Chapter 17, Problem 1BTN

To determine

1)

Introduction:

Analysis of Financial Statements

• Analysis of Financial Statements is a study of several key metrics of a company based on the data presented in its’ financial statements with an objective to evaluate the financial health of a company.

• It is essential for investors, stakeholders, government bodies etc. to evaluate the key metrics of an entity in order to ensure that the company fulfills the going concern principle and displays financial stability.

Trend Analysis

• Trend Analysis is a technique of performance measurement and evaluation where the performance of the current year is compared to that of a base year and the direction of the results are analyzed.

• The movement of the results can be interpreted as a positive or favorable trend or as a negative or unfavorable trend.

• Favorable trends mean increase in revenues and decrease in costs and are hence subjective in nature. Unfavorable trends mean decrease in revenues and increase in costs and are also subjective in nature.

• Trend analysis helps in evaluation of repetitive behavior as well as evaluation of effectiveness of strategies implemented by allowing analysis of performance over time.

To Determine:

Trend percent analysis for the years 2013, 2014 and 2015 taking 2013 as the base year for several key figures

Answer to Problem 1BTN

Solution:

Particulars (Amounts in Million)	2013	2014	2015
Net Sales
Amount	$ 170,910.00	$ 182,795.00	$ 233,715.00
Trend Percentage	100%	107%	137%
Cost of Sales
Amount	$ 106,606.00	$ 112,258.00	$ 140,089.00
Trend Percentage	100%	105%	131%
Operating Income
Amount	$ 48,999.00	$ 52,303.00	$ 71,230.00
Trend Percentage	100%	107%	145%
Other Income (Expense) Net
Amount	$ 1,156.00	$ 980.00	$ 1,285.00
Trend Percentage	100%	85%	111%
Net provision for income taxes
Amount	$ 13,118.00	$ 13,973.00	$ 19,121.00
Trend Percentage	100%	107%	146%
Net Income
Amount	$ 37,037.00	$ 39,510.00	$ 53,394.00
Trend Percentage	100%	107%	144%

Explanation of Solution

• Trend analysis compares figures of subsequent years with the base year and analyzes the increase or decrease in the figures of the subsequent years.

• While performing trend analysis, in case of revenues, increase in trend percents is preferred over a period of time and in case of costs decrease in trend percents is preferred is preferred over a period of time.

• For instance in case of the Net sales, Trend percentage for the year 2014 is calculated as follows: $\text{182,795 / 170,910 x 100\% = 107\%}$

• The above methodology is used for computation of trend percents for the metrics of Net sales, Net Operating Income etc.

Conclusion

Hence the trend percents have been computed for the years 2013 – 2015.

To determine

2)

Introduction:

Common Size Comparative Statements

• Common size statements are comparative financial statements that facilitate data analysis and comparison of the financial results with the results of previous time periods.

• While preparing a common size income statement, the elements of the financial statements such as expenses, costs and net results (profit / loss) are expressed as a percentage of a fixed base, usually the sales for the year.

• While preparing a common size balance Sheet, the elements of the financial statements such as current assets, fixed assets and current liabilities etc. are expressed as a percentage of a fixed base, usually the total of assets / liabilities for the year.

• The individual cost elements are then analyzed and year on year analysis is performed in order to check if the growth in revenues and expenses / assets and liabilities correspond to a matching proportionate increase and vice versa.

• The main purpose of common size financial statements is to enable comparison with results of previous financial time periods and also facilitate tracking and review.

To Prepare:

Common size percents for the years 2014 and 2015 for Assets

Answer to Problem 1BTN

Solution:

Particulars	2014	2015
Current Assets, Total
Amount	$ 68,531.00	$ 89,378.00
Common Size Percentage	23.6%	38.6%
Property plant and Equipment, Net
Amount	$ 20,624.00	$ 22,471.00
Common Size Percentage	7.1%	9.7%
Goodwill plus acquired Intangible assets, Net
Amount	$ 8,758.00	$ 9,009.00
Common Size Percentage	3.0%	3.9%
Total of Above
Amount	$ 97,913.00	$ 120,858.00
Common Size Percentage	33.7%	52.1%
Total Assets
Amount	$ 290,479.00	$ 231,839.00
Common Size Percentage	100%	100%

Explanation of Solution

• Assets and Liabilities of similar nature are grouped and valued together. Example: Current Assets, Long term Liabilities etc. Doing so ensures consistency in financial statements and also indicates where the funds of the business are being utilized.

