chapter 13 Analyzing Financial Statements

Financial Accounting
9e
Libby • Libby • Hodge

13-1
Understanding the Business

External Decision Makers Include

 Present and potential owners Annual
 Investment analysts Report
 Creditors

13-2
The Investment Decision

Economy-wide
Industry Factors
Individual
Factors Company Factors

Invest?

No Yes

13-3
Understanding a Company’s Strategy

Is the company trying to earn a high rate of return through product

differentiation or cost differentiation?

13-4
Financial Statement Analysis

Financial statement analysis

is based on comparisons.

Time-series analysis Cross-sectional analysis

Examines a single Provides insights concerning

company to identify a company’s relative
trends over time. performance to other
companies.

13-5
Component Percentages

Express each item on a particular statement as a

percentage of a single base amount.

Net sales Total assets

on the income on the balance
statement sheet

The comparative income statements of The Home Depot

for 2013, 2014, and 2015 appear on the next slide.

Prepare component percentage income statements

where net sales equal 100 percent.

13-6
Exhibit 13.1
The Home Depot Financial Statements
Net sales will be set to
100 percent,THE
andHOME DEPOT, INC., AND SUBSIDIARIES
all other
Consolidated Statement of Earnings
components will be in millions, except per share data)
(amounts
expressed as a Fiscal Year Ended
February 1, February 2, February 3,
percentage of net sales. 2015 2014 2013
Net Sales $83,176 $78,812 $74,754
Cost of Sales 54,222 51,422 48,912
Gross Profit 28,954 27,390 25,842
Operating Expenses:
Selling, General and Administrative 16,834 16,597 16,508
Depreciation and Amortization 1,651 1,627 1,568
Total Operating Expenses 18,485 18,224 18,076
Operating Income 10,469 9,166 7,766
Interest and Other (Income) Expense:
Interest and Investment Income (337) (12) (20)
Interest Expense 830 711 632
Other — — (67)
Interest and Other, net 493 699 545
Earnings before Provision for Income Taxes 9,976 8,467 7,221
Provision for Income Taxes 3,631 3,082 2,686
Net Earnings $ 6,345 $ 5,385 $ 4,535
Weighted Average Common Shares 1,338 1,425 1,499
Basic Earnings per Share $ 4.74 $ 3.78 $ 3.03
Diluted Weighted Average Common Shares 1,346 1,434 1,511
Diluted Earnings per Share $ 4.71 $ 3.76 $ 3.00

13-7
Exhibit 13.1
The Home Depot Financial Statements
Net sales will be set to
100 percent,THE
andHOME DEPOT, INC., AND SUBSIDIARIES
all other 2014 Cost of Sales ÷ 2014 Net
Consolidated Statement of Earnings
components will be in millions, except per shareSales$54,222
(amounts data) ÷ $83,176 = 0.6519 or
expressed as a 65.19%
Fiscal Year Ended
February 1, February 2, February 3,
percentage of net sales. 2015 2014 2013
Net Sales $83,176 $78,812 $74,754
Cost of Sales 54,222 2014 Gross
51,422 Profit ÷
2014 Net Sales
48,912
Gross Profit 28,954 27,390 25,842
Operating Expenses: $28,954 ÷ $83,176 = 0.3481 or 34.81%
Selling, General and Administrative 16,834 16,597 16,508
Depreciation and Amortization 1,651 1,627 1,568
Total Operating Expenses 18,485 18,224 18,076
Operating Income 10,469
2014 Selling, G&A
9.166 7,766
÷
2014 Net Sales
Interest and Other (Income) Expense: $16,834 ÷ $83,176 = 0.2024 or 20.24%
Interest and Investment Income (337) (12) (20)
Interest Expense 830 711 632
Other — — (67)
Interest and Other, net 493 699 545
Earnings before Provision for Income Taxes 9,976 8,467 7,221
Provision for Income Taxes 3,631 3,082 2,686
Net Earnings $ 6,345 $ 5,385 $ 4,535
Weighted Average Common Shares 1,338 1,425 1,499
Basic Earnings per Share $ 4.74 $ 3.78 $ 3.03
Diluted Weighted Average Common Shares 1,346 1,434 1,511
Diluted Earnings per Share $ 4.71 $ 3.76 $ 3.00

