Chapter 15 Financial Analysis1426

1
Click to edit Master title style
Financial
Statement
Analysis
1
5
1
Revised by Judy Beebe, Western Oregon University
Horizontal Analysis
151
The percentage analysis of

increases and decreases in
related items in comparative
financial statements is called
horizontal analysis.
2
Exhibit 1 Comparative Balance Sheets

Lincoln Company
Comparative Balance Sheet
December 31, 2008 and 2007
2008
2007
151
Increase (Decrease)
Amount
Percent
Assets
Current assets $ 550,000 $ 533,000
$ 17,000 3.2%
Long-term investments 95,000
177,500 (82,500) (46.5%)
Prop., plant, and equip. (net) 444,500 470,000 (25,500) (5.4%)
Intangible assets
50,000
50,000
Total assets
$1,139,500
$1,230,500
$ (91,000)(7.4%)
Liabilities
Current liabilities $ 210,000
$ 243,000
$ (33,000)(13.6%)
Long-term liabilities
100,000
200,000
100,000) (50.0%)
Total liabilities $ 310,000
$ 443,000
$(133,000)(30.0%)
Stockholders Equity
Preferred 6% stock, $100 par $ 150,000
$ 150,000
Common stock, $10 par 500,000 500,000

Retained earnings
179,500
137,500
$ 42,000 30.5%
Total stockholders equity $ 829,500
$ 787,500
$ 42,000 5.3%
Total liab. & stockholders eq. $1,139,500
$1,230,500
$ (91,000)(7.4%)

Lincoln Company
2008
2007
151
Increase (Decrease)
Amount
Percent
Assets
Current assets $ 550,000 $ 533,000
$ 17,000 3.2%
177,500 (82,500) (46.5%)
Horizontal
Intangible assets
50,000
50,000 Analysis:
Total assets
$1,139,500
$1,230,500
$ (91,000)(7.4%)
Liabilities
Difference
$17,000
$ 243,000
$ (33,000)(13.6%)= 3.2%
Base year
(2007) $533,000
100,000
200,000
100,000) (50.0%)
$ 443,000
$(133,000)(30.0%)
Stockholders Equity
$ 150,000
Common stock, $10 par 500,000 500,000

Retained earnings
179,500
137,500
$ 42,000 30.5%
$ 787,500
$ 42,000 5.3%
$1,230,500
$ (91,000)(7.4%)

Lincoln Company
2008
2007
151
Increase (Decrease)
Amount
Percent
Assets
Current assets $ 550,000 $ 533,000
$ 17,000 3.2%
177,500 (82,500) (46.5%)
Intangible assets
50,000
50,000
Horizontal
Analysis:
Total assets
$1,139,500
$1,230,500
$ (91,000)(7.4%)
Liabilities
$ 243,000
$ (33,000)(13.6%)
Difference
$(82,500)
100,000
200,000
100,000) =
(50.0%)
(46.5%)
Base $year
(2007)$(133,000)(30.0%)
$177,500
443,000
Stockholders Equity
$ 150,000
Common stock, $10 par 500,000 500,000

Retained earnings
179,500
137,500
$ 42,000 30.5%
$ 787,500
$ 42,000 5.3%
$1,230,500
$ (91,000)(7.4%)

Comparative Schedule of
Current Assets
151
Lincoln Company
Comparative Schedule of Current Assets
Cash
Marketable securities
Accounts receivable (net)
Inventories
Prepaid expenses
Total current assets
2008
2007
$ 90,500 $ 64,700
75,000
60,000
115,000 120,000
264,000 283,000
5,500
5,300
$550,000 $533,000
Increase (Decrease)
Amount Percent
$ 25,800
39.9%
15,000
25.0%
(5,000)
(4.2%)
(19,000)
(6.7%)
200
3.8%
$17,000
3.2%
6
151
Lincoln Company
Comparative Schedule of Current Assets
Increase (Decrease)
2008
2007
Amount Percent
Cash
$ 90,500 $ 64,700 $ 25,800
39.9%
75,000
60,000
15,000
25.0%
115,000 120,000 (5,000)
(4.2%)
Horizontal
Analysis:
Inventories
264,000 283,000 (19,000)
(6.7%)
Prepaid expenses
5,500
5,300 $25,800
200
3.8%
Difference
$550,000 $533,000 $17,000 = 39.9%
3.2%
Base year (2007)
$64,700
97