• Assets have a debit balance and liabilities have a credit balance. An increase in assets indicates an increase in cash inflows over time and an increase in liabilities indicates an increase in the cash outflows over time.

• Common size percentages are computed to determine the overall composition of a component in relation to the total. For instance, composition of total current assets to total assets.

• Common Size percentages of Current assets increase from 23.6% in 2014 to38.6% in 2015 revealing a positive trend.

• For instance, Common size percentages for the Current Assets in proportion to the Total assets for the year 2014 is calculated as: $\text{\$68,531 / \$ 290,479 x 100\% = 23}\text{.60\%}$

Conclusion

Hence the common size percents are computed.

To determine

3)

Introduction

Analysis of Financial Statements

• Analysis of Financial Statements is a study of several key metrics of a company based on the data presented in its’ financial statements with an objective to evaluate the financial health of a company.

• It is essential for investors, stakeholders, government bodies etc. to evaluate the key metrics of an entity in order to ensure that the company fulfills the going concern principle and displays financial stability.

Trend Analysis

• Trend Analysis is a technique of performance measurement and evaluation where the performance of the current year is compared to that of a base year and the direction of the results are analyzed.

• The movement of the results can be interpreted as a positive or favorable trend or as a negative or unfavorable trend.

• Favorable trends mean increase in revenues and decrease in costs and are hence subjective in nature. Unfavorable trends mean decrease in revenues and increase in costs and are also subjective in nature.

• Trend analysis helps in evaluation of repetitive behavior as well as evaluation of effectiveness of strategies implemented by allowing analysis of performance over time.

Common Size Comparative Statements

• Common size statements are comparative financial statements that facilitate data analysis and comparison of the financial results with the results of previous time periods.

• While preparing a common size income statement, the elements of the financial statements such as expenses, costs and net results (profit / loss) are expressed as a percentage of a fixed base, usually the sales for the year.

• While preparing a common size balance Sheet, the elements of the financial statements such as current assets, fixed assets and current liabilities etc. are expressed as a percentage of a fixed base, usually the total of assets / liabilities for the year.

• The individual cost elements are then analyzed and year on year analysis is performed in order to check if the growth in revenues and expenses / assets and liabilities correspond to a matching proportionate increase and vice versa.

• The main purpose of common size financial statements is to enable comparison with results of previous financial time periods and also facilitate tracking and review.

To Determine:

Analysis of Changes in income statement components and balance sheet items

Answer to Problem 1BTN

Solution:

• Trend analysis reveals that there is a steady progression in the figures of net sales, net operating income and net income over a period of 3 years from 2013 to 2015.

• The figures of cost of sales have increased proportionately, thus ensuring that the yearly profit margins are maintained since the increase in profitability is in proportion to the increase in the sales.

• Common size analysis reveals, that the cash flows have increased and been utilized for acquisition of plant, property and other assets that have a direct correlation to the increase in revenues over a period of time.

• The common size statement analysis also reveals that the composition of total assets and proportion of current assets, plant property and equipment, goodwill and other intangible assets in proportion to the total assets have significantly changed over a period of 2 years i.e. 2014 to 2015.

Explanation of Solution

Particulars (Amounts in Million)	2013	2014	2015
Net Sales
Amount	$ 170,910.00	$ 182,795.00	$ 233,715.00
Trend Percentage	100%	107%	137%
Cost of Sales
Amount	$ 106,606.00	$ 112,258.00	$ 140,089.00
Trend Percentage	100%	105%	131%
Operating Income
Amount	$ 48,999.00	$ 52,303.00	$ 71,230.00
Trend Percentage	100%	107%	145%
Other Income (Expense) Net
Amount	$ 1,156.00	$ 980.00	$ 1,285.00
Trend Percentage	100%	85%	111%
Net provision for income taxes
Amount	$ 13,118.00	$ 13,973.00	$ 19,121.00
Trend Percentage	100%	107%	146%
Net Income
Amount	$ 37,037.00	$ 39,510.00	$ 53,394.00
Trend Percentage	100%	107%	144%

• Trend analysis compares figures of subsequent years with the base year and analyzes the increase or decrease in the figures of the subsequent years. In case of revenues, increase in trend percents is preferred and in case of costs decrease in trend percents is preferred.