13-8
Exhibit 13.2
Component Percentages for The Home Depot

COMPONENT PERCENTAGES*
February 1, 2015 February 2, 2014 February 3, 2013
Income Statement (fiscal 2014) (fiscal 2013) (fiscal 2012)
Net sales 100.00% 100.00% 100.00%
Cost of Sales 65.19 65.25 65.43
Gross profit 34.81 34.75 34.57
Operating Expenses:
Selling, General, and Administrative 20.24 21.06 22.08
Depreciation and Amortization 1.98 2.06 2.10
Total Operating Expenses 22.22 23.12 24.18
Operating Income 12.59 11.63 10.39
Interest and Other (Income) Expense:
Interest and Investment Income (0.41) (0.01) (0.03)
Interest Expense 1.00 0.90 0.85
Other 0.00 0.00 (0.09)
Interest and Other, net 0.59 0.89 0.73
Earnings before Provision for Income Taxes 12.00 10.74 9.66
Provision for Income Taxes 4.37 3.91 3.59
Net Earnings 7.63 6.83 6.07
*Numbers are rounded.

13-9
Exhibit 13.1
The Home Depot Financial Statements
THE HOME DEPOT, INC., AND SUBSIDIARIES
Consolidated Balance Sheets
(amounts in millions, except share and per share data)
February 1, February 2,
2015 2014

ASSETS
Current Assets:
Cash and Cash Equivalents $ 1,723 $ 1,929
Receivables, net 1,484 1,398
Merchandise Inventories 11,079 11,057
Other Current Assets 1,016 895
Total Current Assets 15,302 15,279
Property and Equipment, at cost 38,513 39,064
Less Accumulated Depreciation and Amortization 15,793 15,716
Net Property and Equipment 22,720 23,348
Goodwill 1,353 1,289
Other Assets 571 602
Total Assets $39,946 $40,518

13-10
Exhibit 13.1
The Home Depot Financial Statements
February 1, February 2,
2015 2014
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Short-Term Debt $ 290 $ —
Accounts Payable 5,807 5,797
Accrued Salaries and Related Expenses 1,391 1,428
Sales Taxes Payable 434 396
Deferred Revenue 1,468 1,337
Income Taxes Payable 35 12
Current Installments of Long-Term Debt 38 33
Other Accrued Expenses 1,806 1,746
Total Current Liabilities 11,269 10,749
Long-Term Debt, excluding current installments 16,869 14,691
Other Long-Term Liabilities 1,844 2,042
Deferred Income Taxes 642 514
Total Liabilities 30,624 27,996
STOCKHOLDERS’ EQUITY
Common Stock, par value $0.05; authorized: 10 billion shares; issued: 1.768
billion shares at February 1, 2015, and 1.761 billion shares at February 2, 2014;
outstanding: 1.307 billion shares at February 1, 2015, and 1.380 billion shares
at February 2, 2014 88 88
Paid-In Capital 8,885 8,402
Retained Earnings 26,995 23,180
Accumulated Other Comprehensive (Loss) Income (452) 46
Treasury Stock, at cost, 461 million shares at February 1, 2015, and 381 million
shares at February 2, 2014 (26,194) (19,194)
Total Stockholders’ Equity 9,322 12,522
Total Liabilities and Stockholders’ Equity $39,946 $40,518
13-11
Return on Equity (ROE)

Profitability is a primary measure of

the overall success of a company.

Net Income
Return on Equity =
Average Stockholders’ Equity

$6,345
Return on Equity = = 58.09%
($9,322 + $12,522) ÷ 2

This measure indicates how much income was earned for every dollar
invested by the owners.

13-12
Return on Assets (ROA)

Return on Net Income

Assets = Average Total Assets

Return on $6,345
= = 15.77%
Assets ($39,946 + $40,518) ÷ 2

This ratio measures how well assets have been employed by the business.

13-13
Net Profit Margin

Net Profit Net Income

Margin =
Net Sales Revenue

Net Profit $6,345

Margin = = 7.63%
$83,176

This ratio tells us the percentage of each sales dollar, on average, that
represents income.

13-14
Earnings per Share (EPS)

Net Income*
EPS =
Weighted Average Number
of Shares Outstanding

Remember from Chapter 11 that if there are preferred dividends,

the amount is subtracted from net income.

$6,345
EPS = = $4.74
1,338

Average number of shares based on the number

of shares at the beginning and end of the year.

Earnings per share is probably the single most widely watched

financial ratio.