Comparative Income Statement
Lincoln Company
For the Year Ended December 31, 2008 and 2007
Increase (Decrease)
2008
2007
Amount
Percent
Sales
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Other income
Other expense (interest)
Income before income tax
Income tax expense
Net income
$1,530,500
32,500
$1,498,000
1,043,000
$ 455,000
$ 191,000
104,000
$ 295,000
$ 160,000
8,500
$ 168,500
6,000
$ 162,500
71,500
$ 91,000
$1,234,000
34,000
$1,200,000
820,000
$ 380,000
$ 147,000
97,400
$ 244,400
$ 135,600
11,000
$ 146,600
12,000
$ 134,600
58,100
$ 76,500
$296,500
(1,500)
$298,000
223,000
$ 75,000
$ 44,000
6,600
$ 50,600
$ 24,400
(2,500)
$ 21,900
(6,000)
$ 27,900
13,400
$ 14,500
24.0%
(4.4%)
24.8%
27.2%
19.7%
29.9%
6.8%
20.7%
18.0%
(22.7%)
14.9%
(50.0%)
20.7%
23.1%
19.0%
151
Lincoln Company
For the Year Ended December 31, 2008 and 2007
Increase (Decrease)
2008
2007
Amount
Percent
Current assets
$1,530,500
$1,234,000 $296,500
24.0%
Sales returns and allowances
32,500
34,000
(1,500)
(4.4%)
Net sales
$1,498,000
$1,200,000 $298,000
24.8%
Cost of goods sold
1,043,000
820,000
223,000
27.2%
Gross profit
$ 455,000
$ 380,000 $ 75,000
19.7%
Selling expenses
$ 191,000
$ 147,000 $ 44,000
29.9%
Horizontal104,000
Analysis: 97,400
6,600
6,.8%
$ 295,000
$ 244,400 $ 50,600
20.7%
$ 160,000
$ 24,400
18.0%
Increase
amount$ 135,600
$296,500
Other income
8,500
11,000
(2,500)
= 24.0%(22.7%)
$ 168,500
146,600 $ 21,900
14.9%
Base year
(2007)$$1,234,000
6,000
12,000
(6,000)
(50.0%)
$ 162,500
$ 134,600 $ 27,900
20.7%
Income tax expense
71,500
58,100
13,400
23.1%
Net income
$ 91,000
$ 76,500 $ 14,500
19.0%
151
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10
Comparative Retained
Earnings Statement
151
Lincoln Company
Comparative Retained Earnings Statement
A percentage analysis that

Increase (Decrease)
shows the relationship
each Percent
2008
2007 ofAmount
Retained earnings, Jan. 1 $137,500 $100,000 $37,500
37.5%
component
to
the
total
within
Net income for year
91,000
76,500
14,500
19.0%
Total
$228,500 $176,500
$52,000
29.5%)
a single statement
is called
Dividends:
analysis.
On preferred stock vertical
$ 9,000
$ 9,000
On common stock
Total
40,000
30,000
$ 49,000 $ 39,000
$179,500 $137,500
10,000
$10,000
$42,000
33.3%
25.6%
30.5%
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11
11

Lincoln Company
Comparative Retained Earnings Statement
151
A percentage analysis that

