L77 CTE - BMM

Comparative Analysis

Unit: Critical Thinking and Analysis

Problem Area: Financial Information Interpretation

Lesson: Comparative Analysis

Student Learning Objectives.

Instruction in this lesson should result in students

achieving the following objectives:

Analyze internal financial performance comparing like time periods.

Evaluate financial performance across industry competitors.

¢ Resources.

The following resources may be useful in teaching this lesson:

E-unit(s) corresponding to this lesson plan. CAERT, Inc. http://www.mycaert.com.

“Financial Statement Analysis Primer,” Wiley. Accessed Aug. 18, 2016.

http://www.wiley.com/college/kieso/0470587237/gateway_ics/

Financial_Statement_Analysis_Primer/analysis_primer.html.

“Horizontal Analysis of Financial Statements,” Accounting for Management.org. Accessed

Aug. 18, 2016. http://www.accountingformanagement.org/horizontal-analysis-of-

financial-statements/.

“What Is the Difference Between Vertical Analysis and Horizontal Analysis?” Accounting

Coach

. Accessed Aug. 18, 2016. http://www.accountingcoach.com/blog/vertical-

analysis-horizontal-analysis.

Wilkinson, Jim. “Comparison Analysis,” The Strategic CFO. Accessed Aug. 18, 2016.

http://strategiccfo.com/comparison-analysis/

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Equipment, Tools, Supplies, and Facilities

Overhead or PowerPoint projector

Visual(s) from accompanying master(s)

Copies of sample test, lab sheet(s), and/or other items designed for duplication

Materials listed on duplicated items

Computers with printers and Internet access

Classroom resource and reference materials

Key Terms.

The following terms are presented in this lesson (shown in bold italics):

accounting period

accounts receivable turnover ratio

accrual basis of accounting

balance sheet

cash flow statement

comparative analysis

competitor analysis

current assets

current liabilities

current ratio

dividends

drawing

efficiency ratio

financial ratio

financial statement

horizontal analysis

income statement

inventory turnover ratio

liquidity ratio

market share

owner contributions

profit margin ratio

profitability ratio

statement of cash flows

statement of owner’s equity

statement of retained earnings

trend analysis

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Interest Approach.

Use an interest approach that will prepare the students for the

lesson. Teachers often develop approaches for their unique class and student situations. A

possible approach is included here.

Ask your students the following: How do you monitor your progress as a

student? Do you look only at the grade you have in a class today, or do you

compare your grade today with what it has been in previous grading periods? If

you have moved from a “C” to a “B” in a class, you would be sure to tell your

parents you are doing better. Businesses will likewise compare current

performance with performance from the past. A common way to do this is by

using financial statements for comparative analysis.

CONTENT SUMMARY AND

TEACHING STRATEGIES

Objective 1: Analyze internal financial performance comparing like time periods.

Anticipated Problem: What methods are used to analyze internal financial performance

using like time periods?

I. Financial performance comparisons over time

A. Comparative analysis is a method of conducting a side-by-side appraisal of

financial data for multiple accounting periods of the same type (e.g., month,

quarter, or year). In accounting, comparative analysis can identify budget

variances, trends, or significant line item changes. To detect emerging trends in

the company, an accountant examines financial statement line items from one

period to the next and investigates any notable differences to identify and project

changes in operations and results.

B. A financial statement is a series of reports that summarize the business’s

financial results, condition, and cash flows. The financial statements of a company

tell the story of the company’s operations and financial health.

