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IQRA UNIVERSITY CITY CAMPUS

Analysis of Financial Statements

Intisar M.Usmani FCMA First Habib Modaraba

Basics of Analysis
Application of analytical tools

Reduces uncertainty

Involves transforming data

Intisar M.Usmani FCMA First Habib Modaraba

Purpose of Analysis
Financial statement analysis helps users make better decisions.

Internal Users Managers Officers M.Usmani FCMA Internal AuditorsIntisar First Habib Modaraba

External Users Shareholders Lenders Customers

Building Blocks of Analysis

Ability to meet short-term obligations and to efficiently generate revenues Ability to generate future revenues and meet long-term obligations

Liquidity and Efficiency

Solvency

Ability to provide financial rewards sufficient to attract and retain financing

Market Profitability Prospects

Intisar M.Usmani FCMA First Habib Modaraba

Ability to generate positive market expectations

Information for Analysis

Income Statement Balance Sheet
Statement of Changes in Stockholders Equity Notes

Statement of Cash Flows

Intisar M.Usmani FCMA First Habib Modaraba

Standards for Comparison

To help me interpret our financial statements, I use several standards of comparison.

Intracompany Competitor

Industry
Intisar M.Usmani FCMA First Habib Modaraba

Guidelines

Tools of Analysis

Horizontal Analysis
Comparing a companys financial condition and performance across time

Time
Intisar M.Usmani FCMA First Habib Modaraba

Tools of Analysis
Comparing a companys financial condition and performance to a base amount

V e r t i c a l A n a l y s i s

Intisar M.Usmani FCMA First Habib Modaraba

Tools of Analysis
Using key relations among financial statement items

Intisar M.Usmani FCMA First Habib Modaraba

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Horizontal Analysis Now, lets look at some ways to use horizontal analysis.

Time

Intisar M.Usmani FCMA First Habib Modaraba

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CLOVER CORPORATION Comparative Balance Sheets December 31, 2008 Assets Current assets: Cash and equivalents Accounts receivable, net Inventory Prepaid expenses Total current assets Property and equipment: Land Buildings and equipment, net Total property and equipment Total assets 2007 Dollar Change Percent Change

12,000 60,000 80,000 3,000 $ 155,000 40,000 120,000 $ 160,000 $ 315,000

23,500 40,000 100,000 1,200 $ 164,700 40,000 85,000 $ 125,000 $ 289,700

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Comparative Statements
Calculate Change in Dollar Amount
Dollar Change

Analysis Period Amount

Base Period Amount

Since we are measuring the amount of the change between 2003 and 2004, the dollar amounts for 2003 become the base period amounts.
Intisar M.Usmani FCMA First Habib Modaraba

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Comparative Statements
Calculate Change as a Percent
Percent Change = Dollar Change Base Period Amount

100%

Intisar M.Usmani FCMA First Habib Modaraba

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CLOVER CORPORATION Comparative Balance Sheets December 31, 2008 2007 Dollar Change Percent Change*

Assets Current assets: Cash and equivalents $ 12,000 $ 23,500 $ (11,500) (48.9) Accounts receivable, net 60,000 40,000 Inventory 80,000 100,000 Prepaid expenses 3,000 1,200 $12,000 $23,500 = $(11,500) Total current assets $ 155,000 $ 164,700 Property and equipment: ($11,500 $23,500) 100% = 48.9% Land 40,000 40,000 Buildings and equipment, net 120,000 85,000 Total property and equipment $ 160,000 $ 125,000 Total assets $ 315,000 $ 289,700 Intisar M.Usmani FCMA * Percent rounded to first decimal point. First Habib Modaraba

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CLOVER CORPORATION Comparative Balance Sheets December 31, 2008 Assets Current assets: Cash and equivalents $ 12,000 $ Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 $ Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 $ Total assets $ 315,000 $ Intisar M.Usmani FCMA * Percent rounded to first decimal point. First Habib Modaraba 2007 Dollar Change Percent Change*

23,500 $ (11,500) 40,000 20,000 100,000 (20,000) 1,200 1,800 164,700 $ (9,700) 40,000 85,000 35,000 125,000 $ 35,000 289,700 $ 25,300

(48.9) 50.0 (20.0) 150.0 (5.9) 0.0 41.2 28.0 8.7

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Now, lets review the dollar and percent changes for the liabilities and shareholders equity accounts.