Increase (Decrease)
shows the relationship
each Percent
2008
2007 ofAmount
Retained earnings, Jan. 1 $137,500 $100,000 $37,500
37.5%
component
to
the
total
within
Net income for year
91,000
76,500
14,500
19.0%
Total
$228,500 $176,500
$52,000
29.5%)
a single statement
is called
Dividends:
analysis.
On preferred stock vertical
$ 9,000
$ 9,000
Horizontal Analysis:
On common stock
40,000
30,000
10,000
33.3%
Total
$ 49,000
$ 39,000
$10,000
25.6%
Increase
amount
$37,500
$179,500 $137,500 $42,000
30.5%
= 37.5%
Base year (2007) $100,000
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151
Example Exercise 15-1
The comparative cash and accounts receivable for a

company are provided below:
2008
2007
Cash
$62,500 $50,000
74,400 80,000
Based on this information, what is the amount and
percentage of increase or decrease that would be shown
in a balance sheet with horizontal analysis?
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151
Follow My Example 15-1
Cash
$12,500 increase ($62,500
$50,000), or 25%
Accounts
Receivable $5,600 decrease ($74,400 $80,000)
or 7%
For Practice: PE 15-1A, PE 15-1B
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Vertical Analysis
151
A percentage analysis used to

show the relationship of each
component to the total within a
single statement is called
vertical analysis.
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Vertical Analysis of Balance Sheet
151
In a vertical analysis of the balance

sheet, each asset item is stated as a
percent of the total assets. Each
liability and stockholders equity item
is stated as a percent of the total
liabilities and stockholders equity.
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Lincoln Company
For the Years Ended December 31, 2008 and 2007
2008
2007
Amount Percent
Amount Percent
Assets
Current assets
$ 550,000
Long-term investments
95,000
Property, plant, & equip. (net)
444,500
Intangible assets
50,000
Total
assets
$1,139,500
Total
assets
$1,139,500
Liabilities
Current liabilities
$ 210,000
100,000
Total liabilities
$ 310,000
Stockholders Equity
Preferred 6% stock, $100 par
$ 150,000
2.2% Common stock, $10 par
500,000
Retained earnings
179,500
Total stockholders equity
$ 829,500
Totalliab.
liab.&&stockholders
Stockholdersequity
equity $1,139,500
$1,139,500
Total
48.3%
8.3
39.0
4.4
100.0%
100.0%
18.4%
8.8
27.2%
13.2%
43.9
15.7
72.8%
100.0%
100.0%
151
$ 533,000
43.3%
177,500
14.4
470,000
38.2
50,000
4.1
$1,230,500 100.0%
$1,230,500100.0%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
$ 150,000
12.2%
500,000
40.6
137,500
11.2
$ 787,500
64.0%
$1,230,500 100.0%
$1,230,500100.0%
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151
To demonstrate how vertical

analysis percentages are
calculated for the balance sheet,
lets see how the 48.3 percent
was calculated for the 2008
current assets in the next slide.
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Lincoln Company
2008
2007
Amount Percent
Amount Percent
Assets
Current assets
$ 550,000
Long-term investments
95,000
Property, plant, & equip. (net)
444,500
Intangible assets
50,000
Total
assets
$1,139,500
Total
assets
$1,139,500
Liabilities
Current liabilities
$ 210,000
100,000
Total liabilities
$ 310,000
Stockholders
Equity
Vertical Analysis:
Preferred 6% stock, $100 par
$ 150,000
2.2%
Common stock,
$10 par $550,000
500,000
Current
assets
Retained earnings
179,500
Total
stockholders
$ 829,500
Total
assetsequity $1,139,500
Totalliab.
liab.&&stockholders
Stockholdersequity
equity $1,139,500
$1,139,500
Total
48.3%
8.3
39.0
4.4
100.0%
100.0%
18.4%
8.8
27.2%
151
$ 533,000
43.3%
177,500
14.4
470,000
38.2
50,000
4.1
$1,230,500 100.0%
$1,230,500100.0%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
13.2%
$ 150,000
1
43.9
500,000
40.6
=15.7
48.3% 137,500 11.2
72.8%
$ 787,500
64.0%
100.0%
$1,230,500 100.0%
100.0% $1,230,500100.0%
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Vertical Analysis of Income Statement
151
In a vertical analysis of the

