LLH9e Chapter - 13

chapter 13 Analyzing Financial Statements
Financial Accounting
9e
Libby • Libby • Hodge
Copyright ©2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 13-1
Understanding the Business
External Decision Makers Include

 Present and potential owners Annual
 Investment analysts Report
 Creditors
The Investment Decision
Economy-wide
Industry Factors
Individual
Factors Company Factors
Invest?
No Yes
Understanding a Company’s Strategy
Is the company trying to earn a high rate of return through product

differentiation or cost differentiation?
Financial Statement Analysis
Financial statement analysis

is based on comparisons.
Time-series analysis Cross-sectional analysis
Examines a single Provides insights concerning

company to identify a company’s relative
trends over time. performance to other
companies.
Component Percentages
Express each item on a particular statement as a

percentage of a single base amount.
Net sales Total assets

on the income on the balance
statement sheet
The comparative income statements of The Home Depot

for 2013, 2014, and 2015 appear on the next slide.
Prepare component percentage income statements

where net sales equal 100 percent.
Exhibit 13.1
The Home Depot Financial Statements
Net sales will be set to
100 percent, THE
andHOME DEPOT, INC., AND SUBSIDIARIES
all other
Consolidated Statement of Earnings
components will be in millions, except per share data)
(amounts
expressed as a Fiscal Year Ended
February 1, February 2, February 3,
percentage of net sales. 2015 2014 2013
Net Sales $83,176 $78,812 $74,754
Cost of Sales 54,222 51,422 48,912
Gross Profit 28,954 27,390 25,842
Operating Expenses:
Selling, General and Administrative 16,834 16,597 16,508
Depreciation and Amortization 1,651 1,627 1,568
Total Operating Expenses 18,485 18,224 18,076
Operating Income 10,469 9,166 7,766
Interest and Other (Income) Expense:
Interest and Investment Income (337) (12) (20)
Interest Expense 830 711 632
Other — — (67)
Interest and Other, net 493 699 545
Earnings before Provision for Income Taxes 9,976 8,467 7,221
Provision for Income Taxes 3,631 3,082 2,686
Net Earnings $ 6,345 $ 5,385 $ 4,535
Weighted Average Common Shares 1,338 1,425 1,499
Basic Earnings per Share $ 4.74 $ 3.78 $ 3.03
Diluted Weighted Average Common Shares 1,346 1,434 1,511
Diluted Earnings per Share $ 4.71 $ 3.76 $ 3.00
Exhibit 13.1
Net sales will be set to
100 percent,THE
andHOME 2014 Cost of Sales ÷ 2014 Net
DEPOT, INC., AND SUBSIDIARIES
all other
Consolidated Statement of Earnings
components will be in millions, except per shareSales$54,222
(amounts data) ÷ $83,176 = 0.6519 or
expressed as a 65.19%
Fiscal Year Ended
February 1, February 2, February 3,
percentage of net sales. 2015 2014 2013
Net Sales $83,176 $78,812 $74,754
Cost of Sales 54,222 51,422
2014 Gross 48,912
Profit
2014 Net Sales ÷
Gross Profit 28,954 27,390 25,842
Operating Expenses: $28,954 ÷ $83,176 = 0.3481 or 34.81%
Selling, General and Administrative 16,834 16,597 16,508
Depreciation and Amortization 1,651 1,627 1,568
Total Operating Expenses 18,485 18,224 18,076
Operating Income 10,469 2014 Selling,
9.166 G&A
7,766÷
2014 Net Sales
Interest and Other (Income) Expense: $16,834 ÷ $83,176 = 0.2024 or 20.24%
Interest and Investment Income (337) (12) (20)
Interest Expense 830 711 632
Other — — (67)
Interest and Other, net 493 699 545
Earnings before Provision for Income Taxes 9,976 8,467 7,221
Provision for Income Taxes 3,631 3,082 2,686
Net Earnings $ 6,345 $ 5,385 $ 4,535
Weighted Average Common Shares 1,338 1,425 1,499
Basic Earnings per Share $ 4.74 $ 3.78 $ 3.03
Diluted Weighted Average Common Shares 1,346 1,434 1,511
Diluted Earnings per Share $ 4.71 $ 3.76 $ 3.00
Exhibit 13.2
Component Percentages for The Home Depot
COMPONENT PERCENTAGES*
February 1, 2015 February 2, 2014 February 3, 2013
Income Statement (fiscal 2014) (fiscal 2013) (fiscal 2012)