1. Financial statements are used to:

a. Determine whether or not to extend credit to a business

b. Decide whether or not to invest in a business

c. Track the financial performance over a period of time

d. Track financial trends

2. The four primary business financial statements are the balance sheet, income

statement, statement of cash flows, and statement of owner’s equity.

a. The balance sheet is the part of the financial statement that reports the

assets, liabilities, and owner’s equity at a specific point in time. In essence,

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the balance sheet reflects the accounting equation: Assets = Liabilities +

Owner’s Equity.

b. The income statement is the part of the financial statement that reports a

company’s financial performance over a specific period of time. The income

statement is also referred to as the profit and loss statement or P&L. The

income statement may be simple and report on income and expenses, or it

may include computations of costs of goods sold (COGS) and

subcategories of expenses. On the income statement, expenses are

subtracted from revenue to calculate the net income or net loss for the

period. The accounting period is the timeframe for which the company is

reporting the results of its operations. The accounting period is usually a

month, a quarter (three months), or one year.

c. The statement of cash flows is the part of the financial statement that

reports the inflow and outflow of cash for the accounting period of the

income statement: operating activities, investing activities, financing

activities, and certain supplemental information for the period. The

statement of cash flows is also known as the cash flow statement.It

contrasts the income statement, which presents net income or net loss on

the accrual basis of accounting. The accrual basis of accounting is a

system that matches revenues and expenses based on when they occur,

not when cash is exchanged. Therefore, the income statement does not

display the actual cash generated and used. Instead, it displays revenues

and expenses.

d. The statement of owner’s equity is the part of the financial statement

that reconciles changes in the retained earnings account for a corporation.

Owner’s equity changes are reported as follows:

Beginning Owner’s Equity

+ Owner Contributions

+ Net Income or – Net Loss

–

Owner Withdrawals (drawing or dividends)

Ending Owner’s Equity

C. Owner contributions are types of capital investment (e.g., money or assets).

1. For a corporation, owner contributions are from purchases of capital stock, and

this statement of owner’s equity is called the statement of retained earn

ings.

2. For a sole proprietorship and for a partnership, owner withdrawals are referred

to as drawing. For a corporation, owner withdrawals are dividends.

D. Horizontal analysis

1. One method companies use to compare financial performance is to look at

financial statements from one time period to another. Decision-makers com

pare financial statement line items from one month to another, from quarter to

quarter, or from year to year. Typically, comparisons are made for like time

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periods. Quarterly numbers should not be compared to monthly or annual

numbers. In addition, monthly numbers should not be compared to quarterly or

annual numbers.

2. Horizontal analysis is the comparison of financial information over a series of

historical periods.

a. Income statement analysis: Typically, horizontal analysis of an income

statement involves comparing two years of income statements side by side

with a third column to report the variance between the two years. For

example:

(1) Sales are reported for the year ending Dec. 31, 2016, as $50,000.

Sales are reported for the year ending Dec. 31, 2015, as $45,000.

Comparison shows a positive variance of $5,000.

(2) Statement users would note that sales had increased by 11 percent

((50,000 – 45,000) ÷ 5,000). The same process is completed for

each line item of the income statement.

b. Balance sheet analysis: The horizontal analysis of the balance sheet is

performed in the same manner as for the income statement. Two years of

balance sheets are presented side by side, with a third column to report

the variance.

3. Trend analysis is a method to compare the same item (e.g., weekly sales fig-

ures or monthly sales figures) over a long period. Then trend lines are drawn

for the key item in the financial statements over several accounting periods.

Trend lines are frequently drawn for revenues, expenses, net income, and

debt. Trend analysis helps to:

a. Detect patterns between factors or variables

b. Project future pattern direction

E. Asking “Why?”

1. It is not enough to compile comparative financial statements, calculate vari-

ances, and draw trend lines. A key step to analysis is to ask questions about

the variances and trends.

2. Financial statement users analyze the variances and ask why the variances

occurred. They may decide to conduct a detailed analysis of a specific general

ledger account to determine the transactions that made up the variance.

3. Decision-makers are able to determine what caused the trends detected by

the comparisons and whether the data supports the continuation of the trend.

Teaching Strategy:

Many techniques can be used to help students master this

objective. Use VM–A and VM–B.

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Objective 2: Evaluate financial performance across industry competitors.

Anticipated Problem: How is financial performance evaluated across industry

competitors?