income statement, each item is
stated as a percent of net sales.
As an example, lets see how the
percent of 12.8% was calculated
for 2008 selling expenses.
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Lincoln Company
2008
2007
Amount Percent
Amount
Percent
Sales
$1,530,500 102.2%
$1,234,000
102.8%
Sales returns and allow.
32,500
2.2
34,000
2.8
Net sales
$1,498,000 100.0%
$1,200,000
100.0%
Cost of goods sold
1,043,000
69.6
820,000
68.3
Gross profit
$ 455,000
30.4%
$ 380,000
31.7%
Selling expenses
$ 191,000
12.8%
$ 147,000
12.3%
104,000
6.9
97,400
8.1
$ 295,000
19.7%
$ 244,400
20.4%
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3%
$ 146,600
12.2%
6,000
0.4
12,000
1.0
Income before income tax $ 162,500
10.9%
$ 134,600
11.2%
Income tax expense
71,500
4.8
58,100
4.8
Net income
$ 91,000
6.1%
$ 76,500
6.4%
151
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Lincoln Company
2008
2007
Amount Percent
Amount
Percent
Sales
$1,530,500 102.2%
$1,234,000
102.8%
Sales returns and allow.
32,500
2.2
34,000
2.8
Net sales
$1,498,000 100.0%
$1,200,000
100.0%
Cost of goods sold
1,043,000
69.6
820,000
68.3
Gross profit
$ 455,000
30.4%
$ 380,000
31.7%
Selling expenses
$ 191,000
12.8%
$ 147,000
12.3%
104,000
6.9
97,400
8.1
$ 295,000
19.7%
$ 244,400
20.4%
$ 160,000
10.7
$ 135,600
11.3%
Other income
8,500
0.6
11,000
0.9
$ 168,500
11.3%
$ 146,600
12.2%
Other expense
(interest)
6,000
0.4
12,000
1.0
Vertical
Analysis:
Income before income tax $ 162,500
10.9%
$ 134,600
11.2%
Selling
expenses
$191,000
Income tax
expense
71,500
4.8
58,100
4.8
=6.1%
12.8%$ 76,500
Net income
$ 91,000
6.4%
Net sales
$1,498,000
151
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Common-Size Statements
151
In a common-sized statements, all

items are expressed as a percentage.
Common-sized statements are
useful in comparing the current
period with prior periods, individual
businesses, or one business with
with industry percentages.
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Statement to edit Master title style
Common-Size Income
151
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151
Income statement information for Lee Corporation is

provided below:
Lee Corporation
Sales
$100,000
Cost of goods sold
Prepare a vertical analysis of the income statement for
Lee Corporation.
65,000
Gross profit
$ 35,000
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151
Sales
Cost of goods
65,000
Gross profit
Amount Percentage
$100,000 100% ($100,000/$100,000)
sold
65($65,000/$100,000)
35,000 35% ($35,000/$100,000)
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Solvency Analysis
152
The ability of a business to meet

its financial obligations (debts)
is called solvency.
The ability of a business to earn
income is called profitability.
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Current Position Analysis
152
Using measures to assess a

businesss ability to pay its
current liabilities is called
current position analysis. Such
analysis is of special interest to
short-term creditors.
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Working Capital
152
The excess of current assets of a

business over its current liabilities
is called working capital. The
working capital is often used in
evaluating a companys ability to
meet currently maturing debts.
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152
Lincoln Company
Current asset:
Cash $ 90,500
Marketable securities 75,000
Accounts receivable (net) 115,000
Inventories 264,000
Prepaid expenses 5,500
a. Total current assets
$550,000
b. Current liabilities
210,000
Working capital (a b)
$340,000
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Current Ratio
152
The current ratio, sometimes

called the working capital
ratio or bankers ratio, is
computed by dividing the total
current assets by the total
current liabilities.
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152
Lincoln Company
a. Current assets
Working capital (a b)
Current ratio (a/b)
2008
$550,000
210,000
$340,000
2007
$533,000
243,000
$290,000
2.6
2.2
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Quick Ratio
152
A ratio that measures the

instant debt-paying ability
of a company is called the
quick ratio or acid-test ratio.
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Quick
Quickassets
assetsare
arecash
cash
and
andother
othercurrent
currentassets
assets
that
thatcan
canbe
bequickly
quickly
converted
convertedtotocash
cash..
152
Lincoln Company
Quick assets:
Cash
a. Total quick assets
Quick ratio (a/b)
2008
2007
$ 90,500
75,000
115,000
$280,500
$210,000
1.3
$ 64,700
60,000
120,000
$244,700
$243,000
1.0
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152
The following items are reported on a companys

balance sheet:
Cash
$300,000
100,000
Determine
(a) the current ratio and (b) the quick ratio.
200,000
Inventory
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to
edit
Master
title
style
152
a. Current Ratio = Current Assets/Current Liabilities