Intisar M.Usmani FCMA First Habib Modaraba

CLOVER CORPORATION Comparative Balance Sheets December 31, 2008 Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 67,000 Notes payable 3,000 Total current liabilities $ 70,000 Long-term liabilities: Bonds payable, 8% 75,000 Total liabilities $ 145,000 Shareholders' equity: Preferred stock 20,000 Common stock 60,000 Additional paid-in capital 10,000 Total paid-in capital $ 90,000 Retained earnings 80,000 Total shareholders' equity $ 170,000 Total liabilities and shareholders' equity $ 315,000 Intisar M.Usmani FCMA Habib Modaraba * Percent rounded to first decimalFirst point. 2007 Dollar Change

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Percent Change*

$ 44,000 $ 23,000 6,000 (3,000) $ 50,000 $ 20,000 80,000 (5,000) $ 130,000 $ 15,000 20,000 60,000 10,000 $ 90,000 69,700 10,300 $ 159,700 $ 10,300 $ 289,700 $ 25,300

52.3 (50.0) 40.0 (6.3) 11.5 0.0 0.0 0.0 0.0 14.8 6.4 8.7

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Now, lets look at trend analysis!

Intisar M.Usmani FCMA First Habib Modaraba

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Trend Analysis

Trend analysis is used to reveal patterns in data covering successive periods.

Trend Analysis Period Amount = Percent Base Amount Intisar Period M.Usmani FCMA
First Habib Modaraba

100%

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Trend Analysis
Berry Products Income Information For the Years Ended December 31,
Item Revenues Cost of sales Gross profit 2008 $ 400,000 285,000 115,000 2007 $ 355,000 250,000 105,000 2006 $ 320,000 225,000 95,000 2005 $ 290,000 198,000 92,000 2004 $ 275,000 190,000 85,000

2000 is the base period so its amounts will equal 100%.

Intisar M.Usmani FCMA First Habib Modaraba

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Trend Analysis
Berry Products Income Information For the Years Ended December 31,
Item Revenues Cost of sales Gross profit 2008 $ 400,000 285,000 115,000 2007 $ 355,000 250,000 105,000 2006 $ 320,000 225,000 95,000 2005 $ 290,000 198,000 92,000 2004 $ 275,000 190,000 85,000

Item Revenues

2008

2007

Year 2006

2005 105%

2004 100%

(290,000 275,000) 100% = 105% Intisar (198,000 190,000) M.Usmani 100% FCMA = 104% First Habib Modaraba (92,000 85,000) 100% = 108%

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Trend Analysis
Berry Products Income Information For the Years Ended December 31,
Year 2006 $ 320,000 225,000

Item Revenues Cost of sales

2008 $ 400,000 285,000

2007 $ 355,000 250,000

2005 $ 290,000 198,000

2004 $ 275,000 190,000

Item Revenues Cost of sales Gross profit

2008 145% 150% 135%

2007 129% 132% 124%

2006 116% 118% 112%

2005 105% 104% 108%

2004 100% 100% 100%

How would this trend analysis Intisar M.Usmani FCMA lookFirst on a line graph? Habib Modaraba

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Trend Analysis
160 150

We can use the trend percentages to construct a graph so we can see the trend over time.

Percentage

140 130 120 110 100 2004 2005 2006 Year Intisar M.Usmani FCMA First Habib Modaraba 2007 2008 Revenues Cost of Sales Gross Profit

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V e r t i c a l A n a l y s i s

Now, lets look at some vertical analysis tools!

Intisar M.Usmani FCMA First Habib Modaraba

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Common-Size Statements
Calculate Common-size Percent
Common-size Percent

Analysis Amount Base Amount

100%

Financial Statement Balance Sheet Income Statement

Intisar M.Usmani FCMA First Habib Modaraba

Base Amount Total Assets Revenues

R CORPORATION ive Balance Sheets cember 31, Common-size Percents* 2008 2007

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2008

2007

12,000 60,000 80,000 3,000 $ 155,000 40,000 120,000 $ 160,000 $ 315,000 point.

