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# chapter03 - Confirming Pages Financial Statements Analysis...

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Trade in Hormone-Treated Beef

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PART 1 Overview 46 problem, however. It’s almost impossible to directly compare the financial statements for two companies because of differences in size. For example, Ford and GM are obviously serious rivals in the auto market, but the two companies are not the same size, so it is difficult to compare them directly. For that matter, it’s difficult to even compare financial statements from different points in time for the same company if the company’s size has changed. The size problem is compounded if we try to compare GM and, say, Toyota. If Toyota’s financial statements are denomi- nated in yen, then we have a size and a currency difference. To start making comparisons, one obvious thing we might try to do is to somehow standardize the financial statements. One very common and useful way of doing this is to work with percentages instead of total dollars. The resulting financial statements are called common-size statements . We consider these next. Common-Size Balance Sheets For easy reference, Prufrock Corporation’s 2007 and 2008 balance sheets are provided in Table 3.1 . Using these, we construct common-size balance sheets by expressing each item as a percentage of total assets. Prufrock’s 2007 and 2008 common-size balance sheets are shown in Table 3.2 . Notice that some of the totals don’t check exactly because of rounding errors. Also notice that the total change has to be zero since the beginning and ending numbers must add up to 100 percent. In this form, financial statements are relatively easy to read and compare. For exam- ple, just looking at the two balance sheets for Prufrock, we see that current assets were 19.7 percent of total assets in 2008, up from 19.1 percent in 2007. Current liabilities de- clined from 16.0 percent to 15.1 percent of total liabilities and equity over that same time. Similarly, total equity rose from 68.1 percent of total liabilities and equity to 72.2 percent. TABLE 3.1 PRUFROCK CORPORATION Balance Sheets as of December 31, 2007 and 2008 (\$ in millions) Assets Current assets Cash Accounts receivable Inventory Total Fixed assets Net plant and equipment Total assets 2007 \$ 84 165 393 \$ 642 \$2,731 \$3,373 2008 \$ 98 188 422 \$ 708 \$2,880 \$3,588 Liabilities and Owners’ Equity Current liabilities Accounts payable Notes payable Total Long-term debt Owners’ equity Common stock and paid-in surplus Retained earnings Total Total liabilities and owners’ equity \$ 312 231 \$ 543 \$ 531 \$ 500 1,799 \$2,299 \$3,373 \$ 344 196 \$ 540 \$ 457 \$ 550 2,041 \$2,591 \$3,588
CHAPTER 3 Financial Statements Analysis and Long-Term Planning 47 Overall, Prufrock’s liquidity, as measured by current assets compared to current liabilities, increased over the year. Simultaneously, Prufrock’s indebtedness diminished as a percentage of total assets. We might be tempted to conclude that the balance sheet has grown “stronger.” Common-Size Income Statements A useful way of standardizing the income statement shown in Table 3.3 is to express each item as a percentage of total sales, as illustrated for Prufrock in Table 3.4 .

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chapter03 - Confirming Pages Financial Statements Analysis...

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