Current Ratio = ($300,000 + $100,000 + $200,000 +
$200,000)/$400,000
Current Ratio =2.0
b. Quick Ratio =
Quick Assets (cash, marketable securities,
and
accounts receivable)/Current Liabilities
(accounts payable)
Quick Ratio = ($300,000 + $100,000 + $200,000)/$400,000
Quick Ratio = 1.5
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Accounts Receivable Turnover
152
The relationship between sales and

accounts receivable may be stated as
the accounts receivable turnover.
The ratio is to assess the efficiency of
the firm in collecting receivables and
in the managing of credit.
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Lincoln Company
152
2008
2007
a. Net sales $1,498,000
$1,200,000
Accounts receivable (net):
Beginning of year $ 120,000
$ 140,000
End of year
115,500
120,000
Total $ 235,000
$ 260,000
b. Average (Total/2)
$ 117,500
$ 130,000
Accounts receivable turnover
(a/b)
12.7
9.2
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Number of Days Sales in

Receivables
152
The number of days sales in

receivables is an estimate of the length
of time (in days) the accounts
receivable have been outstanding.
Comparing this measure with the credit
terms provides information on the
efficiency in collecting receivables.
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Master
Lincoln
Companytitle style
152
2008
2007
a. Average (Total/2) $ 117,500$ 130,000
Net sales $1,498,000
$1,200,000
b. Average daily sales on
account (Sales/365) $
4,104
$
3,288
Number of days sales in
receivables (a/b)
28.6
39.5
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40
152
A company reports the following:

Net sales
$960,000
Determine
(a) the accounts receivable turnover and (b)
Averageofaccounts
receivable
(net) Round to one
the number
days sales
in receivables.
decimal place.
48,000
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41
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to
edit
Master
title
style
152
a. Accounts Receivable Turnover = Sales/Average accounts

receivable
Accounts Receivable Turnover = $960,000/$48,000
Accounts Receivable Turnover = 20.0
b. Number of Days Sales in Receivables = Average accounts
receivable/Average
daily sales
Number of Days Sales in Receivables =
$48,000/
($960,000/ 365)
$48,000/$2,630
18.3 days
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Inventory Turnover
152
The relationship between the

volume of goods (merchandise)
sold and inventory may be stated
as the inventory turnover. The
purpose of this ratio is to assess
the efficiency of the firm in
managing its inventory.
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43

Lincoln Company
152
2008
2007
$1,043,000
$ 820,000
a. Cost of goods sold

Inventories:
Beginning of year $ 283,000
$ 311,000
End of year
264,000
283,000
Total $ 547,000
$ 594,000
$ 273,500
$ 297,000
Inventory
turnover (a/b)
3.8
2.8
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Number of Days Sales in Inventory
152
Lincoln Company
2008
2007
a. Average (Total/2) $ 273,500
$ 297,000
Cost of goods sold $1,043,000
$ 820,000
b. Average daily cost of goods
sold (COGS/365 days) $2,858 $2,247
Number of days sales in
inventory (a/b)
95.7
132.2
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152

Cost of goods sold
Determine
(a) the inventory turnover and
$560,000
(b) the
number
of days sales in inventory.
Average
inventory
Round to one decimal place.
112,000
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46
152
a. Inventory Turnover = Cost of Goods Sold/Average

Inventory
Inventory Turnover = $560,000/$112,000
Inventory Turnover = 5.0
b. Number of Days Sales in Inventory = Average Inventory/
Average Daily Cost
of Goods Sold
Number of Days Sales in Inventory = $112,000/
($560,000/365)
Number of Days Sales in Inventory = $112,000/$1,534
Number of Days Sales in Inventory = 73.0 days
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Ratio of Fixed Assets to Long-Term