Net sales 100.00% 100.00% 100.00%
Cost of Sales 65.19 65.25 65.43
Gross profit 34.81 34.75 34.57
Operating Expenses:
Selling, General, and Administrative 20.24 21.06 22.08
Depreciation and Amortization 1.98 2.06 2.10
Total Operating Expenses 22.22 23.12 24.18
Operating Income 12.59 11.63 10.39
Interest and Other (Income) Expense:
Interest and Investment Income (0.41) (0.01) (0.03)
Interest Expense 1.00 0.90 0.85
Other 0.00 0.00 (0.09)
Interest and Other, net 0.59 0.89 0.73
Earnings before Provision for Income Taxes 12.00 10.74 9.66
Provision for Income Taxes 4.37 3.91 3.59
Net Earnings 7.63 6.83 6.07
*Numbers are rounded.
Exhibit 13.1
THE HOME DEPOT, INC., AND SUBSIDIARIES
Consolidated Balance Sheets
(amounts in millions, except share and per share data)
February 1, February 2,
2015 2014
ASSETS
Current Assets:
Cash and Cash Equivalents $ 1,723 $ 1,929
Receivables, net 1,484 1,398
Merchandise Inventories 11,079 11,057
Other Current Assets 1,016 895
Total Current Assets 15,302 15,279
Property and Equipment, at cost 38,513 39,064
Less Accumulated Depreciation and Amortization 15,793 15,716
Net Property and Equipment 22,720 23,348
Goodwill 1,353 1,289
Other Assets 571 602
Total Assets $39,946 $40,518
Exhibit 13.1
February 1, February 2,
2015 2014
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Short-Term Debt $ 290 $ —
Accounts Payable 5,807 5,797
Accrued Salaries and Related Expenses 1,391 1,428
Sales Taxes Payable 434 396
Deferred Revenue 1,468 1,337
Income Taxes Payable 35 12
Current Installments of Long-Term Debt 38 33
Other Accrued Expenses 1,806 1,746
Total Current Liabilities 11,269 10,749
Long-Term Debt, excluding current installments 16,869 14,691
Other Long-Term Liabilities 1,844 2,042
Deferred Income Taxes 642 514
Total Liabilities 30,624 27,996
STOCKHOLDERS’ EQUITY
Common Stock, par value $0.05; authorized: 10 billion shares; issued: 1.768
billion shares at February 1, 2015, and 1.761 billion shares at February 2, 2014;
outstanding: 1.307 billion shares at February 1, 2015, and 1.380 billion shares
at February 2, 2014 88 88
Paid-In Capital 8,885 8,402
Retained Earnings 26,995 23,180
Accumulated Other Comprehensive (Loss) Income (452) 46
Treasury Stock, at cost, 461 million shares at February 1, 2015, and 381 million
shares at February 2, 2014 (26,194) (19,194)
Total Stockholders’ Equity 9,322 12,522
Total Liabilities and Stockholders’ Equity $39,946 $40,518
Return on Equity (ROE)
Profitability
Profitabilityisisaaprimary
primarymeasure
measureof
of
the
theoverall
overallsuccess
successof
ofaacompany.
company.
Net Income
Return on Equity =
Average Stockholders’ Equity
$6,345
Return on Equity = = 58.09%
($9,322 + $12,522) ÷ 2
This
Thismeasure
measureindicates
indicateshow
howmuch
muchincome
incomewas
wasearned
earnedfor
forevery
everydollar
dollar
invested
investedby
bythe
theowners.
owners.
Return on Assets (ROA)
Return on Net Income

=
Assets Average Total Assets
Return on $6,345
= = 15.77%
Assets ($39,946 + $40,518) ÷ 2
This
Thisratio
ratiomeasures
measureshow
howwell
wellassets
assetshave
havebeen
beenemployed
employedby
bythe
thebusiness.
business.
Net Profit Margin
Net Profit Net Income

