Ratios
Fixed Asset Turnover
– indicates
how much revenue the company generates in sales for each dollar invested in fixed assets,
Home Depot
2013
fixed asset turnover ratio was
3.32
Return on Equity (ROE)
– Compares the amount of net income to average stockholders’ equity. ROE reports the net amount earned
during the period as a percentage of each dollar contributed by stockholders and retained in the business.Slide23
Profitability Ratios
Earnings Per Share (EPS)
–
Shows
the amount of earnings generated for each share of outstanding common stock.
Price /Earnings (P/E) Ratio
–
Shows
the relationship between EPS and the market price of one share of the company’s stock.Slide24
Liquidity Ratios
Let’s change our attention to an examination of liquidity ratios. The analyses in this section focus on the company’s ability to survive in the
short term
, by converting assets to cash that can be used to pay current liabilities as they come due.
Receivable
Turnover
Ratio
=
Net Sales Revenue
Average Net Receivables
Receivable Turnover Ratio
– Most retail home improvement companies have low levels of accounts receivable relative to sales revenue because they collect the majority of their sales immediately in cash.Slide25
Liquidity Ratios
Inventory Turnover Ratio
– The inventory turnover ratio indicates how frequently inventory is bought and sold. The “days to sell” indicates the average number of days needed to sell each purchase of inventory.
Home Depot sells its inventory in an average of
77
days in
2013.
Current Ratio
–
The current ratio measures the company’s ability to pay its current liabilitiesSlide26
Solvency Ratios
Debt to Assets Ratio
– indicates the proportion of total assets that creditors finance.
In
2013,
The Home Depot had a debt-to-assets ratio of
69 percent.
Times Interest Earned – indicates how many times the company’s interest expense was covered by its operating results.Slide27
Learning Objective 13-6
Describe how analyses depend on key accounting decisions and concepts.Slide28
Underlying Accounting Decisions and Concepts
Accounting Decisions
Difference in Strategies,
e.g
.,
type of financing.
Difference in Accounting Methods, e.g., FIFO vs. LIFO.Difference in Operations,e.g.,
quality of items sold.Slide29
Accounting Concepts
Companies may elect to use any acceptable generally accepted accounting principle (GAAP) as long as they apply the principle consistently.Slide30
Conceptual Framework for Financial Accounting and ReportingSlide31
Factors Contributing to Going-Concern Problems
Factors that commonly contribute to going-concern problems are listed below.Slide32
Chapter 13
Supplement 13ANonrecurring and Other Special ItemsSlide33
Learning Objective 13-S1
Describe how
nonrecurring and other comprehensive income items are reported.Slide34
Nonrecurring Items
Extraordinary Items
Very few events qualify as extraordinary items.
Cumulative Effect of Changes in Accounting Methods
Direct adjustment to Retained Earnings rather than income reporting.
Discontinued Operations
For discontinued component two items are reported:
Operating income prior to the date of disposal.
Gain or loss on sale or disposal of net assets.
Slide35
Nonrecurring Items
NONRECURRING
I
TEM
Discontinued Operations.Slide36
Other Special Items
Comprehensive Income includes:
Gains or losses from certain foreign currency exchange rate changes.
Gains or losses
resulting
from the change in value of certain types of investments.
Excluded from net income because they are likely to disappear before they are ever realized.Slide37
Chapter 13
Supplement 13BReviewing and Contrasting IFRS and GAAPSlide38
Learning Objective 13-S2
Describe
significant differences between GAAP and IFRS.Slide39
Overview
At a basic level both IFRS and GAAP are concerned with accounting rules that describe
when an item should be recognized in the accounting system,
how that item should be classified (asset , liability, equity, expense, or revenue), and
the amount at which each item should be measured.
Report fixed assets at fair value.
IFRS
Yes
GAAP
NoSlide40
Chapter 13
Solved ExercisesM13-1, M13-2, M13-6, E13-1, E13-3, E13-4, E13-10, E13-13Slide41
M13-1 Calculations for Horizontal Analyses
Using the following income statements, perform the calculations needed for horizontal analyses. Round percentages to one decimal place.Slide42
M13-1 Calculations for Horizontal Analyses
($100,000 – $75,000)
$75,000
× 100 = 33.3%
Current
PreviousSlide43
M13-2 Calculations for Vertical Analyses
Refer to M13-1 . Perform the calculations needed for vertical analyses. Round percentages to one decimal place.