Liabilities
152
The ratio of fixed assets to longterm liabilities is a solvency measure

that indicates the margin of safety of
the noteholders or bondholders. It
also indicates the ability of the
business to borrow additional funds
on a long-term basis.
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48
152

Lincoln Company
a. Fixed assets (net)
b. Long-term liabilities
Ratio of fixed assets to
long-term liabilities (a/b)
2008
$444,500
$100,000
4.4
2007
$470,000
$200,000
2.4
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Ratio of Liabilities to Stockholders

Equity
152
The relationship between the

total claims of the creditors and
ownersthe ratio of liabilities to
stockholders equityis a
solvency measure that indicates
the margin of safety for creditors.
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50

Lincoln Company
a. Total liabilities
b. Total stockholders equity
Ratio of liabilities to
stockholders equity (a/b)
2008
$310,000
$829,500
0.4
152
2007
$443,000
$787,500
0.6
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51
152
The following information was taken from Acme

Companys balance sheet:
Fixed assets (net)
$1,400,000
Determine the companys (a) ratio of fixed assets to
400,000
long-term
liabilities and (b) ratio of liabilities to
Total liabilities
stockholders
equity.
560,000
Total stockholders equity
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52
52
152
a. Ratio of Fixed Assets to Long-Term Liabilities = Fixed Assets/

LongTerm
Liabilities
Ratio of Fixed Assets to Long-Term Liabilities = $1,400,000/
$400,000
Ratio of Fixed Assets to Long-Term Liabilities = 3.5
b. Ratio of Liabilities to Total Stockholders Equity = Total
Liabilities/Total Stockholders Equity
Ratio of Liabilities to Total Stockholders Equity = $560,000/
$1,400,000
Ratio of Liabilities to Total Stockholders Equity = 0.4
52
53
53
Number of Times Interest Charges

Earned
152
Corporations in some industries

normally have high ratios of debt to
stockholders equity. For such
corporations, the relative risk of the
debtholders is normally measured as the
number of times interest charges are
earned (during the year), sometimes
called the fixed charge coverage ratio.
53
54
54

Lincoln Company
152
2008
2007
Income before income tax $162,500 $134,600
a. Add interest expense
6,000
12,000
b. Amount available to meet
interest charges $168,500 $146,600
Number of times interest
charges earned (b/a)
28.1
12.2
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55
55
152

$250,000
Determine
the number of times interest charges
Interest expense
are earned.
100,000
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56
56
152
Number of Times Interest Charges are Earned =

(Income Before Income Tax + Interest Expense)/
Interest Expense
Number of Times Interest Charges are Earned =
($250,000 + $100,000)/$100,000
Number of Times Interest Charges are Earned = 3.5
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57
57
Profitability Analysis
Profitability is the ability of an entity to earn

profits.
This ability to earn profits depends on the
effectiveness and efficiency of operations as
well as resources available as reported in the
balance sheet.
Profitability analysis focuses primarily on
the relationship between operating results
reported in the income statement and
resources reported in the balance sheet.
153
57
58
58
Ratio of Net Sales to Assets
153
The ratio of net sales to assets

is a profitability measure that
shows how effectively a firm
utilizes its assets.
58
59
59

Lincoln Company
a. Net sales
Total assets:
Beginning of year
End of year
Total
2008
$1,498,000
2007
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
153
Excludes
Excludes long-term
long-term investments
investments
59
60
60

Lincoln Company
a. Net sales
Total assets:
Beginning of year
End of year
Total
Ratio of net sales to assets (a/b)
2008
$1,498,000
2007
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
1.4
1.2
153
60
61
61
153

Net sales
$2,250,000
Determine
the ratio of net sales to assets.
Average total sales
Ratio of1,500,000
Net Sales to Total Assets = Net Sales/Average Total
Assets
Ratio of Net Sales to Total Assets = $2,250,000/$1,500,000
Ratio of Net Sales to Total Assets = 1.5
61
62
62
Rate Earned on Total Assets
153
The rate earned on total

assets measures the
profitability of total assets,
without considering how the
assets are financed.
62
63
63

