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well good morning everyone we have reached a great milestone in this course and this semester we are down to our last chapter chapter 13 on the analysis of financial statements so basically know thus far we have looked at the prepare side of the financial statements so you should have gained a pretty good understanding of you know how numbers come to be what's presented on the income statement and the balance sheet and so for this chapter what we're doing is kind of stepping away from this micro view of the financial statement into a macro view of financial statements and just assess the companies and management's performance so these are the objectives that we'll be covering there's some that we are going to reserve for another time and I'll let you know when we come to that so the first thing that we're gonna do is sort of explain this analysis the purpose of it which is pretty much to evaluate as I said the company's performance so this is helpful for creditors if they're going to lend money to the company is also helpful for management to see how are they performing and of course for investors and so basically we're looking at three aspects kind of like a 360 performance evaluation we're looking at past and current performance we're looking at the current financial position and we're looking at future right that's this and number three is probably the most important because no financial statements are based on historical data and so we kind of need to extrapolate that information to project to make future projections for future performance and like I said is this is helpful for internal users and external users so we have our four blocks of analysis and we're gonna need are of course our annual report the financial statements a income statement and balance sheet the statement of stockholders equity the statement of cash flows and the notes to the financial statements so actually our 360 performance evaluation it's gonna start to evaluate within the company so we're gonna look at within the company what has been past performance and current performance and then of course that is only just one part of the analysis we need to kind of compare with you know competitors the industry and other guidelines it's like you for example now you receive a grade or not an exam and you might turn around and talk to your classmate and say hey what did you get on on that exam and so you kind of compare your performance on the exam with your peers so in the same way is what we're doing with our company so there are different tools of analysis we have the horizontal and vertical analysis and ratio analysis you're most familiar with ratio analysis or some of the ratios that we have looked on throughout the semester so the first thing is the horizontal analysis so we're looking at data for the company across time okay and in order to calculate this horizontal analysis it begins with analyzing the change the dollar change from our base period to the analysis period so for example I want to analyze the change between 2019 and 2018 so 2019 will be the analysis period and 2018 will be the base period and so in order after that figured out the dollar change then we're gonna divide that by the base period amount and multiply it by a hundred to come out to a percentage which will make more sense when we are analyzing these changes so here we have an example of apple company we can see and let me just get my handy pen here okay we can see that for some reason we have a negative balance on our cash account cash account hasn't changed we ended up it's like it changed pretty much but it changed very slightly now compared with other accounts something that make all my attention might be you know the accounts increase on accounts receivable so maybe we want to evaluate how we're granting credit what is you know our accounts receivable turnover what are you know compared to days how many days are these receivables outstanding and the same analysis will probably need to be made for our inventory because it has more than double in the period excuse me and so that is something that we also need to analyze with maybe ratios okay other things that we might be concerned are we have an increase in our security so it looks like we're investing and we're also purchasing property plans so we're expanding and since our cash is sort of you know pretty stable from year to year hasn't significantly increased to support these expansions this will probably need to an increase in our liabilities and we can see here that we have this long-term debt that has increased basically we have to finance this expansion somehow and if we don't have the cash to do so then it's gonna come from that and it may also come from capital okay so those are you know just a few items that we can analyze when looking at these percentage changes and the same will go for the income statement okay so exactly how was this 6.3 calculated we have a difference of thirteen thousand five hundred and ninety five of course this is in thousands but thirteen thousand five ninety five so this is the dotted change between our base year and the current year and then we take this dollar change divided by the base year to arrive at the six point three and we can see here that our sales remain fairly you know increased by six percent but our cost of sales seems to have increased at a higher rate so that could be of a concern maybe we need to analyze you know our purchasing you know our inventory and this correlates with that big jump on inventories so this is something that requires further analysis and of course you know you have to look at the industry we're looking at a technology company so of course there's gonna be a big amount of monies and capital going to research and development and so in essence we end up with an increase of our I'm sorry point out the wrong or an increase in our income okay and so we kinda this is just two years usually a five-year analysis of trends will be more significant and that's what we're heading in a few minutes here we go train analysis and so looking at trends in order to calculate our trend percentage we're gonna take the analysis period divided by the base period and then multiply it by 100 so again if we're analyzing 2019 versus 2018 we take our 2019 amount for example cash and then divided by the 2018 cash balance and then multiply that by 100 and we arrive our percentage so here we have the figures okay the dollar amount and we have converted those into trend analysis so this fourth year here is the base period and these are the analysis period okay and so how did I arrive at the one hundred and seven point zero percent is I divided my analysis period by the base period and multiply it by 100 okay so that's the calculation and then for the second year I will take two hundred and thirty three thousand seven hundred and fifteen and divided by a hundred and seventy and then multiplied by a hundred and so on and so forth so we're just all using the same base period in calculating the percentages and ones that we have compiled that information then it'll be easier to analyze okay so I can see that sales were increasing okay something took place a year ago that my cells went down slightly and then it looks like it's on the recovery stage in the current year and the same thing with our costs so they seem to be pretty much manageable and the one does concern is probably our operating expenses so this is something that we need to check so it may be related to the research and development expenses but perhaps this is something we need to take a closer look and of course another graph it describes this relationship a lot better than just looking at numbers and percentages so you can see that our operating expenses here this