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Appendix A
MANAGERIAL ACCOUNTING
8e
Al L. HARTGRAVES Wayne J. MORSE
© Cambridge Business Publishers, 2018
2
Describe the importance of analyzing financial statements.
1
Learning Objective
Management’s Analysis
© Cambridge Business Publishers, 2018
3
Primary reason to analyze
Evaluate the overall performance of the firm
Especially as seen by those external to the firm
Should be aware of total company performance, in addition to each manager’s own responsibility area
Analysis helps managers understand
How the firm is performing, and
How the firm is perceived
© Cambridge Business Publishers, 2018
4
Evaluate factors that influence financial statements and their analysis.
2
Learning Objective
Factors Impacting Financial Statement Analysis
© Cambridge Business Publishers, 2018
5
Changes in product mix can distort a comparison of financial statements
Because individual products have unique profit margins and a change in mix influences the firm’s profit margin
Changes in organizational structure should be reviewed as part of financial analysis
Mergers and acquisitions
© Cambridge Business Publishers, 2018
6
Specify alternative standards useful in financial statement analysis. Perform vertical and horizontal analysis.
3
Learning Objective
Financial Analysis Standards
© Cambridge Business Publishers, 2018
7
Vertical analysis
Restatement of amounts in the current financial statements as a percentage of some base measure
Horizontal analysis
Comparison of a firm’s current financial measures to those of previous periods
Competitor analysis
Comparison of a firm’s financial measures to similar measures for other firms in the industry or to industry averages
Comparison of a firm’s financial measures to its budgeted measures
Beginning the Financial Analysis
© Cambridge Business Publishers, 2018
8
Vertical analysis
Conversion of all amounts to percentages of a base amount
Base amount on income statement is sales
Base amount on balance sheet is total assets
Common size statements
After all accounts of a particular statement are converted into percentages
Useful for
Detecting items that are out of line
Detecting deviations from preset amounts
Detecting other problems
Evaluating Against Comparable Measures
© Cambridge Business Publishers, 2018
9
Beneficial to managers to compare against other firms in the same industry
Financial information services publish averages for all major industries
Dun and Bradstreet
Standard & Poor’s
Moody’s
Awareness of differences between firms is necessary, such as
Geographical effects
Accounting practices
Other Measures
© Cambridge Business Publishers, 2018
10
Measures of solvency and performance
Should be compared to industry norms
Comparison of three successive periods is helpful
Determining averages for a period
Beginning amount + Ending amount
2
© Cambridge Business Publishers, 2018
11
Describe vertical and horizontal analysis, and their difference.
4
Learning Objective
Uses sales from the income statement and total assets from the balance sheet
Both set at 100%
Helps to identify
Significant changes that have taken place during the period, and
Determine whether the changes have favorable or unfavorable impacts on solvency and performance
Determine if the company’s operating goals are met
Vertical Analysis
© Cambridge Business Publishers, 2018
12
Common Size Income Statement
© Cambridge Business Publishers, 2018
13
Useful for analyzing changes over time
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Common Size Balance Sheet Asset Section
© Cambridge Business Publishers, 2018
14
Useful for analyzing changes over time
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Common Size Balance Sheet Liabilities & Stockholders’ Equity Section
© Cambridge Business Publishers, 2018
15
Useful for analyzing changes over time
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Horizontal Analysis
© Cambridge Business Publishers, 2018
16
Used to evaluate trends in the financial condition of an organization
Allows current year common size statements to be compared
To those of prior years, and
To the organization’s goals and objectives
Calculate the % change from one year to the next, making sure to use the prior year as the base.
© Cambridge Business Publishers, 2018
17
Explain the analysis of a firm’s solvency.
