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Chapter 13 Notes

Chapter 13 Notes - CHAPTER 13 Financial Analysis The Big...

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CHAPTER 13 Financial Analysis: The Big Picture Study Objectives 1. Describe and apply horizontal analysis. 2. Describe and apply vertical analysis. 3. Identify and compute ratios used in analyzing a company’s liquidity, solvency, and profitability. 4. Understand the concept of quality of earnings. 13-1

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Chapter Outline Study Objective 1 – Describe and Apply Horizontal Analysis In assessing the financial performance of a company, investors are interested in the core or sustainable earnings of a company. Investors are also interested in making comparisons from period to period. Three types of comparisons have been shown in the text to improve the decision usefulness of financial information: 1. Intracompany basis. Comparisons within a company are often useful to detect changes in financial relationships and significant trends. A comparison of Kellogg's current year's cash amount with the prior year's cash amount shows either an increase or a decrease. Likewise, a comparison of Kellogg's year-end cash amount with the amount of total assets at year-end shows the proportion of total assets in the form of cash. 2. Intercompany basis. Comparisons with other companies provide insight into a company's competitive position. Kellogg's total sales for the year can be compared with the total sales of its competitors such as Quaker Oats and General Mills. 3. Industry averages. Comparisons with industry averages provide information about a company's relative position within the industry. Kellogg's financial data can be compared with the averages for its industry compiled by financial ratings organizations such as Dun & Bradstreet, Moody's, and Standard & Poor's or with information provided on the Internet by organizations such as Yahoo! on its financial site. Three basic tools are used in financial statement analysis to highlight the significance of financial statement data: 1. Horizontal analysis 2. Vertical analysis 3. Ratio analysis Horizontal analysis , also known as trend analysis, is a technique for evaluating a series of financial statement data over a period of time. Its purpose is to determine the increase or decrease that has taken place. The increase or decrease can be expressed as either an amount or a percentage. 13-2
To illustrate horizontal analysis, the most recent net sales figures (in millions) of Kellogg Company are given: 2007 2006 2005 2004 2003 \$11,776 \$10,907 \$10,177 \$9,614 \$8,812 If we assume that 2003 is the base year, we can measure all percentage increases or decreases from this base-period amount with the following formula: Change Since Base Period = Current-Year Amount - Base-Year Amount Base-Year Amount For example, we can determine that net sales for Kellogg Company increased approximately 9.1% [(\$9,614 - \$8,812) / \$8,812] from 2003 to 2004.

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Chapter 13 Notes - CHAPTER 13 Financial Analysis The Big...

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