13-15
Earnings Quality
Earnings Cash Flows from Operating Activities
Quality = Net Income
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Earnings $6,345
The Home Depot’s Reconciliation of Net Earnings to Net Cash
Provided by Operating Activities:
Earnings Quality
Depreciation and Amortization 1,786
Stock-Based Compensation Expense 225
$8,242 Gain on Sales of Investments (323)
= 1.30 Goodwill Impairment —
$6,345
Changes in Assets and Liabilities, net of the
effects of acquisitions:
Receivables, net $ (81)
Merchandise Inventories (124)
Other Current Assets (199)
A ratio higher than 1 indicates
Accounts Payable and Accrued Expenses 244
high-quality earnings. Deferred Revenue 146
Income Taxes Payable 168
Deferred Income Taxes 159
Other Long-Term Liabilities (152)
Other 48
Net Cash Provided by Operating Activities 8,242

13-16
Total Asset Turnover Ratio

Total Asset Net Sales Revenue

=
Turnover Average Total Assets

Total Asset = $83,176 = 2.07

Turnover ($39,946 + $40,518) ÷ 2

This ratio captures how well a company uses its assets to generate
revenue.

13-17
Fixed Asset Turnover Ratio

Fixed
Net Sales Revenue
Asset =
Turnover Average Net Fixed Assets

Fixed
$83,176
Asset = = 3.61
Turnover ($22,720 + $23,348) ÷ 2

This ratio measures a company’s ability to generate sales given an

investment in fixed assets.

13-18
Receivable Turnover Ratio

Receivable Turnover Net Credit Sales

=
Ratio Average Net Receivables

Receivable Turnover $83,176

= = 57.72 times
Ratio ($1,484 + $1,398) ÷ 2

This ratio measures how quickly a company collects its

accounts receivable.

13-19
Tests of Liquidity ─ Average Age of
Receivables
Average Age of Days in Year
=
Receivables Receivable Turnover

Days Sales =
Outstanding

This ratio measures the average number of

days it takes to collect receivables.

13-20
Inventory Turnover Ratio

Inventory Cost of Goods Sold

Turnover Ratio = Average Inventory

Inventory $54,222
= = 4.90 times
Turnover Ratio ($11,079 + $11,057) ÷ 2

This ratio measures how quickly the company sells its

inventory.

13-21
Tests of Liquidity ─ Average Days’
Supply in Inventory
Average Days’ Days in Year
Supply in =
Inventory Turnover
Inventory

Average Days’
Supply in =
Inventory

This ratio measures the average number of

days it takes to sell the inventory.

13-22
Tests of Liquidity ─ Accounts
Payable Turnover RATIO
Accounts Cost of Goods Sold
Payable =
Average Accounts Payable
Turnover

Accounts
Payable =
Turnover

This ratio measures how quickly the

company pays its accounts payable.

13-23
The DuPont Model
FINANCIAL ANALYSIS

The DuPont model brings together several of the ratios

$$$
we have discussed so far and reflects how these ratios
are related. The model is:

ROE Net Profit Total Asset Financial

= × Turnover Leverage
Margin
×
Net Sales
Net Income Net Income Revenue Average Total Assets
Average Total Stockholders’
= Net Sales
× Average Total
× Average Total Stockholders’
Equity Revenue Assets Equity

13-24
Current Ratio

Current Current Assets

= Current Liabilities
Ratio

Current $15,302
= = 1.36
Ratio $11,269

This ratio measures the ability

of the company to pay current
debts as they become due.

13-25
Quick Ratio

Quick Quick Assets

=
Ratio Current Liabilities

Quick ($1,723 + $1,484 + $0)

= = 0.28
Ratio $11,269

This ratio is like the current ratio, but it measures the

company’s immediate ability to pay debts.

13-26
Times Interest Earned Ratio

Tests of solvency measure a company’s ability to meet its long-term

obligations.

Net Interest Income Tax

+ +
Times Interest = Income Expense Expense
Earned
Interest Expense

Times Interest $6,345 + $830 + $3,631

Earned = = 13.02 times
$830

This ratio indicates a margin of protection for creditors.

13-27
Debt-to-Equity Ratio

Total Liabilities
Debt-to-Equity Ratio =
Stockholders’ Equity

$30,624
Debt-to-Equity Ratio = = 3.29
$9,322

This ratio measures the amount of liabilities that exists for

each $1 invested by the owners.

13-28
Price/Earnings (P/E) Ratio

The price/earnings ratio reflects the stock market’s assessment of a

company’s future performance.

Current Market Price per Share

P/E Ratio =
Earnings per Share

$104.43
P/E Ratio = = 22.03
$4.74

At the end of fiscal 2014, The Home

Depot’s stock was trading at
$104.43 per share.

This ratio measures the relationship between the current market price of the
stock and its earnings per share.

13-29
Dividend Yield Ratio

Dividend Dividends per Share

=
Yield Ratio Market Price per Share

Dividend $1.16 = 1.11%

=
Yield Ratio $104.43

The Home Depot paid dividends of $1.16 per share when the market
price was $104.43 per share.

This ratio is often used to compare the dividend-paying performance of

different investment alternatives.

13-30