Accounting Principles II – Financial Statement Analysis - Quick Guides

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Study GuideAccounting Principles II–Financial Statement Analysis1. Need for Financial Statement AnalysisWhat Is Financial Statement Analysis?Financial statement analysis helps us understand how a business is performing. It focuses onstudying the numbers in financial statements to findpatterns, trends, and relationships. By doingthis, we can see whether a company is improving, struggling, or staying stable over time.Who Uses Financial Statement Analysis?Financial statement analysis is useful forboth internal and external users:•Internal users(like managers) use it to make better business decisions.•External users(such as investors, creditors, and financial analysts) use it to decide whetherthey should invest in the company, lend money to it, or trust its financial stability.WhatDoes Financial Statement Analysis Measure?This analysis helps evaluate three important aspects of a company’s financial health:•Profitability–How well the company earns profits from its operations•Liquidity–The company’s ability to pay short-term obligations•Solvency–The company’s ability to meet long-term debts and continue operating in thefutureUnderstanding these areas gives a complete picture of how financially strong a company is.Common Methods of Financial Statement AnalysisThere are three widely used methods to analyze financial statements:

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Study Guide1.Trend AnalysisThis method compares financial data over several years. It helps identify whether figures likesales, profits, or expenses are increasing or decreasing over time.2.Common-Size StatementsIn this method, financial statement items are shown as percentages. This makes it easier tocompare companies of different sizes or analyze changes within the same company.3.Ratio AnalysisRatio analysis uses relationships between different financial figures. Ratios help measureprofitability, liquidity, and solvency in a simple and meaningful way.Why Comparisons MatterThe results of financial statement analysis become more useful when they are compared with:•The company’spastperformance•Competitor companies•Industry averagesThese comparisons help determine the company’srelative strength and overall performance.2. Trend AnalysisWhat Is Trend Analysis?Trend analysis is a method used to study how a financial statement item changes over time. It looksatpercentage changesacrosstwo or more years. This helps students and analysts understandwhether an account isgrowing, shrinking, or staying stableover time.1.Percentage Change (Two-Year Comparison)What Does Percentage Change Show?Percentage change measures how much an account hasincreased or decreasedfrom one year tothe next. It is most often used when comparingtwo consecutive years.

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Study GuideHowto Calculate Percentage ChangeTo find the percentage change between two periods, follow these steps:1.Find the increase or decreaseSubtract the earlier year’s amount from the later year’s amount.○Apositive resultmeans an increase○Anegative resultmeans a decrease2.Calculate the percentage changeDivide the increase or decrease by theearlier year’s amount.Then multiply the result by100.Formula:

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Study GuideImportant Notes About Percentage Change•Theearlier yearis always used as the base for comparison.•If the earlier year amount iszero or negative, the percentage change isnot meaningful(N/M).•Percentages are usuallyrounded to one decimal place.•Small dollar amounts can sometimes showlarge percentage changes, which may bemisleading.2.Trend Percentages (Multi-Year Comparison)What Are Trend Percentages?Trend percentages are used when analyzing changes over alonger period of time, such asfive ormore years. Instead of comparing year-to-year changes, all years are compared to asingle baseyear.Steps to Calculate Trend PercentagesTo calculate trend percentages, follow these steps:1.Select a base yearThe base year serves as the starting point for comparison.2.Set the base year to 100%Every account in the base year is assigned a trend percentage of100.0%.3.Calculate trend percentages for other years○Divide each year’s amount by the base year amount○Multiply the result by100How to Interpret Trend Percentages•100.0%→ No change from the base year

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Study Guide•Less than 100.0%→ Decrease from the base year•More than 100.0%→ Increase over the base year•Negative percentage→ The account balance is negative•If the base year iszero or negative, the trend percentage isnot meaningful

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Study GuideUnderstanding the Example ResultsIn the given example:•Salesincreased by59.3%over the five-year period.•Cost of goods soldincreased by55.9%.•Operating expensesincreased by57.5%.At first glance, this looks positive because salesincreased more than costs overall.However, when we look only up to20X0:•Sales increased by about20%•Cost of goods sold increased by31%•Operating expenses increased by almost41%This means costs were risingfaster than sales, which had anegative impact on net incomeduringthat period.Why Net Income Trend Percentages Can Be MisleadingNet income trend percentages may look unusually high because thebase year amount is verysmall. When the starting value is low, even a modest increase can produce alarge percentagechange.3.Common-Size Analysis (Vertical Analysis)What Is Common-Size Analysis?Common-size analysis, also calledvertical analysis, is a method used to understand financialstatements by showingeach item as a percentage of a base amount. Instead of focusing only ondollar amounts, this approach helps students see how important each item isrelative to the whole.This makes financial statements easier to compare:

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Study Guide•Betweendifferent yearsof the same company•Betweencompanies of different sizes1.Base Amounts Used in Common-Size AnalysisBalance SheetFor thebalance sheet, the base amount is usuallytotal assets.This works because:•Total assets = Total liabilities + Stockholders’ equityEach asset, liability, and equity item is shown as apercentage of total assets.Income StatementFor theincome statement, the base amount is usuallynet sales (or revenues).Each revenue and expense item is expressed as apercentage of net sales, making it easy to seehow sales are being spent and how much profit remains.

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