II. Financial performance evaluation

A. Competitor analysis is the process of evaluating strategies, strengths, and

weaknesses related to a common product or service, typically as part of a

marketing plan. Competitor analysis is a method to analyze a company’s financial

performance by making comparisons to others in the same industry. It is similar to

being at the produce section of a grocery store. If a person wants to buy the best

quality apple based on taste, appearance, crunch, and color, the shopper

compares several types of apples (e.g., Fugi, Gala, Granny Smith, and Red

Delicious). However, that shopper would not compare an apple to types of

oranges to determine apple quality. Competitor analysis is conducted with like

businesses in the same industry. In business, different industries have different

operating structures that may put constraints on profitability or other margins.

Several ways exist to make comparisons from one like competitor to another,

including:

1. Market share is a business’s sales in a market compared to the total sales in

that market. It is typically reported as a percentage of total sales. A business

compares its own market share to its closest competitors. Market share

involves capturing new customers to the market and maintaining current

customers.

2. Innovation may be compared as a variable of competitor analysis. For

instance, is the business generating new products or processes in the market-

place before its competitors? Is the business considered an industry leader in

innovation and production?

B. A financial ratio is a computation that indicates a company’s performance and

monetary situation; it helps people conduct comparative analysis.

1. A financial ratio is calculated based on financial statement figures. Ratios are

proportional to the business that allows small or large businesses to compare

financial information. Common financial ratio comparisons made within an

industry are liquidity, profitability, and efficiency ratios.

a. A liquidity ratio is a proportional relation that measures a company’s

ability to pay off debts as they become due. The current ratio is a

proportional ratio that measures a company’s ability to pay off current

liabilities with current assets. It is calculated as: Current Ratio = Current

Assets ÷ Current Liabilities.

(1) Current assets are resources that can easily be converted to cash.

(2) Current liabilities are obligations due within the next year.

b. A profitability ratio is a proportional relation that measures a company’s

ability to generate profits from its operations. A common profitability ratio

used for comparisons is the profit margin ratio—a proportional relation

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that measures how much profit will be generated from each dollar of sales.

It measures how effectively the company converts sales into net income

and is calculated as: Profit Margin Ratio = Net Income ÷ Net Sales.

c. An efficiency ratio is a proportional relation that measures how well a

company uses its assets to generate income.

(1) An accounts receivable turnover ratio is a proportional relation that

measures how many times a business can turn its accounts

receivable into cash. It is calculated as: Accounts Receivable Turnover

Ratio = Net Credit Sales ÷ Average Inventory.

(2) An inventory turnover ratio is a proportional relation that measures

how many times average inventory is sold during the period. It is

calculated as: Inventory Turnover Ratio = Cost of Goods Sold ÷

Average Inventory.

2. Many additional financial ratios may be used to make comparisons within an

industry. Financial statement users compare one company’s financial ratio to

another company’s financial ration within the industry to determine which one

is performing better. In addition, the ratios may be compared to industry aver

ages to determine whether or not the company is performing at, above, or

below the industry as a whole.

Teaching Strategy:

Many techniques can be used to help students master this

objective. Use VM–C. Assign LS–A.

¢ Review/Summary.

Use the student learning objectives to summarize the lesson.

Have students explain the content associated with each objective. Student responses can

be used in determining which objectives need to be reviewed or taught from a different

angle. If a textbook is being used, questions at the ends of chapters may be included in

the Review/Summary.

Application.

Use the included visual master(s) and lab sheet(s) to apply the

information presented in the lesson.

Evaluation.

Evaluation should focus on student achievement of the objectives for the

lesson. Various techniques can be used, such as student performance on the application

activities. A sample written test is provided.

Answers to Sample Test:

Part One: Matching

1. d

2. e

3. c

4. a

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5. f

6. b

Part Two: Completion

1. market share

2. financial ratios

3. accounting period

4. current assets

5. horizontal analysis

6. current liabilities

Part Three: Short Answer

Answers will vary but should be similar to the following: Comparative analysis is a

method of conducting a side-by-side appraisal of financial data for multiple accounting

periods of the same type (e.g., month, quarter, or year). In accounting, comparative

analysis can identify budget variances, trends, or significant line item changes. To

detect emerging trends in the company, an accountant examines financial statement

line items from one period to the next and investigates any notable differences to

identify and project changes in operations and results.