Lincoln Company
Net income
Plus interest expense
a. Total
Total assets:
Beginning of year
End of year
Total
Rate earned on total
assets (a/b)
2008
$ 91,000
6,000
$ 97,000
2007
$ 76,500
12,000
$ 88,500
$1,230,500
1,139,500
$2,370,000
$1,185,000
$1,187,500
1,230,500
$2,418,000
$1,209,000
8.2%
153
7.3% 63
64
64
153
A company reports the following income statement and

balance sheet information for the current year:
Net income
$ 125,000
Interest expense
Determine the rate earned on total assets.
25,000
Average total assets
2,000,000
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65
65
153
Rate Earned on Total Assets = (Net Income + Interest

Expense)/Average Total
Assets
Rate Earned on Total Assets = ($125,000 + $25,000)/
$2,000,000
Rate Earned on Total Assets = 7.5%
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66
66
Rate Earned on Stockholders Equity
153
The rate earned on

stockholders equity measure
emphasizes the rate of income
earned on the amount invested
by the stockholders.
66
67
67

Lincoln Company
a. Net income
Stockholders equity:
Beginning of year
End of year
Total
Rate earned on stockholders
equity (a/b)
2008
$ 91,000
2007
$ 76,500
$ 787,500
829,500
$1,617,000
$ 808,500
$ 750,000
787,500
$1,537,500
$ 768,750
11.3%
153
10.0%
67
68
68
Leverage
153
The difference in the rate

earned on stockholders equity
and the rate earned on total
assets is called leverage.
68
69
69

Leverage
11.3%
10%
8.2%
Leverage
3.1%
153
10.0%
7.3%
Leverage
2.7%
5%
0%
2008
Rate earned on
total assets
2007
Rate earned on
stockholders equity
69
70
70
Rate Earned on Common

Stockholders Equity
153
The rate earned on common

stockholders equity focuses
only on the rate of profits
earned on the amount invested
by the common stockholders.
70
71
71
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Master
Lincoln
Companytitle style
2008
91,000
9,000
82,000
Net income
$
Less preferred dividends
a. Remaindercommon stock $
Common stockholders equity:
Beginning of year
$ 637,500
End of year
679,500
Total
$1,317,000
$ 658,500
Rate earned on common
stockholders equity (a/b)
12.5%
153
2007
$ 76,500
9,000
$ 67,500
$ 600,000
637,500
$1,237,500
$ 618,750
10.9%
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72
72
153

Net income
$ 125,000
Preferred dividends
5,000
Determine
(a) the rate earned on stockholders equity
stockholders
equity stockholders
and Average
(b) the rate
earned on common
equity.
1,000,000
Average common stockholders
equity
72
73
73
153
a. Rate Earned on Stockholders Equity = Net Income/Average

Stockholders Equity
Rate Earned on Stockholders Equity = $125,000/$1,000,000
Rate Earned on Stockholders Equity = 12.5%
b. Rate Earned on Common Stockholders Equity = (Net

Income Preferred Dividends)/Average Common
Stockholders Equity
Rate Earned on Common Stockholders Equity =
($125,000 $5,000)/$800,000
Rate Earned on Common Stockholders Equity = 15%
73
74
74
Earnings per Share on Common Stock
153
One of the profitability

measures often quoted by the
financial press is earning per
share (EPS) on common stock.
It is also normally reported in
the income statement in
corporate annual reports.
74
75
75

Lincoln Company
2008
Net income $ 91,000 $ 76,500
Preferred dividends
9,000
9,000
a. Remainderidentified with
common stock $ 82,000 $ 67,500
b. Shares of common stock 50,000 50,000
Earnings per share on common
stock (a/b)
$1.64
153
2007
$1.35
75
76
76
Price-Earnings Ratio
153
Another profitability measure

quoted by the financial press
is the price-earnings (P/E)
ratio on common stock. The
price-earnings ratio is an
indicator of a firms future
earnings prospects.
76
77
77
153
Lincoln Company
2008
Market price per share of
common stock
Earnings per share on common
stock
Price-earnings ratio on
common stock
2007
$41.00 $27.00
/ 1.64
25
/ 1.35
20
77
78
78
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to
edit
Master
title
style
153