$21,000
$100,000
× 100 = 21.0%
Current
PreviousSlide44
M13-6 Inferring Financial Information Using Gross Profit Percentage and Year-over-Year Comparisons
A consumer products company reported a 25 percent increase in sales from
last year to this year.
Sales
last year
were $200,000.
This year, the company reported Cost of Goods Sold in the amount of $150,000. What was the gross profit percentage this year? Round to one decimal place.
$100,000
$250,000
× 100 = 40.0%
Sales ($200,000 x 1.25) $250,000 100.0%
Cost of Goods Sold (given)
(150,000)
-60.0%Gross Profit $100,000 40.0%Slide45
E13-1 Preparing and Interpreting a Schedule for Horizontal
and Vertical Analyses
The average price of a gallon of gas in
2013 dropped $0.12 (3
percent) from
$3.61
in 2012 (to $3.49 in 2013). Let’s see whether these changes are reflected in the income statement of Chevron Corporation for the year ended December 31, 2013 (amounts in billions).Required:1. Conduct a horizontal analysis by calculating the year-over-year changes in each line item, expressed in dollars and in percentages (rounded to one decimal place). How did the change in gas prices compare to the changes in Chevron Corp.’s total revenues and costs of crude oil and products?2. Conduct a vertical analysis by expressing each line as a percentage of total revenues (round to one decimal place). Excluding income tax and other operating costs, did Chevron earn more profit per dollar of revenue in 2013 compared to
2012?Slide46
E13-1 Preparing and Interpreting a Schedule for Horizontal
and Vertical Analyses
The 3% decrease in the average gas price was less than
the 4.8
% decrease in
revenues
and less than the 4.0% decrease in cost of crude
oil and products. It appears
from this analysis that the decrease in gas prices explains only part of Chevron’s decrease in revenues. Note that the percentage decrease in revenues was similar to the percentage decrease in the cost of crude oil and products, suggesting the costs
of crude oil really did decrease a lot in 2013, consistent with the decrease in gas
prices.
Req. 1Slide47
E13-1 Preparing and Interpreting a Schedule for Horizontal
and Vertical Analyses
As a percent of
revenues
, Chevron’s cost of crude oil and products was
higher in 2013
(65.0%) than in 2012 (64.5%). This implies that
Chevron earned less profit
(excluding income tax and other operating costs) per dollar of revenues in 2013 than in 2012.
Req. 2Slide48
E13-3 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses
According to the producer price index database maintained by the Bureau of Labor Statistics, the average cost of computer equipment fell
8.1
percent between
2012
and
2013. Let’s see whether these changes are reflected in the income statement of Computer Tycoon Inc. for the year ended December 31, 2013.Required:1. Conduct a horizontal analysis by calculating the year-over-year changes in each line item, expressed in dollars and in percentages (rounded to one decimal place). How did the change in computer prices compare to the changes in Computer Tycoon’s sales revenues?2. Conduct a vertical analysis by expressing each line as a percentage of total revenues (round to one decimal place). Excluding income tax, interest, and operating expenses, did Computer Tycoon earn more profit per dollar of sales in 2013 compared to 2012?Slide49
E13-3 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses
The 8.1% decrease in the average price of computer
equipment
was less than the
16.7
% decrease in total revenues. It appears from this
analysis
that the 8.1% decrease in computer prices was not offset by an increase in
Computer Tycoon’s sales volume. In fact, the sales volume also decreased, leaving an overall decrease in sales revenues of 16.7%.
Req. 1Slide50
E13-3 Preparing and Interpreting a Schedule for Horizontal and Vertical Analyses
Excluding income tax, interest, and operating expenses
(
i.e
., looking at gross profit), we
see
that Computer Tycoon earned 40.0% gross profit in 2013, which is down from
40.4% in 2012. In other words, Computer Tycoon earned 0.4 cents less (40.0 – 40.4) per dollar of revenues in 2013 than in 2012.
Req. 2Slide51
E13-4 Computing Profitability Ratios
Use the information in E13-3 to complete the following requirements.