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Sample Test

Name ________________________________________

Comparative Analysis

Part One: Matching

Instructions: Match the term with the correct definition.

a. accounts receivable turnover ratio d. liquidity ratio

b. inventory turnover ratio e. profitability ratio

c. efficiency ratio f. trend analysis

_____1. A proportional relation that measures a company’s ability to pay off debts as they

become due

_____2. A proportional relation that measures a company’s ability to generate profits from its

operations

_____3. A proportional relation that measures how well a company uses its assets to generate

income

_____4. A proportional relation that measures how many times a business can turn its accounts

receivable into cash

_____5. A method to compare the same item (e.g., weekly sales figures or monthly sales

figures) over a long period

_____6. A proportional relation that measures how many times average inventory is sold during

the period

Part Two: Completion

Instructions: Provide the word or words to complete the following statements.

1. A business’s sales in a market compared to the total sales in that market is

_________________________.

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2. Computations from financial statements used for comparisons are

_________________________.

3. The timeframe for which the company is reporting the results of its operations is the

_________________________.

4. Assets that can easily be converted to cash are termed _________________________.

5. Comparing financial information over a series of historical periods is called

_________________________.

6. Liabilities due within the next year are termed _________________________.

Part Three: Short Answer

Instructions: Answer the following.

What is your “walking definition” (a description in your own words) of comparative analysis in

accounting?

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VM–A

COMPARATIVE ANALYSIS:

STATISTICS

Comparative analysis is a method of conducting a side-by-

side appraisal of financial data for multiple accounting

periods of the same type (e.g., month, quarter, or year). In

accounting, comparative analysis can identify budget

variances, trends, or significant line item changes.

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VM–B

HOW DO YOU MEASURE

PROGRESS?

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VM–C

MAKING FINANCIAL

COMPARISONS

Compare like periods: month to month or year to year.

Compare companies within the same industry—

competitor analysis.

t Ask why variances and trends are occurring. Dig deeper!

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LS–A

Name ________________________________________

Financial Statement Comparative

Analysis

Purpose

The purpose of this activity is to explore comparative analysis and the associated

computations.

Objectives

1. Select a company on which to conduct comparative analysis computations.

2. Calculate horizontal analysis for certain line items.

3. Calculate specific financial ratios.

4. Draw conclusions based on computations.

5. Report your findings and key questions.

Materials

lab sheet

writing utensil

paper

device with Internet access

Procedure

1. Work independently or with a partner. Take notes on your paper as needed.

2. Use Yahoo! Finance at https://finance.yahoo.com/

or another Internet search engine to

access two consecutive years of financial statements for a company of your choice.

Record the company you chose here: _________________________

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3. Perform horizontal analysis for the specific items listed below. Record your computations

in the space provided.

Item

Year 2:

(Most recent year) Year 1:

Variance

(Year 2 – Year 1)

% Variance

Variance ÷ Year 1

Current assets

Current liabilities

Total equity

Net sales

Total expenses

Net income

4. Calculate the following ratios for the most recent year using the financial statements for

the company chosen in Procedure 2. Record your computations:

a. Current ratio:

b. Profit margin ratio:

c. Inventory turnover ratio:

5. Compare the ratios you calculated with the industry average ratios. Find the industry

averages on Yahoo! Finance at https://finance.yahoo.com/

. Record your findings below.

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Ratio Type Chosen Company’s Ratio Industry Average Ratio

Current

Profit margin

Inventory turnover

6. Based on your research, consider the following questions. Write a response and

explanation to each question on your paper.

a. Does the company seem to be improving or declining over time?

b. How is the company doing in comparison to others in the same industry?

c. What may be the cause(s) of the company’s current financial condition?

d. If you were the CFO of the company, what questions would you ask to help make

financial decisions?

7. Report your findings and your questions (from Procedure 6) to your classmates and

instructor.

8. Turn in your completed lab sheet to your instructor.

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