LEN-09-1211-001.qxd:. 6/30/10 2:58 PM Page 48 48 Chapter 1 Overview of FinancialReporting, FinancialStatementAnalysis, and Valuation EXHIBIT 1.20 Common-Size and Percentage Change Income Statements for Coca-Cola (allow for rounding) Common-Size Income Statements Percentage Change Income Statements 2008 2007 2006 2005 2004 2008 2007 2006 2005 Net revenue 100.0% 100.0% 100.0% 100.0% 100.0% 10.7% 19.8% 4.3% 6.3% Cost of sales 35.6% 36.1% 33.9% 35.5% 35.3% 9.3% 27.5% (0.4%) 6.8% Gross Profit 64.4% 63.9% 66.1% 64.5% 64.7% 11.5% 15.9% 6.8% 6.0% Selling, general, and administrative expenses 36.9% 37.9% 39.2% 37.8% 36.3% 7.6% 16.1% 7.9% 10.8% Other operating charges 1.1% 0.9% 0.8% 0.4% 2.2% 37.8% 37.3% 117.6% (82.3%) Operating Profit 26.4% 25.1% 26.2% 26.3% 26.2% 16.5% 15.0% 3.7% 6.8% Bottling equity income (2.7%) 2.3% 0.4% 2.9% 2.9% (230.8%) 554.9% (85.0%) 9.5% Interest expense (1.4%) (1.6%) (0.9%) (1.0%) (0.9%) (3.9%) 107.3% (8.3%) 22.4% Interest income 1.0% 0.8% 0.8% 1.0% 0.7% 41.1% 22.3% (17.9%) 49.7% Other income (loss), net (0.1%) 0.6% 0.8% (0.3%) (0.3%) (116.2%) (11.3%) (378.6%) 20.7% Income before Income Taxes 23.3% 27.3% 27.3% 29.0% 28.6% (5.5%) 19.7% (1.7%) 7.5% Provision for income taxes 5.1% 6.6% 6.2% 7.9% 6.3% (13.7%) 26.3% (17.6%) 32.2% Net Income 18.2% 20.7% 21.1% 21.1% 22.3% (2.9%) 17.7% 4.3% 0.5%
LEN-09-1211-001.qxd:. 6/30/10 2:58 PM Page 49 Step 4: Analyze Profitability and Risk 49 The analyst must interpret common-size financial statements carefully. The amount for any one item in these statements is not independent of all other items. The dollar amount for an item might increase between two periods, but its relative percentage in the commonsize statement would decrease (or remain the same) if the dollar amount increased at a slower (or the same) rate as total assets. For example, PepsiCo’s dollar amounts for property, plant, and equipment increased between 2007 and 2008, but the common-size percentages remained the same because they increased at the same rate as total assets. Common-size percentages provide a general overview of financial position and operating performance, but the analyst must supplement them with other analytical tools. Percentage Change FinancialStatements Another powerful analytical tool is percentage change financial statements, a tool that is helpful in highlighting the relative rates of growth in financial statement amounts from year to year and over longer periods of time. These statements present the percentage change in the amount of an item relative to its amount in the previous period or the compounded average percentage change over several prior periods. The four rightmost columns of Exhibit 1.17 present percentage changes in balance sheet items during 2005 through 2008 for PepsiCo. Note that the increase in cash and the decrease in short-term investment securities are the largest percentage changes in assets between 2007 and 2008, consistent with the preceding observations with respect to changes in the common-size balance sheet. Another large percentage change between 2007 and 2008 occurred for long-term obligations, consistent with the prior observation from the statement of cash flows that PepsiCo issued a large amount of long-term debt in 2008. Also note that the huge percentage increase in accumulated other comprehensive loss for 2008 was 393 percent. This change reflects an increase in the accumulated loss from a negative $952 million in 2007 to a negative $4,694 million in 2008. This is an example in which a large percentage change in an account corresponds with a large dollar amount of change. For comparison, the four rightmost columns of Exhibit 1.19 present the percentage changes in balance sheet items for Coca-Cola during 2005 through 2008. The analyst must exert particular caution when interpreting percentage change balance sheets for a particular year. If the amount for the preceding year that serves as the base is relatively small, even a small change in dollar amount can result in a large percentage change. This is the case, for example, with PepsiCo’s deferred tax liability. The liability declined by 65.0 percent in 2008, but it amounted to only a drop from $646 million in 2007 to $226 million in 2008. However, note that the deferred tax liability comprises only 0.6 percent of total assets at the end of 2008. A large percentage change in an account that makes up a smaller portion of total financing is not as meaningful as a smaller percentage change in an account that makes up a larger portion of total assets or total financing. The four rightmost columns of Exhibit 1.18 present percentage change income statement amounts for PepsiCo. Note that during 2008, 2007, and 2005, net income growth did not keep pace with revenue growth. An analyst might direct particular concern to the rapid growth rates in cost of sales, which have exceeded the growth rates in sales each of the four years. This implies a lower degree of cost control, a loss of pricing power, or a shift in product mix to lower margin products, leading to shrinking gross profit margins. The analyst should carefully investigate the reasons for this deterioration in PepsiCo’s profitability. By comparison, the four rightmost columns of Exhibit 1.20 present the percentage change income statement amounts for Coca-Cola during the same span of years, and they reveal that (with the exception of 2007) Coca-Cola exhibited stronger control over cost of sales as a percentage of revenues.