Net income
$250,000
Preferred dividends
$15,000
Shares of common stock
outstanding
a. Determine
the companys earnings per share on
20,000
common
stock.
Market price
share of price-earnings ratio.
b. Determine
the per
companys
common
Round
to onestock
decimal place.
$35
78
79
79
153
(a) Earnings Per Share of Common Stock = (Net

Income Preferred Dividends)/Shares of
Common Stock Outstanding
Earnings per Share of Common Stock =
($250,000 $15,000)/20,000
Earnings per Share of Common Stock =
$11.75
(Continued)
79
80
80
153

(b) Price-Earnings Ratio = Market Price per Share of
Common Stock/Earnings per Share on Common
Stock
Price-Earnings Ratio = $35.00/$11.75
Price-Earnings Ratio = 3.0
(Concluded)
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81
81
Dividends per Share
153
Dividends per share can be reported

with earnings per share to indicate the
relationship between dividends and
earnings. Comparing these two per
share amounts indicates the extent to
which the corporation is retaining its
earnings for use in operations.
81
82
82

Dividends and Earning per
Share of Common Stock
153
Lincoln Company
$2.00
$1.64
Per
share
$1.50
$1.00
$1.35
$0.80
$0.60
$0.50
$0.00
2008
Dividends
2007
Earnings
82
83
83
Dividend Yield
153
The dividend yield on common

stock is a profitability measure
that shows the rate of return to
common stockholders in terms
of cash dividends.
83
84
84
153
Lincoln Company
2008
Dividends per share of
common stock
$ 0.60
Market price per share of
common stock
Dividend yield on
/27.00
common stock
2007
$ 0.80
/41.00
2.0%
2.2%
84
85
85
Corporate Annual Reports
154
In addition to the financial statements and

the accompanying notes, corporate annual
reports usually include the following
sections:
Management Discussion and Analysis
Report on adequacy of internal control
Report on fairness of financial statements
85
86
86
Management Discussion and

Analysis
154
The Management Discussion and Analysis

(MD&A) includes an analysis of the results
of operations and discusses managements
opinion about future performance. It
compares the prior years income statement
with the current years. It also contains an
analysis of the firms financial condition.
86
87
87
Report on Adequacy of
Internal Control
154
Management is required by the SarbanesOxley Act of 2002 to provide a report stating

their responsibility for establishing and
maintaining internal control. In addition, the
report must state managements conclusion
concerning the effectiveness of internal
controls over financial reporting.
87
88
88
Report on Fairness of Financial

Statements
154
All publicly held corporations are

required to have an independent audit
(examination) of their financial
statements. The CPAs who conduct the
audit render an opinion on the fairness
of the statements.
88

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1

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The percentage analysis of

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Exhibit 1 Comparative Balance Sheets

Common stock, $10 par 500,000 500,000

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Common stock, $10 par 500,000 500,000

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Common stock, $10 par 500,000 500,000

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Base year (2007)

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A percentage analysis that

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A percentage analysis that

Base year (2007) $100,000

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Example Exercise 15-1

The comparative cash and accounts receivable for a

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Follow My Example 15-1

For Practice: PE 15-1A, PE 15-1B

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A percentage analysis used to

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Vertical Analysis of Balance Sheet

In a vertical analysis of the balance

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To demonstrate how vertical

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Vertical Analysis of Income Statement

In a vertical analysis of the

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Comparative Income Statement

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In a common-sized statements, all

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Example Exercise 15-2

Income statement information for Lee Corporation is

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Follow My Example 15-2

For Practice: PE 15-2A, PE 15-2B

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The ability of a business to meet

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Current Position Analysis

Using measures to assess a

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The excess of current assets of a

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The current ratio, sometimes

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A ratio that measures the

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