17-1

CHAPTER 17

ANALYSIS AND
INTERPRETATION OF

FINANCIAL STATEMENTS

Methods of
Financial Statement Analysis
Horizontal

Vertical
Trend

Analysis

Analysis

Percentages

17-2

17-3

Horizontal Analysis
Using comparative financial
statements to calculate dollar
or percentage changes in a
financial statement item from
one period to the next

17-4

Vertical Analysis
For a single financial
statement, each item
is expressed as a
percentage of a
significant total,
e.g., all income
statement items are
expressed as a
percentage of sales

17-5

Common-Size Statements
Financial statements that show
only percentages and no
absolute dollar amounts

17-6

Trend Percentages
Show changes over time in
given financial statement items
(can help evaluate financial
information of several years)

17-7

Horizontal Analysis Example

The management of Clover Company
provides you with comparative balance
sheets of the years ended December 31,
1999 and 1998. Management asks you to
prepare a horizontal analysis on the
information.

17-8

CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
1999

1998

Assets
Current assets:
Cash

12,000

23,500

Accounts receivable, net

60,000

40,000

Inventory

80,000

100,000

3,000

1,200

155,000

164,700

40,000

40,000

120,000

85,000

160,000

125,000

Prepaid expenses
Total current assets
Property and equipment:
Land
Buildings and equipment, net
Total property and equipment
Total assets

315,000

289,700

Incre
Amo

17-9

Horizontal Analysis Example

Calculating Change in Dollar Amounts
Dollar
Change

Current Year
Figure

Base Year
Figure

17-10

Horizontal Analysis Example

Calculating Change in Dollar Amounts
Dollar
Change

Current Year
Figure

Base Year
Figure

Since we are measuring the amount of

the change between 1998 and 1999, the
dollar amounts for 1998 become the
base year figures.

17-11

Horizontal Analysis Example

Calculating Change as a Percentage
Percentage
Change

Dollar Change
Base Year Figure

100%

17-12

Horizontal Analysis Example

CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
1999

1998

Increase (Decrease)
Amount
%

Assets
Current assets:
Cash
$
12,000 $
23,500 $ (11,500)
Accounts receivable, net
60,000
40,000
Inventory
80,000
100,000
Prepaid expenses
3,000
1,200
Total current assets
155,000
164,700
$12,000

$23,500
= $(11,500)
Property and equipment:
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

17-13

Horizontal Analysis Example

CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
1999

1998

Increase (Decrease)
Amount
%

Assets
Current assets:
Cash
$
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
Total current assets
155,000
164,700
($11,500

$23,500)
100% = 48.9%
Property and equipment:
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

17-14

Horizontal Analysis Example

CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
Increase (Decrease)
Amount
%

1999

1998

12,000 $
60,000
80,000
3,000
155,000

23,500 $ (11,500)
40,000
20,000
100,000
(20,000)
1,200
1,800
164,700
(9,700)

40,000
120,000
160,000
315,000 $

40,000
85,000
125,000
289,700 $

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
Total assets

35,000
35,000
25,300

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

17-15

Horizontal Analysis Example

Lets apply the same
procedures to the
liability and stockholders
equity sections of the
balance sheet.

17-16

CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
1999
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable
Notes payable
Total current liabilities
Long-term liabilities:
Bonds payable, 8%
Total liabilities
Stockholders' equity:
Preferred stock
Common stock
Additional paid-in capital
Total paid-in capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity

67,000 $
3,000
70,000

1998

Increase (Decrease)
Amount
%

44,000 $
6,000
50,000

23,000
(3,000)
20,000

52.3
(50.0)
40.0

75,000
145,000

80,000
130,000

(5,000)
15,000

(6.3)
11.5

20,000
60,000
10,000
90,000
80,000
170,000
315,000 $

20,000
60,000
10,000
90,000
69,700
159,700
289,700 $

10,300
10,300
25,300

0.0
0.0
0.0
0.0
14.8
6.4
8.7

17-17

Horizontal Analysis Example

Now, lets apply the
procedures to the
income statement.

17-18

CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999
1998
Amount
%
Net sales
$ 520,000 $ 480,000 $ 40,000
8.3
Cost of goods sold
360,000
315,000
45,000
14.3
Gross margin
160,000
165,000
(5,000)
(3.0)
Operating expenses
128,600
126,000
2,600
2.1
Net operating income
31,400
39,000
(7,600)
(19.5)
Interest expense
6,400
7,000
(600)
(8.6)
Net income before taxes
25,000
32,000
(7,000)
(21.9)
Less income taxes (30%)
7,500
9,600
(2,100)
(21.9)
Net income
$ 17,500 $ 22,400 $
(4,900)
(21.9)