line in green is rising a lot you know more than our net sales in fact our net sales seems to have been meeting our cost of sales our line over here okay in terms of vertical analysis pretty much the same formula the analysis amount divided by the base amount times 100 but our based amount instead of being prior year our base amount is going to be depending on what account and analyzing so if I'm not analyzing a balance sheet account the base amount is gonna be total assets if I'm analyzing an income statement account the base amount will be our revenues okay and that will give us a percentage per account in relationship to total assets for the balance sheet or sales for the income statement okay so we can say for example that now 51 percent of securities of all of our assets looks like the bulk is being invested in marketable securities okay so more than 50 percent of our assets are going to marketable securities okay so we can analyze the percentages and we do the same thing with the income statement except that we're comparing each account with sales so cost of sales is sixty one point five percent of sales gross profit is thirty two thirty eight point five percent of sales and so on and so forth the next part of our analysis includes ratio analysis and you know you guys are familiar with liquidity ratios so far we have looked at those throughout the chapters and throughout the semester including our well I don't think we have looked at working capital but working capital it's just a quick and quick calculation of you know how much cash do we have how much liquidity do we have in hand to kind of cover our liabilities so we take our current assets less her current liabilities and hopefully we have it positive amount our current ratio as you know is our current assets divided by our current liabilities and when we say current we mean one year or less okay so current assets where we're gonna derive a benefit within one year or less that's current so mostly property plant and equipment will not be part of our current assets most intangibles will not be part of our current assets etc and then current liabilities is the same is one year or less so this will include our unearned revenues and accounts payable and accrued liabilities etc and so we're basically saying or it's preferable preferably to get a current ratio of 1.0 and above but you know we also have to compare with the industry so depending on the industry the current ratio of 1.0 might be preferable or may not okay so depending on that to so the other test ratio or quick ratio is just the same as the current ratio except that we have made a change and we are excluding things like inventory prepaid expenses from our ratio this was very very liquid okay accounts receivable turnover we looked at this I believe in Chapter seven as well how we take our net sales can be divided by the average accounts receivable the average is calculated by adding the beginning and ending balances of accounts receivable divided by two and indicates how many times the company converts is receivable to cash so I made a sell on credit and so how long is gonna you know take me to collect the cash from there so that would be one time that that will complete the cycle and so how many of those cycles do I have throughout a year our inventory turnover is the same concept as our accounts receivable and so we're looking instead the formula has changed we're looking at cost of goods sold divided by our average inventory so again we're looking at the time that you know how many times do we go through the process of purchasing the inventory and selling the inventory they sells uncollected it indicates how many days our receivables have been outstanding and as we know you know theoretically the longer a receivable is outstanding and less likely we're gonna get paid and so knowing how many days the receivable is outstanding will help us know increase or have certain you know discounts or incentives so that we can get cash quicker okay and then our day sells in inventory again you know we're trying to find out how many days our inventory is on on-hand okay because you know the longer that we have our inventory the longer that we run the risk that the inventory may become obsolete it might be damaged our cost increases because we have to have a warehouse where the inventory have security for the inventory etc okay so this is an important piece of information total asset turnover we're looking at how do we using our assets to generate sales so you know what what kind of assets are we investing and how do those contribute to increase our net sales and so we have this ratio to help us we divide our net sales divided by average total assets to calculate that ratio and so that will complete the liquidity ratios and then we move on to solvency so creditors might be interested not only just on liquidity are you able to pay the dead you have enough cash on hand to pay to make those monthly payments on your loan but they're also looking at you know what is you know your your the amount of assets that you have versus you know other liabilities that you have and so we don't want the company to become and solve it okay and so we have these ratios to guide that and I want to make a distinguishment between debt ratio and debt to equity ratios so debt ratio is basically the ratio between our total liabilities compared to total liabilities and equity okay and so and then we have the equity ratio which is total equity divided by total liabilities and equity so in this case what we're saying is the 64% is financed by debt and 35 almost 38 percent is financed with capital with equity okay so we need to make sure that we're not highly leveraged that our operations are now run heavily with debt so that's something that we need to keep an eye on it we need to compare with previous years no it's just increasing and decreasing and how does it compare with other companies in the industry our debt to equity ratio were looking at total liabilities divided by total equity so if you remember the debt to debt ratio was total liabilities divided by total liabilities plus equity here we're looking at total liabilities the body only just by equity okay and so again we're looking at no leverage okay another estimation of solvency is times interest earned so basically we're looking at you know how many times our ability to pay the interest on the debt you have to think that there's a close relationship with between debt on the balance sheet right and interest so no one's gonna give you money for free you know whoever the bank or any other is gonna charge you interest and that interest expense is going to affect your in statement is gonna affect your bottom line so we want to assess you know the power or the ability to pay this interest so we started with our book net income and then we add interest expense and we add income taxes to arrive at this income before interest and taxes and then we divided by interest expense okay the last one that we're looking at here is profitability we only have three ratios the first one being profit margin that will be our net income divided by net sales we're looking at return on assets we're looking at net income divided by our total average assets and then we're looking at return on common stockholders equity so that will be our net income with any preferred dividends divided by the average common stockholders equity we're gonna leave or put a pin on market prospects and come back to that later you have a good summary of the ratios which you can use to while you're preparing your assignments or completing the exam this last part it just shows a report for the analysis and the structure of that report and we don't need to look at the appendix so this will pretty much complete our presentation for chapter 13