Example #2: A common-size horizontal statement. This is the same company’s income statement for three years. The statement appears first, and then the common-size, or trend analysis, statement follows. Amounts from Year 1 are expressed as 100%, and on each line, amounts from Years 2 and 3 are expressed as percentages of Year 1. This same analysis can be done on a balance sheet. Income Statement: Year 3 Year 2 Year 1 Net revenues $10,400 $11,100 $ 9,900 Cost of goods sold 3,200 3,400 3,000 Gross profit $ 7,200 $ 7,700 $ 6,900 Research and development expense $ 3,000 $ 1,800 $ 1,200 Selling, general and administrative expense 1,500 1,700 1,400 Operating income $ 2,700 $ 4,200 $ 4,300 Net gains (losses) (344) 338 382 Interest and dividend income 177 129 118 Earnings before interest and taxes (EBIT) $ 2,533 $ 4,667 $ 4,800 Interest expense (400) (400) (400) Earnings before taxes (EBT) $ 2,133 $ 4,267 $ 4,400 Income taxes (25%) (533) (1,067) (1,100) Net Income $ 1,600 $ 3,200 $ 3,300 Percentages of Year 1: Note: The percentages below do not represent percentages of increase or decrease from one year to another year. Instead, they represent the proportional amounts for Years 2 and 3 compared to Year 1. They were calculated by dividing each amount for the year in question by the same amount for Year 1. Year 3 Year 2 Year 1 Net revenues 105.1% 112.1% 100.0% Cost of goods sold 106.7% 113.3% 100.0% Gross profit 104.3% 111.6% 100.0% Research and development expense 250.0% 150.0% 100.0% Selling, general and administrative expense 107.1% 121.4% 100.0% Operating income 62.8% 97.7% 100.0% Net gains (losses) N/M * 88.5% 100.0% Interest and dividend income 150.0% 109.3% 100.0% Earnings before interest and taxes (EBIT) 52.8% 97.2% 100.0% Interest expense (100.0%) (100.0%) (100.0%) Earnings before taxes (EBT) 48.5% 97.0% 100.0% Income taxes ( 48.5%) ( 97.0%) (100.0%) Net income 48.5% 97.0% 100.0% * N/M means Not Meaningful. Investment income in Year 1 was $500 and in Year 2, investment income decreased to $467, or to 93.4% of the previous year’s income (calculated as $467 ÷ $500). However, in Year 3, it became an investment loss of $167 because of losses in the company’s investment portfolio. A calculation dividing $167 by $500 would not be meaningful. It would be meaningful only if Year 3’s investment results had been an income amount. Analysis and interpretation: In the common-size horizontal statement, we compare this company’s financial results against its results from previous years. The analysis does not end with developing the percentages. An analysis like the one above is called a variation analysis, and it can be used to determine both the causes and to see the effects of shifts that have taken place over time. Net revenues increased in Year 2 to 112% of Year 1’s revenues but then decreased in Year 3 to just 105% of Year 1’s revenues. The economy went into a recession in Year 3, and that is the probable reason for the sales decrease. Gross profit, of course, was lower as well in Year 3. Increases and decreases in revenues can be analyzed to determine how much of the revenue decline in Year 3 was due to lower volume being sold and how much was due to lower prices being charged. Analysis like this is covered on the CMA Part 1 exam in the topic of Variance Analysis. It is interesting and worth noting that much of the decrease in net income in Year 3 was due to increased R&D expense. In a year when revenues and gross profit decreased, the company chose to increase its R&D expense. This is a strong company in the technology industry, and its management is taking advantage of the slower selling period during the recession to position itself for a very strong upward movement in sales when the economy recovers, by having new products available to sell as a result of its increased R&D activity.
Posted on: Sat, 20 Dec 2014 07:12:28 +0000
Trending Topics
Recently Viewed Topics
© 2015