4
Learning Objective
Solvency Analysis
© Cambridge Business Publishers, 2018
18
A firm’s ability to pay its debts as they come due
Primary measures
Short-term solvency
Current ratio
Working capital
Acid test ratio
Inventory turnover
Days sales in receivables
Long-term solvency
Debt-to-equity ratio
Times-interest-earned
Current Ratio
© Cambridge Business Publishers, 2018
19
Measures the relation between current assets and current liabilities
Indicates the extent to which current assets are available to cover current liabilities
Current assets
Current liabilities
Current ratio =
$16,993 million
$12,526 million
Current ratio for Home Depot =
= 1.36
Home Depot, Inc. has $1.36 of current assets for each $1 of current liabilities.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Working Capital
© Cambridge Business Publishers, 2018
20
The net amount of working funds available in the short run
Working Capital = Current assets – Current liabilities
Working capital for Home Depot =
$16,993 million – $12,526 million = $4,467 million
Home Depot, Inc. has $4,467 million available in the short-run for operations.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Acid Test (Quick) Ratio
© Cambridge Business Publishers, 2018
21
Measures the availability of assets that can be quickly converted into cash to pay current liabilities
Acid test ratio for Home Depot
$2,216 mil + $0 mil + $1,890 mil
$12,526 mil
= 0.328
=
Home Depot has about $0.33 of current monetary assets for each $1 of current liabilities.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Acid test
ratio
Cash +
Marketable
securities
+
Current accounts
receivable
Current liabilities
=
Inventory Turnover
© Cambridge Business Publishers, 2018
22
Measures the approximate number of times the average stock of inventory is sold and replenished during the year
Inventory turnover for Home Depot
$58,254 million
[($11,809 million + $11,079 million) / 2]
= 5.09
=
Cost of goods sold
Average inventory
Inventory turnover =
Home Depot’s average stock of inventory was sold and replenished about 5.09 times during the year.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Days Sales in Receivables
© Cambridge Business Publishers, 2018
23
Measures the number of days, on average, it takes to generate the credit sales uncollected at any point in time
Accounts receivable
Average daily credit sales
Days sales in
receivables
=
Home Depot takes approximately 16 days to convert its accounts receivable into cash.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Days sales in receivables for Home Depot
$1,890 million
[($88,519 million x 50%*) / 365]
=
*Estimated credit sales
= 15.59 days
Debt-to-Equity Ratio
© Cambridge Business Publishers, 2018
24
Measures the degree to which a company relies on debt versus equity financing
Total liabilities
Total stockholders’ equity
Debt-to-equity ratio
=
Debt-to-equity ratio for Home Depot
$36,233 million
$6,316 million
=
= 5.74
Home Depot’s debt-to-equity ratio indicates that its creditors have provided $5.74 of capital for each $1 that stockholders have provided.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Times-Interest-Earned
© Cambridge Business Publishers, 2018
25
Measures the adequacy of earnings to provide payment of interest charges
Times-interest-earned
=
Net
income
Interest
expense
+
Income
taxes
Interest expense
+
Times-interest-earned
for Home Depot
$7,009 mil + $919mil + $4,012 mil
$919 mil
12.99 times
=
=
Home Depot has approximately 13 times the earnings needed to cover its annual interest costs.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
© Cambridge Business Publishers, 2018
26
Explain the analysis of a firm’s performance.
5
Learning Objective
Performance Analysis
© Cambridge Business Publishers, 2018
27
Basic activities of a typical for-profit organization
Generating capital—equity and debt
Acquiring assets with capital
Using assets to generate sales and profits
Using profits to pay the cost of capital
Primary measures of performance
Gross Margin
Asset turnover
Return on sales
Return on assets
Return on equity
Earnings per share
Asset Turnover
© Cambridge Business Publishers, 2018
28
Measures the firm’s ability to use its assets to generate sales
Asset
Turnover for
Home Depot
$88,519 million
[($42,549 million + $39,946 million) / 2]
= 2.15
=
Sales
Average total assets
Asset turnover =
Each $1 of Home Depot’s assets during the year generated $2.15 of sales.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Return on Sales
© Cambridge Business Publishers, 2018
29
Measures the ability to generate profits from sales produced by the firm’s assets
On average, 8.58% of each $1 of Home Depot’s sales remained as profit after covering all expenses other than interest.
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Return on sales =
Net of tax
interest expense
Net income
Sales
+
*Effective tax rate from Home Depot’s annual report
Return on sales for Home Depot
$7,009 million + [$919 x (1 – 0.364*)]
$88,519 million
=
= 8.58%
Return on Assets
© Cambridge Business Publishers, 2018
30
Measures the firm’s ability to use its assets to generate profits
Combines asset turnover and return on sales
Return on assets =
Net of tax
interest expense
Net income
Average total assets
+
OR: Asset turnover x Return on sales
= 2.15 x 8.58% = 18.45%
*Effective tax rate from Home Depot’s annual report
Return on assets for Home Depot
$7,009 million + [$919 x (1 – 0.364*)]
[($42,549 million + $39,946 million) / 2]
=
= 18.41%
Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf
Difference due to rounding
Return on Equity
© Cambridge Business Publishers, 2018
31
Measures the profits attributable to shareholders as a percentage of their equity in the firm
Return on equity =
Net income
Average stockholders’ equity
Return on equity for Home Depot
$7,009 million
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