17-19

CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 1999 and 1998
Increase (Decrease)
1999
1998
Amount
%
Net sales
$ 520,000 $ 480,000 $ 40,000
8.3
Cost of goods sold
360,000
315,000
45,000
14.3
Gross margin
160,000
165,000
(5,000)
(3.0)
Operating expenses
128,600
126,000
2,600
2.1
Net operating income
31,400
39,000
(7,600)
(19.5)
Interest expense
6,400
7,000
(600)
(8.6)
Sales increased by
8.3% while
net
Net income before taxes
25,000
32,000
(7,000)
(21.9)
income
decreased
by
21.9%.
Less income taxes (30%)
7,500
9,600
(2,100)
(21.9)
Net income
$ 17,500 $ 22,400 $
(4,900)
(21.9)

17-20

There were increases in both cost of goods

sold (14.3%) and operating expenses (2.1%).
These increased costs
more
than offset the
CLOVER
CORPORATION
Income
increase inComparative
sales, yielding
anStatements
overall
Fordecrease
the Years Ended
in netDecember
income. 31, 1999 and 1998
Net sales
Cost of goods sold
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before taxes
Less income taxes (30%)
Net income

1999
$ 520,000
360,000
160,000
128,600
31,400
6,400
25,000
7,500
$ 17,500

1998
$ 480,000
315,000
165,000
126,000
39,000
7,000
32,000
9,600
$ 22,400

Increase (Decrease)
Amount
%
$ 40,000
8.3
45,000
14.3
(5,000)
(3.0)
2,600
2.1
(7,600)
(19.5)
(600)
(8.6)
(7,000)
(21.9)
(2,100)
(21.9)
$
(4,900)
(21.9)

17-21

Vertical Analysis Example

The management of Sample Company asks
you to prepare a vertical analysis for the
comparative balance sheets of the
company.

17-22

Vertical Analysis Example

Sample Company
Balance Sheet (Assets)
At December 31, 1999 and 1998
% of Total Assets
1999
1998
1999
1998
Cash
$ 82,000
$ 30,000
17%
8%
Accts. Rec.
120,000
100,000
25%
26%
Inventory
87,000
82,000
18%
21%
Land
101,000
90,000
21%
23%
Equipment
110,000
100,000
23%
26%
Accum. Depr.
(17,000)
(15,000)
-4%
-4%
Total
$ 483,000
$ 387,000
100%
100%

17-23

Vertical Analysis Example

Sample Company
Balance Sheet (Assets)
At December 31, 1999 and 1998
% of Total Assets
1999
1998
1999
1998
Cash
$ 82,000
$ 30,000
17%
8%
Accts. Rec.
120,000
100,000
25%
26%
Inventory
18%
21%
$82,00087,000
$483,000 82,000
= 17% rounded
Land
101,000
90,000
21%
23%
$30,000 $387,000 = 8% rounded
Equipment
110,000
100,000
23%
26%
Accum. Depr.
(17,000)
(15,000)
-4%
-4%
Total
$ 483,000
$ 387,000
100%
100%

17-24

Vertical Analysis Example

Sample Company
Balance Sheet (Liabilities & Stockholders' Equity)
At December 31, 1999 and 1998
% of Total Assets
1999
1998
1999
1998
Acts. Payable
$ 76,000
$ 60,000
16%
16%
Wages Payable
33,000
17,000
7%
4%
Notes Payable
50,000
50,000
10%
13%
Common Stock
170,000
160,000
35%
41%
Retained Earnings
154,000
100,000
32%
26%
Total
$ 483,000
$ 387,000
100%
100%

$76,000 $483,000 = 16% rounded

17-25

Trend Percentages Example

Wheeler, Inc. provides you with the
following operating data and asks that
you prepare a trend analysis.
1999
Revenues $ 2,405
Expenses
2,033
Net income $
372

Wheeler, Inc.
Operating Data
1998
1997
$ 2,244
$ 2,112
1,966
1,870
$
278
$
242

1996
$ 1,991
1,803
$
188

1995
$ 1,820
1,701
$
119

17-26

Trend Percentages Example

Wheeler, Inc. provides you with the
following operating data and asks that
you prepare a trend analysis.
1999
Revenues $ 2,405
Expenses
2,033
Net income $
372

Wheeler, Inc.
Operating Data
1998
1997
$ 2,244
$ 2,112
1,966
1,870
$
278
$
242

1996
$ 1,991
1,803
$
188

1995
$ 1,820
1,701
$
119

$1,991 - $1,820 = $171

17-27

Trend Percentages Example

Using 1995 as the base year, we develop
the following percentage relationships.

Revenues
Expenses
Net income

1999
132%
120%
313%

Wheeler, Inc.
Operating Data
1998
1997
123%
116%
116%
110%
234%
203%

1996
109%
106%
158%

1995
100%
100%
100%

$1,991 - $1,820 = $171

$171 $1,820 = 9% rounded

17-28

140

Trend line
for Sales

% of 100 Base

130
120
110
100
90
Sales
Expenses

1995

1996

1997
Years

1998

1999