OF THE 500 What makes a top corporate performer? To determine how the companies in the S&P 500 index stack up. against one another, Business Week ranked all 500 using eight key criteria of financial success, We looked at growth in sales, profits, and return to shareholders.
To reward’ consis,teney, we measured performance over both one year and three years. And to gef a better fix on which companies squeeze the most out of operations, we analyzed profit margins and return on equity. Using those’rankings, we assigned grades for each measure. The top 20% received an A, the next 20% got a B and so on; down to the F’s in the bottom quintile,
Finally, we combined the ~ndividual category rankings and added a weighting for sales volume to come up with our overall ranking Financial measures are often used to rank corporate performance.
Growth in sales.,return to stockholders, profit margins, return on equity-all are measures of financial performance that can be determined by analyzing a company’s financial statements. Included among the companies that rank at the top of Business WeeKs analysis are Microsoft (computers), Pfizer (health care), US Airways (transportation), and Gap (tashion retailing). As you have already: learned, financial statements include a wealth of important” information that is useful to inv.estors, creditors, and other external users. In this chapter, we take a closer look at how information in the tnancial statements can be combined, analyzed, and used to support many important financial decisions.
Our discussion Of financial statement analysis in this chapter is divided i~to three sections. First, we. consider general tools of analysis that emphasize comparing lntorrnation about an enterprise with relevant benchmarks.
Second, we consider measures of liquidity and credit risk, followed by measures of profitability. Third, we present a comprehensive mustranon in which we analyze a company’s financial statements from the perspec- I tive of three important users of information-commpn stockholders, long-term creditors, and short-term creditors. Throughout this chapter, we draw on information that was covered in earlier chapters and we use new information that is presented here for the first time. Financial Statements Are Designed for Analysis In today’s global economy, investment capital is always on the move. Through organized capital markets such as the New York Stock exchange, investors each day shift billions of investment dollars among different companies, Industries, and nations. Capital flows to those areas in which investors expect to earn the greatest returns with the least risk,
How do investors forecast risk and potential returns? By analyzing accounting information for a specific company in the context of its unique industry setting. The goal of accounting is to provide economic decision makers with useful information. The financial statements generated through the accounting process are designed to assist users in identifying key relationships and trends. The financial statements of most publicly owned companies are classified and are presented in comparative form.
Often, the word “consolidated” appears in the headings of the statements. Users of financial statements should have a clear understanding of these terms. Most business Organizations prepare classified financial statements, meaning that items with certain’ characteristics are placed together in a group, or classification. The purpose of these classifications is to develop useful subtotals that will assist users of the statements in their analyses. These classifications and subtotals are standardized through- . out most of American business, a practice that assists decision makers in comparing the financial statements of different companies. In comparative financial statements. the financial statement amounts for several years appearside by side in vertical columns.
This-assists investors in-identifying and evaluating significant changes and trends. . Most large corporations own other companies through which they conduct some of their business activities.
A corporation that owns other businesses is the parent company, and the owned companies are called subsidiaries. For example, PepsiCo
• which makes Pepsi Cola, also owns and operates Tropicana and Frito-Lay. In essence these subsidiaries are part of the organization generally known as PepsiCo Consolidated Ilnanelal statements present the financial position and operating results of the parent – company and its subsidiaries as if were a single business organization. For Example..
At this point, take a brief look at the financial statements of Toys “W’ Us. which appear in Appendix A at the end of the text. These financial statements illustrate atl of,the concepts discussed; they are classified and presented in comparative form, and they describe u consolidated business entity. These financial statements also have been audited by Ernst & Young, an international public accounting firm.
TOOLS OF ANALYSIS
Significant changes in financial data are easier to see when financial statement amounts for two of more years are placed side by side in adjacenrcolurnns. Such a statement is called a comparative financial statement.
The’ amounts for the most recent year are usually placed in the left-hand money column. The balance sheet: income statement, and statement of cash flows are often prepared in the form of comparative statements. A highly condensed comparative income statement covering three years is shown below.
Comparative statements place important financial information in a context that is useful for gaining better understanding. For example, knowing that Benson Corporation had sales of $600,000 in 2001 after years in which sales were $500,000 (2000) and $400,000 (1999) is helpful in understanding Benson’s sales trend. ‘. Few figures in a financial statement are highly significant in and of themselves.
It is their relationship to, other quantities or the amount and direction of change that is irn- “portant. Analysis is largely a matter of establishing significant relationships and identifying changes and trends. Four widely used analytical techniques are
(1) dollar and percentage changes,
(2) trend percentages,
(3) component percentages, and
(4) ratios. Dollar and Percentage Changes The dollar amount of change from year to year is significant, and,expressing the change in percentage terms adds perspective. For example, if sales this year have increased by $100,000, the fact that this is an increase of 10% over last year’s sales of $1 million puts. it in a different perspective than if it represented a 1% increase over sales of $ to million for the prior year.
The dollar amount of any change is the difference between the amount for a comparison year and the amount for a base year, The percentage change is computed by dividing the amount of the dollar change between years by the amount for the base year. This is illustrated in the following tabulation, using data from the comparative. income statement shown above:
Although net sales increased $100,000 in both 2000 and 2001, the percentage change differs because of the shift in the base from 1999 to 2000. These calculations present no problems when the figures for the base year are positive amounts. If a negative amount . or a zero amount appears in the base year, however, a percentage change carinot be computed.
Thus if Benson Corporation had incurred a net loss in 2000, the percentage change in net income from 2000 to 200 1 could not have been calculated