121_13SG - Chapter 13Financial Statement Analysis for...

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Financial Statement Analysis for Decision Making 331 Chapter 13—Financial Statement Analysis for Decision Making CHAPTER OVERVIEW Financial statements are the primary means an outsider uses to evaluate a particular company. Once completed, the results can be compared with other companies. There are a variety of tools used to evaluate performance. In this chapter you are introduced to some of these techniques. The learning objectives for the chapter are to 1. Perform a horizontal analysis of comparative financial statements. 2. Perform a vertical analysis of financial statements. 3. Prepare common-size financial statements for benchmarking against the industry average and key competitors. 4. Use the statement of cash flows in decision making. 5. Compute the standard financial ratios used for decision making. 6. Use ratios in decision making. 7. Measure economic value added by a company’s operations. CHAPTER REVIEW Financial statement analysis is based on information taken from the annual report, SEC reports, articles in the business press, and so on. The objective of financial statement analysis is to provide information to creditors and investors to help them 1) predict future returns and 2) assess the risk of those returns. Past performance is often a good indicator of future performance. Three categories of financial statement analysis are: horizontal, vertical, and ratio analysis. Objective 1 - Perform a horizontal analysis of comparative financial statements. The study of percentage changes in comparative statements is called horizontal analysis . Horizontal analysis highlights changes over time. Computing a percentage change in comparative statements requires two steps: 1) compute the dollar amount of the change from the base period to the later period, and 2) divide the dollar amount of the change by the base period amount. The base period for horizontal analysis is the year prior to the year being considered. Suppose there are three years of data. The change from Year 1 to Year 2 is: $ YEAR 2 - $ YEAR 1 $ YEAR 1 and the change from Year 2 to Year 3 is: $ YEAR 3 - $ YEAR 2 $ YEAR 2 No percentage changes are computed if the base-year amount is zero or negative. Exhibits 13-2 and 13-3 illustrate horizontal analysis on an income statement and balance sheet. Trend percentages are a form of horizontal analysis. They indicate the direction of business activities by comparing numbers over a span of several years. Trend percentages are computed by selecting a base
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Chapter 13 332 year and expressing the amount of each item for each of the following years as a percentage of the base year’s amount for that item. Objective 2 - Perform a vertical analysis of financial statements. Vertical analysis
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121_13SG - Chapter 13Financial Statement Analysis for...

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