23,500 3.8% 8.1% 40,000 100,000 1,200 ($12,000 $315,000) 100% = 3.8% $ 164,700

($23,500 $289,700) 100% = 8.1% 40,000 85,000 $ 125,000 $ 289,700 100.0% 100.0% Intisar M.Usmani FCMA
First Habib Modaraba

CLOVER CORPORATION Comparative Balance Sheets December 31,

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2008 Assets Current assets: Cash and equivalents $ 12,000 Accounts receivable, net 60,000 Inventory 80,000 Prepaid expenses 3,000 Total current assets $ 155,000 Property and equipment: Land 40,000 Buildings and equipment, net 120,000 Total property and equipment $ 160,000 Total assets $ 315,000 Intisar M.Usmani FCMA First Habib Modaraba * Percent rounded to first decimal point.

2007

Common-size Percents* 2008 2007

$ 23,500 40,000 100,000 1,200 $ 164,700 40,000 85,000 $ 125,000 $ 289,700

3.8% 19.0% 25.4% 1.0% 49.2% 12.7% 38.1% 50.8% 100.0%

8.1% 13.8% 34.5% 0.4% 56.9% 13.8% 29.3% 43.1% 100.0%

CLOVER CORPORATION Comparative Balance Sheets December 31,

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2008 Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 67,000 Notes payable 3,000 Total current liabilities $ 70,000 Long-term liabilities: Bonds payable, 8% 75,000 Total liabilities $ 145,000 Shareholders' equity: Preferred stock 20,000 Common stock 60,000 Additional paid-in capital 10,000 Total paid-in capital $ 90,000 Retained earnings 80,000 Total shareholders' equity $ 170,000 Intisar M.Usmani Total liabilities and shareholders' equity $ FCMA 315,000 * Percent rounded to first decimal point.
First Habib Modaraba

2007

Common-size Percents* 2008 2007

$ 44,000 6,000 $ 50,000 80,000 $ 130,000 20,000 60,000 10,000 $ 90,000 69,700 $ 159,700 $ 289,700

21.3% 1.0% 22.2% 23.8% 46.0% 6.3% 19.0% 3.2% 28.6% 25.4% 54.0% 100.0%

15.2% 2.1% 17.3% 27.6% 44.9% 6.9% 20.7% 3.5% 31.1% 24.1% 55.1% 100.0%

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CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31, Common-size Percents* 2008 2007 2008 2007 Revenues $ 520,000 $ 480,000 100.0% 100.0% Costs and expenses: Cost of sales 360,000 315,000 69.2% 65.6% Selling and admin. 128,600 126,000 24.7% 26.3% Interest expense 6,400 7,000 1.2% 1.5% Income before taxes $ 25,000 $ 32,000 4.8% 6.7% Income taxes (30%) 7,500 9,600 1.4% 2.0% Net income $ 17,500 $ 22,400 3.4% 4.7% Net income per share $ 0.79 $ 1.01 Avg. # common shares Intisar M.Usmani 22,200 FCMA22,200 First Habib Modaraba * Rounded to first decimal point.

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Common-Size Graphics
This is a graphical analysis of Clover Corporations common-size income statement for 2008.
Interest expense 1.2%
Selling and administrative 24.7%

Income taxes 1.4%

Net income 3.4%

Cost of sales 69.2%

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Liquidity and Efficiency

Solvency

Profitability

Market

Lets use the following financial statements for Norton Corporation for Intisar M.Usmani FCMA First Habib Modaraba our ratio analysis.

NORTON CORPORATION Balance Sheet December 31, 2008 Assets Current assets: Cash Accounts receivable, net Inventory Prepaid expenses Total current assets Property and equipment: Land Buildings and equipment, net Total property and equipment Intisar M.Usmani FCMA Total assets First Habib Modaraba 2007

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$ 30,000 20,000 12,000 3,000 $ 65,000 165,000 116,390 $ 281,390 $ 346,390

$ 20,000 17,000 10,000 2,000 $ 49,000 123,000 128,000 $ 251,000 $ 300,000

NORTON CORPORATION Balance Sheet December 31, 2008 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Notes payable, short-term Total current liabilities Long-term liabilities: Notes payable, long-term Total liabilities Shareholders' equity: Common stock, $1 par value Additional paid-in capital Total paid-in capital Retained earnings Total shareholders' equity
Intisar M.Usmani FCMA Total liabilities and shareholders' equity First Habib Modaraba