Required:
Compute the gross profit percentage for each year (one decimal place). Assuming that the change for
2012
to
2013 is the beginning of a sustained trend, is Computer Tycoon likely to earn more or less gross profit from each dollar of sales in 2014?Compute the net profit margin for each year (expressed as a percentage with one decimal place). Given your calculations here and in requirement 1, explain whether Computer Tycoon did a better or worse job of controlling operating expenses in 2013 relative to 2012.Computer Tycoon reported average net fixed assets of $54,200 in 2013 and $45,100 in 2012. Compute the fixed asset turnover ratios for both years (round to two decimal places). Did the company better utilize its investment in fixed assets to generate revenues in 2013 or 2012?Computer Tycoon reported average stockholders’ equity of $54,000 in
2013 and $40,800 in 2012. Compute the return on equity ratios for both years (expressed as a percentage with one decimal place). Did the company generate greater returns for stockholders in 2013 or 2012?Slide52
E13-4 Computing Profitability Ratios
Req. 1
The
gross profit percentage of 40.0% means that the company generated 40.0 cents of gross profit on each dollar of sales in
2013,
which was down almost half of one cent from
2012.
If this continues, the company could be expected to generate even less gross profit from each dollar of sales in
2014.Slide53
E13-4 Computing Profitability Ratios
Req. 2
Computer Tycoon did a worse job of controlling expenses (other than the cost of goods sold) in 2013 relative to 2012 because the net profit margin decreased 2.5% (5.0 – 2.5), of which only 0.4% was attributable to the gross profit percentage decrease (from 40.4% to 40.0%). Slide54
E13-4 Computing Profitability Ratios
Req. 3
The company better utilized its investment in fixed assets in 2012. Its fixed asset turnover ratio fell from 2.66 in 2012 to 1.85 in 2013.
The
2013 ratio means that the company generated $1.85 of sales revenue for every dollar invested in fixed
assets.Slide55
E13-4 Computing Profitability Ratios
Req. 4
The company generated better returns for stockholders in
2012
(14.8%) than in
2013
(4.6%). Slide56
E13-10
Inferring Financial Information from Profitability and Liquidity Ratios
Dollar General Corporation operates approximately
9,400
general merchandise stores that feature quality merchandise at low prices to meet the needs of middle-, low-, and fixed-income families
in southern, eastern, and mid-western states. For the year ended January 31, 2014, the company reported average inventories of $2,475 (in millions) and an inventory turnover of 4.89. Average total fixed assets were $2,080 (million), and the fixed asset turnover ratio was 8.14.Required:Calculate Dollar General’s gross profit percentage (expressed as a percentage with one decimal place). What does this imply about the amount of gross profit made from each dollar of sales? TIP: Work backward from the fixed asset turnover and inventory turnover ratios to compute the amounts needed for the gross profit percentage.Is this an improvement from the gross profit percentage of 31.7 percent earned during the previous year?Slide57
E13-10
Inferring Financial Information from Profitability and Liquidity Ratios
Req. 1
So, Gross profit percentage = (Net sales – Cost of goods sold) ÷ Net sales
=
($
16,931,200,000 – $12,102,750,000) ÷ $16,931,200,000
=
0.285 or 28.5%
We can get the net sales number from the fixed assets turnover ratio and the cost of goods sold number from the inventory turnover ratio, as shown below. Fixed asset turnover = Net sales ÷ Average fixed assets 8.14 = Net sales ÷ $2,080,000,000 8.14 x $2,080,000,000 = Net sales $16,931,200,000 = Net sales Inventory turnover = Cost of goods sold ÷ Average inventory 4.89 = Cost of goods sold ÷ $2,475,000,000 4.89 x $2,475,000,000 = Cost of goods sold $12,102,750,000 = Cost of goods soldSlide58
E13-13 Analyzing the Impact of Selected Transactions on the
Current Ratio
The Sports Authority, Inc., is
a private full-line
sporting goods retailer.
Assume
one of the Sports Authority stores reported current assets of $88,000 and its current ratio was 1.75, and then completed the following transactions:paid $6,000 on accounts payable, purchased a delivery truck for $10,000 cash, wrote off a bad account receivable for $2,000, and paid previously declared dividends in the amount of $25,000.Required:Compute the updated current ratio rounded to two decimal places, after each transaction.Slide59
E13-13 Analyzing the Impact of Selected Transactions on the
Current RatioSlide60
End of Chapter 13