University:
California State University, Northridge
Course:
ACCT 350 | Intermediate Financial Accounting I
Academic year:

2024
Views:

485

Pages:

24
Author:

essermave1a1

Analysis of Financial Statements Part 2 Chapter 22 Intermediate Accounting Margin vs. Turnover The profitability of each dollar in sales is sometimes called a company’s The degree to margin. which assets are used to generate sales is called turnover. Leverage Ratios • Higher leverage increases ROE through the following chain of events: 1. More borrowing means that more assets can be purchased without any additional equity investment by owners. 2. More assets means that more sales can be generated. 3. More sales means that net income should increase Leverage Ratios Debt ratio: Total liabilities Total assets For Colesville Colesville Corporation Corporation 2007 = $1,101,000 $2,191,000 = 50.3% Leverage Ratios Debt ratio: Total liabilities Total assets For Colesville Colesville Corporation Corporation 2008 = $810,000 $2,278,000 The debt ratio is the percentage of total funds, both borrowed and invested, that a company = 35.6% acquires through borrowing. Leverage Ratios Debt-to-equity ratio: Total liabilities Stockholders’ equity For Colesville Colesville Corporation Corporation 2007 = $1,101,000 $1,090,000 = 1.01 Leverage Ratios Debt-to-equity ratio: Total liabilities Stockholders’ equity For Colesville Colesville Corporation Corporation 2008 = $810,000 $1,468,000 The debt ratio and the debt-to-equity ratio measure the same thing—the level of borrowing = 0.55 relative to funds used to finance the company. Leverage Ratios Times interest earned: Earnings before income taxes Interest expense For Colesville Colesville Corporation Corporation 2007 = $290,000 + $60,000 $60,000 = 5.8 times Leverage Ratios Times interest earned: Earnings before income taxes Interest expense For Colesville Colesville Corporation Corporation 2008 = $260,000 + $40,000 $40,000 Times interest earned reflects the company’s ability to meet = interest payments and the degree 7.5 times of safety afforded the creditors. Other Common Ratios Current Ratio: Current assets Current liabilities For Colesville Colesville Corporation Corporation 2007 = $955,500 $501,000 = 1.91 Other Common Ratios Current Ratio: Current assets Current liabilities For Colesville Colesville Corporation Corporation 2007 = $855,500 $410,000 Historically, the rule of thumb was to have a current ratio of at least 2.0. In 2008, = 2.09 Colesville Corporation is in good shape. Current Ratios: 2004 Advances in information technology have allowed successful firms to reduce this ratio to below 1.0. Company Coca-Cola Delta Airlines Home Depot McDonald’s Wal-Mart Current Ratio 1.10 0.61 1.35 0.81 0.90 Other Common Ratios Cash flow adequacy ratio: Cash from operating activities Total primary cash requirements The sum of dividend payments, long-term Colesville Corporation Colesville Corporation asset For purchases, and long-term debt repayments. 2007 = $424,500 $375,000 = 1.13 Other Common Ratios Earnings per share: Net income Weighted-number of share outstanding Price-earnings ratio: Market price per share Earnings per share Dividend payout ratio: Cash dividends Net income Book-to-market ratio: Stockholders’ equity Market value of shares outstanding Impact of Alternative Accounting Methods • If companies are using differing accounting practices, it will impact the ratios. • Careful financial statement users should make adjustments for accounting differences among the companies being analyzed. Foreign Reporting to U.S. Investors Firms such as The good news is DaimlerChrysler and that the demands of These divergent Disney must producedifferences The significant nationalinternational accounting users financial statementsstandards in accounting forcing practices canare have an for users around not onlythe incompanies world to provide extremely significant their own countriesboth complicate the disclosure so that impact on reported but also in other of users preparation can recognize financialfinancial statements. countries. statements and the and reconcile the understandingdiffering of these accounting statements for users. standards. Meeting the Needs of International Users Some multinational firms respond to users in other countries simply by taking their financial statements or annual reports and translating them into the language of the user. Meeting the Needs of International Users Another response to the international users is to denominate the financial statements in the currency of the country where the financial statements will be used. Meeting the Needs of International Users Some multinationals partially or completely restate the financial statements to the accounting principles of the financial statement users’ country. Meeting the Needs of International Users Mutual recognition involves one country accepting the financial statements of another country in return for that country accepting its financial statements for all regulatory purposes. The SEC’s Form 20-F • The SEC requires foreign companies that list shares on U.S. to provide: 1. Complete U.S. GAAP financial statements. 2. Reconcile their reported net income to what income would be according to U.S. GAAP. Form 20-F provides the reconciliation. Foreign Currency Financial Statements • Translation- Used when the foreign subsidiary is a relatively self-contained unit that is independent from the parent company’s operations. • Remeasurement- Is appropriate when the subsidiary does not operate independently of the parent company. • Functional currency- Currency of the primary economic environment of an entity. Foreign Currency Financial Statements Translation • Assets and liabilities are translated using the current exchange rate prevailing as of the balance sheet date. • Income statement items are translated at the average exchange rate for the year. • Dividends are translated using the exchange rate prevailing on the date the dividends were declared. Foreign Currency Financial Statements Translation • Capital stock is translated at the historical rate, the rate prevailing on the date the subsidiary was acquired or the stock was issued. • Retained earnings is translated in the first year using historical rates. • In subsequent years, take the balance in Retained Earnings from the prior period’s translated financial statements and add translated net income and subtracting translated dividends.

Analysis of Financial Statements, Part 2

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