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Accounting Principles II – Financial Statement Analysis

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    Study Guide Accounting Principles I I – Financial Statement Analysis 1. Need for Financial Statement Analysis What Is Financial Statement Analysis? Financial statement analysis helps us understand how a business is performing. It focuses on studying the numbers in financial statements to find patterns, trends, and relationships . By doing this, we can see whether a company is improving, struggling, or staying stable over time. Who Uses Financial Statement Analysis? Financial statement analysis is useful for both 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 whether they should invest in the company, lend money to it, or trust its financial stability. What Does 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 the future Understanding these areas gives a complete picture of how financially strong a company is. Common Methods of Financial Statement Analysis There are three widely used methods to analyze financial statements:

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    Study Guide 1. Trend Analysis This method compares financial data over several years. It helps identify whether figures like sales, profits, or expenses are increasing or decreasing over time. 2. Common - Size Statements In this method, financial statement items are shown as percentages. This makes it easier to compare companies of different sizes or analyze changes within the same company. 3. Ratio Analysis Ratio analysis uses relationships between different financial figures. Ratios help measure profitability, liquidity, and solvency in a simple and meaningful way. Why Comparisons Matter The results of financial statement analysis become more useful when they are compared with: • The company’s past performance • Competitor companies • Industry averages These comparisons help determine the company’s relative strength and overall performance . 2. Trend Analysis What Is Trend Analysis? Trend analysis is a method used to study how a financial statement item changes over time. It looks at percentage changes across two or more years . This helps students and analysts understand whether an account is growing, shrinking, or staying stable over time. 1. Percentage Change (Two - Year Comparison) What Does Percentage Change Show? Percentage change measures how much an account has increased or decreased from one year to the next. It is most often used when comparing two consecutive years .

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    Study Guide How to Calculate Percentage Change To find the percentage change between two periods, follow these steps: 1. Find the increase or decrease Subtract the earlier year’s amount from the later year’s amount. ○ A positive result means an increase ○ A negative result means a decrease 2. Calculate the percentage change Divide the increase or decrease by the earlier year’s amount . Then multiply the result by 100 . Formula:

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    Study Guide Important Notes About Percentage Change • The earlier year is always used as the base for comparison. • If the earlier year amount is zero or negative , the percentage change is not meaningful (N/M) . • Percentages are usually rounded to one decimal place . • Small dollar amounts can sometimes show large percentage changes , which may be misleading. 2. Trend Percentages (Multi - Year Comparison) What Are Trend Percentages? Trend percentages are used when analyzing changes over a longer period of time , such as five or more years . Instead of comparing year - to - year changes, all years are compared to a single base year . Steps to Calculate Trend Percentages To calculate trend percentages, follow these steps: 1. Select a base year The 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 of 100.0% . 3. Calculate trend percentages for other years ○ Divide each year’s amount by the base year amount ○ Multiply the result by 100 How 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 is zero or negative , the trend percentage is not meaningful

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    Study Guide Understanding the Example Results In the given example: • Sales increased by 59.3% over the five - year period. • Cost of goods sold increased by 55.9% . • Operating expenses increased by 57.5% . At first glance, this looks positive because sales increased more than costs overall. However, when we look only up to 20X0 : • Sales increased by about 20% • Cost of goods sold increased by 31% • Operating expenses increased by almost 41% This means costs were rising faster than sales , which had a negative impact on net income during that period. Why Net Income Trend Percentages Can Be Misleading Net income trend percentages may look unusually high because the base year amount is very small . When the starting value is low, even a modest increase can produce a large percentage change . 3. Common - Size Analysis (Vertical Analysis) What Is Common - Size Analysis? Common - size analysis, also called vertical analysis , is a method used to understand financial statements by showing each item as a percentage of a base amount . Instead of focusing only on dollar amounts, this approach helps students see how important each item is relative to the whole . This makes financial statements easier to compare:

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    Study Guide • Between different years of the same company • Between companies of different sizes 1. Base Amounts Used in Common - Size Analysis Balance Sheet For the balance sheet , the base amount is usually total assets . This works because: • Total assets = Total liabilities + Stockholders’ equity Each asset, liability, and equity item is shown as a percentage of total assets . Income Statement For the income statement , the base amount is usually net sales (or revenues) . Each revenue and expense item is expressed as a percentage of net sales , making it easy to see how sales are being spent and how much profit remains.

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