Margin =
Net Sales Revenue
Net Profit $6,345

Margin = = 7.63%
$83,176
This
Thisratio
ratiotells
tellsus
usthe
thepercentage
percentageof
ofeach
eachsales
salesdollar,
dollar,on
onaverage,
average,that
that
represents
representsincome.
income.
Earnings per Share (EPS)
Net Income*
EPS =
Weighted Average Number
of Shares Outstanding
Remember from Chapter 11 that if there are preferred dividends,

the amount is subtracted from net income.
$6,345
EPS = = $4.74
1,338
Average number of shares based on the number

of shares at the beginning and end of the year.
Earnings
Earningsper
pershare
shareisisprobably
probablythethesingle
singlemost
mostwidely
widelywatched
watched
financial
financialratio.
ratio.
Earnings Quality
Earnings Cash Flows from Operating Activities
Quality =
Net Income
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Earnings $6,345
The Home Depot’s Reconciliation of Net Earnings to Net Cash
Provided by Operating Activities:
Earnings Quality Depreciation and Amortization 1,786
Stock-Based Compensation Expense 225
$8,242 Gain on Sales of Investments (323)
= 1.30 Goodwill Impairment —
$6,345
Changes in Assets and Liabilities, net of the
effects of acquisitions:
Receivables, net $ (81)
Merchandise Inventories (124)
Other Current Assets (199)
A ratio higher than 1 indicates
Accounts Payable and Accrued Expenses 244
high-quality earnings. Deferred Revenue 146
Income Taxes Payable 168
Deferred Income Taxes 159
Other Long-Term Liabilities (152)
Other 48
Net Cash Provided by Operating Activities 8,242
Total Asset Turnover Ratio
Total Asset Net Sales Revenue

=
Turnover Average Total Assets
Total Asset $83,176 = 2.07

=
Turnover ($39,946 + $40,518) ÷ 2
This
Thisratio
ratiocaptures
captureshow
howwell
wellaacompany
companyuses
usesits
itsassets
assetsto
togenerate
generate
revenue.
revenue.
Fixed Asset Turnover Ratio
Fixed
Asset = Net Sales Revenue
Turnover Average Net Fixed Assets
Fixed
Asset = $83,176 = 3.61
Turnover ($22,720 + $23,348) ÷ 2
This
Thisratio
ratiomeasures
measuresaacompany’s
company’sability
abilityto
togenerate
generatesales
salesgiven
givenan
an
investment
investmentininfixed
fixedassets.
assets.
Receivable Turnover Ratio
Receivable Turnover Net Credit Sales

=
Ratio Average Net Receivables
Receivable Turnover $83,176

= = 57.72 times
Ratio ($1,484 + $1,398) ÷ 2
This
Thisratio
ratiomeasures
measureshow
howquickly
quicklyaacompany
companycollects
collectsits
its
accounts
accountsreceivable.
receivable.
Tests of Liquidity ─ Average Age of Receivables
Average Age of Days in Year

=
Receivables Receivable Turnover
Days Sales =
Outstanding
This
Thisratio
ratiomeasures
measuresthetheaverage
averagenumber
numberof
ofdays
days
itittakes
takesto
tocollect
collectreceivables.
receivables.
13-20
Inventory Turnover Ratio
Inventory Cost of Goods Sold

Turnover Ratio = Average Inventory
Inventory $54,222 = 4.90 times

=
Turnover Ratio ($11,079 + $11,057) ÷ 2
This
Thisratio
ratiomeasures
measureshow
howquickly
quicklythe
thecompany
companysells
sellsits
its
inventory.
inventory.
Tests of Liquidity ─ Average Days’ Supply in Inventory
Average Days’ Days in Year

Supply in =
Inventory Inventory Turnover
Average Days’
Supply in =
Inventory
This
This ratio
ratio measures
measures the the average
average number
number of
of days
days
itit takes
takes to
to sell
sell the
the inventory.
inventory.
13-22
Tests of Liquidity ─ Accounts Payable Turnover RATIO
Accounts Cost of Goods Sold

Payable =
Average Accounts Payable
Turnover
Accounts
Payable =
Turnover
This
This ratio
ratio measures
measures howhow quickly
quickly the
the
company
company pays
pays its
its accounts
accounts payable.
payable.
13-23
The DuPont Model
FINANCIAL ANALYSIS
The DuPont model brings together several of the ratios $$$

we have discussed so far and reflects how these ratios
are related. The model is:
ROE Net Profit Total Asset Financial