• Trend Percentage analysis of Net Sales indicates a year on year increase from 100% in 2013 to 107%in 2014 to 137% in 2015 revealing a postive trend.

• Trend Percentage analysis of Cost of Sales indicates a year on year increase from 100% in 2013 to 105% in 2014 to 131% in 2015 revealing a negative trend since it is related to costs. However, an increase in sales is usually accompanied by an increase in the cost of sales and since the increase in sales is greater than the increase in the cost of sales, the yearly trends are favorable.

• Trend Percentage analysis of Operating Income indicates a year on year increase from 100% in 2013 to 107% in 2014 to 145% in 2015 revealing a positive trend

• Trend Percentage analysis of Other Income (Expense) Net shows a fluctuating trend ranging from 100% in 2013 to 85% in 2014 to 111% in 2015. However the overall yearly trend over a period of 3 years is positive.

• Trend Percentage analysis of Net provision for income taxes indicates a year on year increase from 100% in 2013 to 107% in 2014 to 146% in 2015 revealing a negative trend since it is an expense. However, an increase in income would be accompanied by an increase in the taxes payable and since the increase is the same as the increase in income, the trend may be considered favorable.

• Trend Percentage analysis of Net Income indicates a year on year increase from 100% in 2013 to 107% in 2014 to 144% in 2015 revealing a positive trend. The increase in net income is due to the increase in sales revenue and operating incomes with overall steady cost of sales percentages.

Particulars	2014	2015
Current Assets, Total
Amount	$ 68,531.00	$ 89,378.00
Common Size Percentage	23.6%	38.6%
Property plant and Equipment, Net
Amount	$ 20,624.00	$ 22,471.00
Common Size Percentage	7.1%	9.7%
Goodwill plus acquired Intangible assets, Net
Amount	$ 8,758.00	$ 9,009.00
Common Size Percentage	3.0%	3.9%
Total of Above
Amount	$ 97,913.00	$ 120,858.00
Common Size Percentage	33.7%	52.1%
Total Assets
Amount	$ 290,479.00	$ 231,839.00
Common Size Percentage	100%	100%

• Assets and Liabilities of similar nature are grouped and valued together. Example: Current Assets, Long term Liabilities etc. Doing so ensures consistency in financial statements and also indicates where the funds of the business are being utilized.

• Balance Sheets list the closing balances of assets and liabilities after giving effect to the operations for a reporting period. Assets and liabilities are grouped together based on their nature and life.

• Assets have a debit balance and liabilities have a credit balance. An increase in assets indicates an increase in cash inflows over time and an increase in liabilities indicates an increase in the cash outflows over time.

• Common size percentages are computed to determine the overall composition of a component in relation to the total. For instance, composition of total current assets to total assets.

• Common Size percentages of Current assets increase from 23.6% in 2014 to38.6% in 2015 revealing a positive trend. Current assets comprise of cash balances, accounts receivable etc. and a yearly increase is indicative of increase in financial stability and cash inflows.

• Common Size percentages of Property, plant and equipment increase from 7.1% in 2014 to9.7% in 2015 revealing a positive trend. Property, plant and equipment comprises of fixed assets that contribute to revenue generation or cost reduction.

• Common Size percentages of Goodwill plus acquired Intangible assets increase from 3.0% in 2014 to3.9% in 2015 revealing a positive trend. Goodwill plus acquired Intangible assets comprise of Goodwill, patents, trademarks, brands etc. which are essential for revenue generation and entity image.

• Common Size percentages of the Total of the Current Assets, Property plant and Equipment and Goodwill plus acquired Intangible assets increase from 33.7% in 2014 to52.1% in 2015 revealing a positive trend.

• This increase can be attributed to increase in the current assets and may be considered as positive since it indicates higher cash inflows. The rest of the investment in assets is attributable to long term investments and other assets.

Conclusion

Hence the trend analysis and common size analysis trends have been explained.