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2007

$ $

39,000 3,000 42,000

$ $

40,000 2,000 42,000

70,000 $ 112,000 27,400 158,100 $ 185,500 48,890 $ 234,390 $ 346,390

78,000 $ 120,000 17,000 113,000 $ 130,000 50,000 $ 180,000 $ 300,000

NORTON CORPORATION Income Statement For the Years Ended December 31,

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2008 Revenues $ 494,000 Cost of sales 140,000 Gross margin $ 354,000 Operating expenses 270,000 Net operating income $ 84,000 Interest expense 7,300 Net income before taxes $ 76,700 Less income taxes (30%) 23,010 Intisar M.Usmani FCMA Net income $ 53,690 First Habib Modaraba

$ $ $ $ $

2007 450,000 127,000 323,000 249,000 74,000 8,000 66,000 19,800 46,200

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Liquidity and Efficiency

Current Ratio Inventory Turnover

Acid-test Ratio
Accounts Receivable Turnover Total Asset Intisar M.Usmani FCMA Turnover
First Habib Modaraba

Days Sales Uncollected

Days Sales in Inventory

NORTON CORPORATION 2008 Cash Accounts receivable, net Beginning of year $

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30,000 17,000 20,000 10,000 12,000 65,000 42,000 300,000 346,390 494,000 140,000

Use this information to calculate the liquidity and efficiency ratios for Norton Corporation.

End of year Inventory Beginning of year End of year Total current assets Total current liabilities Total assets Beginning of year End of year

Revenues Intisar M.Usmani FCMA First HabibCost Modaraba of sales

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Working Capital
Working capital represents current assets financed from long-term capital sources that do not require near-term repayment.

Dec. 31, 2008 Current assets Current liabilities Working capital

Intisar M.Usmani FCMA First Habib Modaraba

$ $

65,000 (42,000) 23,000

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Current Ratio
Current Current Assets = Ratio Current Liabilities Current = Ratio $65,000 = 1.55 : 1 $42,000

This ratio measures the short-term debt-paying ability of the company.

Intisar M.Usmani FCMA First Habib Modaraba

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Acid-Test Ratio
Quick Assets Acid-Test = Current Liabilities Ratio
Quick assets are Cash, Short-Term Investments, and Current Receivables.

Acid-Test = $50,000 = 1.19 : 1 $42,000 Ratio

This ratio is like the current ratio but excludes current assets such as inventories and prepaid expenses that may be difficult to Intisar M.Usmani FCMA quickly convert into cash.
First Habib Modaraba

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Accounts Receivable Turnover

Accounts Sales on Account Receivable = Average Accounts Receivable Turnover Accounts $494,000 Receivable = ($17,000 + $20,000) 2 = 26.7 times Turnover
This ratio measures how many times a company converts its receivables into cash each year. Intisar M.Usmani FCMA
First Habib Modaraba

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Inventory Turnover
Inventory Turnover Inventory Turnover Cost of Goods Sold = Average Inventory

$140,000 = = 12.73 times ($10,000 + $12,000) 2

This ratio measures the number of times merchandise is sold and replaced during the year.
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Days Sales in Inventory

Days Sales = in Inventory Ending Inventory Cost of Goods Sold

365

Days Sales $12,000 = 365 = 31.29 days in Inventory $140,000

This ratio measures the liquidity of inventory.

Intisar M.Usmani FCMA First Habib Modaraba

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Total Asset Turnover

Total Asset Net Sales = Turnover Average Total Assets Total Asset $494,000 = = 1.53 times Turnover ($300,000 + $346,390) 2

This ratio measures the efficiency of assets in producing sales.

Intisar M.Usmani FCMA First Habib Modaraba

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Solvency
Debt Ratio Equity Ratio Pledged Assets to Secured Liabilities Times Interest Earned

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Use this information to calculate the solvency ratios for Norton Corporation.