= × Turnover Leverage
Margin
×
Net Sales
Net Income Net Income Revenue Average Total Assets
Average Total Stockholders’
= Net Sales
× Average Total
× Average Total Stockholders’
Equity Revenue Assets Equity
Current Ratio
Current Current Assets

Ratio = Current Liabilities
Current $15,302
= = 1.36
Ratio $11,269
This
Thisratio
ratiomeasures
measuresthe
theability
ability
of
ofthe
thecompany
companyto topay
paycurrent
current
debts
debtsasasthey
theybecome
becomedue.
due.
Quick Ratio
Quick Quick Assets

=
Ratio Current Liabilities
Quick ($1,723 + $1,484 + $0)

= = 0.28
Ratio $11,269
This
Thisratio
ratioisislike
likethe
thecurrent
currentratio,
ratio,but
butititmeasures
measuresthe
the
company’s
company’simmediate
immediateability
abilityto
topay
paydebts.
debts.
Times Interest Earned Ratio
Tests
Testsof
ofsolvency
solvencymeasure
measureaacompany’s
company’sability
abilityto
tomeet
meetits
itslong-term
long-term
obligations.
obligations.
Net Interest Income Tax

+ +
Times Interest = Income Expense Expense
Earned
Interest Expense
Times Interest $6,345 + $830 + $3,631

Earned = = 13.02 times
$830
This ratio indicates a margin of protection for creditors.
Debt-to-Equity Ratio
= Total Liabilities
Stockholders’ Equity
= $30,624 = 3.29
$9,322
This
Thisratio
ratiomeasures
measuresthe
theamount
amountofofliabilities
liabilitiesthat
thatexists
existsfor
for
each $1 invested by the owners.
each $1 invested by the owners.
Price/Earnings (P/E) Ratio
The price/earnings ratio reflects the stock market’s assessment of a

company’s future performance.
Current Market Price per Share

P/E Ratio =
Earnings per Share
$104.43
P/E Ratio = = 22.03
$4.74
At the end of fiscal 2014, The Home

Depot’s stock was trading at
$104.43 per share.
This ratio measures the relationship between the current market price of the
stock and its earnings per share.
Dividend Yield Ratio
Dividend Dividends per Share

=
Yield Ratio Market Price per Share
Dividend $1.16 = 1.11%

=
Yield Ratio $104.43
The
TheHome
HomeDepot
Depotpaid
paiddividends
dividendsof
of$1.16
$1.16per
pershare
sharewhen
whenthe
themarket
market
price
pricewas
was$104.43
$104.43per
pershare.
share.
This
Thisratio
ratioisisoften
oftenused
usedtotocompare
comparethe
thedividend-paying
dividend-payingperformance
performanceof
of
different
differentinvestment
investmentalternatives.
alternatives.

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chapter 13 Analyzing Financial Statements

External Decision Makers Include

Is the company trying to earn a high rate of return through product

Financial statement analysis

Time-series analysis Cross-sectional analysis

Examines a single Provides insights concerning

Express each item on a particular statement as a

Net sales Total assets

The comparative income statements of The Home Depot

Prepare component percentage income statements

Income Statement (fiscal 2014) (fiscal 2013) (fiscal 2012)

Return on Net Income

Net Profit Net Income

Net Profit $6,345

Remember from Chapter 11 that if there are preferred dividends,

Average number of shares based on the number

Total Asset Net Sales Revenue

Total Asset $83,176 = 2.07

Receivable Turnover Net Credit Sales

Receivable Turnover $83,176

Average Age of Days in Year

Inventory Cost of Goods Sold

Inventory $54,222 = 4.90 times

Average Days’ Days in Year

Accounts Cost of Goods Sold

The DuPont model brings together several of the ratios $$$

ROE Net Profit Total Asset Financial

Current Current Assets

Quick Quick Assets

Quick ($1,723 + $1,484 + $0)

Net Interest Income Tax

Times Interest $6,345 + $830 + $3,631

This ratio indicates a margin of protection for creditors.

The price/earnings ratio reflects the stock market’s assessment of a

Current Market Price per Share

At the end of fiscal 2014, The Home

Dividend Dividends per Share

Dividend $1.16 = 1.11%

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