NORTON CORPORATION 2008 Net income before interest expense and income taxes Interest expense Total shareholders' equity Total liabilities Total assets
Intisar M.Usmani FCMA First Habib Modaraba

84,000 7,300 234,390 112,000 346,390

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Debt Ratio
Total Liabilities Debt = Ratio Total Assets Debt = Ratio $112,000 = 32.3% $346,390

This ratio measures what portion of a companys assets are contributed by creditors.
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Equity Ratio
Total Equity Equity = Ratio Total Assets Equity = Ratio $234,390 = 67.7% $346,390

This ratio measures what portion of a companys assets are contributed by owners.
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Pledged Assets to Secured Liabilities

Pledged Assets to = Book Value of Pledged Assets Secured Book Value of Secured Liabilities Liabilities

This ratio measures the protection to secured creditors.

Intisar M.Usmani FCMA First Habib Modaraba

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Times Interest Earned

Times Interest = Earned

Net Income before Interest Expense and Income Taxes

Interest Expense

Times $84,000 Interest = = 11.51 $7,300 Earned

This is the most common measure of the ability of a firms operations to provide protection to the long-term creditor. Intisar M.Usmani FCMA
First Habib Modaraba

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Profitability
Profit Margin Basic Earnings per Share Book Value per Common Share Return on Common Stockholders Equity Intisar M.Usmani FCMA
First Habib Modaraba

Gross Margin

Return on Total Assets

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NORTON CORPORATION 2008

Use this information to Net income calculate the profitability Shareholders' equity Beginning of year ratios for Norton End of year Corporation.
Revenues Cost of sales Total assets Beginning of year End of year FCMA Intisar M.Usmani
First Habib Modaraba

Number of common shares outstanding all year $

27,400 53,690 180,000 234,390 494,000 140,000 300,000 346,390

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Profit Margin
Profit = Margin Net Income Net Sales

$53,690 Profit = 10.87% = Margin $494,000

This ratio describes a companys ability to earn a net income from sales.
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Gross Margin
Gross Net Sales - Cost of Sales = Margin Net Sales Gross $494,000 - $140,000 = 71.66% = Margin $494,000

This ratio measures the amount remaining from $1 in sales that is left to cover operating expenses and a profit after considering cost of sales.
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Return on Total Assets

Return on = Net Income Total Assets Average Total Assets Return on $53,690 = = 16.61% Total Assets ($300,000 + $346,390) 2

This ratio is generally considered the best overall measure of a companys profitability.
Intisar M.Usmani FCMA First Habib Modaraba

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Return on Common Stockholders Equity

Return on Common Net Income - Preferred Dividends = Stockholders Average Common Stockholders Equity Equity

Return on $53,690 - 0 Common = = 25.9% Stockholders ($180,000 + $234,390) 2 Equity

This measure indicates how well the company employed the owners investments to earn income. Intisar M.Usmani FCMA
First Habib Modaraba

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Book Value per Common Share

Book Value Shareholders Equity Applicable to per Common Shares = Common Number of Common Shares Share Outstanding

This ratio measures liquidation at reported amounts.

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Basic Earnings per Share

Basic Earnings Net Income - Preferred Dividends = per Weighted-Average Common Share Shares Outstanding

Basic Earnings $53,690 - 0 = = $1.96 per share per 27,400 Share

This measure indicates how much income was earned for each share of common stock outstanding. Intisar M.Usmani FCMA
First Habib Modaraba

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Market Prospects
PriceEarnings Ratio

Dividend Yield

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Market Prospects
Use this information to calculate the market ratios for Norton Corporation.
NORTON CORPORATION December 31, 2008
Earnings per Share Market Price Annual Dividend per Share $ 1.96 15.00 2.00

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Price-Earnings Ratio
Price-Earnings Market Price Per Share = Ratio Earnings Per Share Price-Earnings $15.00 = = 7.65 times Ratio $1.96

This measure is often used by investors as a general guideline in gauging stock values. Generally, the higher the price-earnings ratio, the more opportunity a company has for growth. Intisar M.Usmani FCMA
First Habib Modaraba

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Dividend Yield
Dividend Annual Dividends Per Share = Yield Market Price Per Share Dividend $2.00 = = 13.3% Yield $15.00

This ratio identifies the return, in terms of cash dividends, on the current market price of theFCMA stock. Intisar M.Usmani
First Habib Modaraba

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Thank you

Intisar M.Usmani FCMA First Habib Modaraba