1.11 Effect of Industry Characteristics on Financial Statement Relations. Effective financial statement analysis requires an understanding of a firm's eco- nomic characteristics. The relations between various financial statement items provide evidence of many of these economic characteristics. Exhibit 1.16 (pages 54-55) presents common-size condensed balance sheets and income statements for 12 firms in different industries. These common-size balance sheets and income statements express various items as a percentage of operating revenues. (That is, the statement divides all amounts by operating revenues for the year.) Exhibit 1.16 also shows the ratio of cash flow from operations to capital expenditures. A dash for a particular financial statement item does not necessarily mean the amount is zero. It merely indicates that the amount is not sufficiently large for the firm to disclose it. The 12 com- pany names and brief descriptions follow. A. Abercrombie & Fitch: Sells retail apparel primarily through stores to the fashion-con- scious young adult and has established itself as a trendy, popular player in the specialty retailing apparel industry. B. Allstate Insurance: Sells property and casualty insurance, primarily on buildings and automobiles. Operating revenues include insurance premiums from customers and reve- nues earned from investments made with cash received from customers before Allstate pays customers' claims. Operating expenses include amounts actually paid or expected to be paid in the future on insurance coverage outstanding during the year. C. Best Buy: Operates a chain of retail stores selling consumer electronic and entertain- ment equipment at competitively low prices. D. 3M: Manufactures a wide variety of industrial and consumer products (the firm lists 45 product categories on its website), ranging from home, office, and school products (such as Post-it Notes and Scotch Tape), to wound and skin care (such as Ace bandages), to adhesives for the aerospace and aircraft industries. E. Hewlett-Packard: Develops, manufactures, and sells computer hardware. The firm out- sources manufacturing of many of its computer components. F. HSBC Finance: Lends money to consumers for periods ranging from several months to several years. Operating expenses include provisions for estimated uncollectible loans (bad debts expense). G. Kelly Services: Provides temporary office services to businesses and other firms. Operat- ing revenues represent amounts billed to customers for temporary help services, and operating expenses include amounts paid to the temporary help employees of Kelly. H. McDonald's: Operates fast-food restaurants worldwide. A large percentage of McDonald's restaurants are owned and operated by franchisees. McDonald's frequently owns the res- taurant buildings of franchisees and leases them to franchisees under long-term leases. 1. Merck: A leading research-driven pharmaceutical products and services company. Merck discovers, develops, manufactures, and markets a broad range of products to improve human and animal health directly and through its joint ventures. J. Omnicom Group: Creates advertising copy for clients and is the largest marketing serv- ices firm in the world. Omnicom purchases advertising time and space from various media and sells it to clients. Operating revenues represent commissions and fees earned by creating advertising copy and selling media time and space. Operating expenses include employee compensation. K. Pacific Gas & Electric: Generates and sells power to customers in the western United States. L. Procter & Gamble: Manufactures and markets a broad line of branded consumer products. Exhibit 1.16 Common-Size Financial Statement Data for Firms in 12 Industries (Problem 1.11) 1 2 6.7% 23.0% 48.4 9.6 101.2 (50.9) BALANCE SHEET Cash and marketable securities Receivables Inventories Property, plant, and equipment, at cost Accumulated depreciation Property, plant, and equipment, net Intangibles Other assets Total Assets Current liabilities Long-term debt Other long-term liabilities Shareholders' equity Total Liabilities and Shareholders' Equity INCOME STATEMENT Operating revenues Cost of sales (excluding depreciation) or operating expenses* Depreciation and amortization Selling and administrative Research and development Interest (expense)/income Income taxes All other items, net Net Income Cash flow from operations/capital expenditures "See the problem narrative for items included in operating expenses. 13.7 11.6 76.3 (48.2) 38.1% 39.1 4.1 108.1% 23.5% 28.9 16.8 38.8 108.1% 100.0% (46.1) (4.7) (20.4) (5.8) (0.4) (6.5) (0.0) 16.1% 4.3 50.3% 8.2 58.4 197.9% 60.0% 16.5 42.7 78.7 197.9% 100.0% (23.4) (6.8) (24.1) (20.1) (1.1) (8.4) 16.7 32.7% 5.1 3 9.2% 25.0 2.9 272.3 (92.8) 179.5% 60.5 277.1% 51.2% 70.1 88.9 66.9 277.1% 100.0% (60.7) (12.6) (4.8) (3.3) (10.6) 8.1% 0.8 362.6% 47.7 10.3 (6.7) 5 6.0% 8.9 8.7 46.4 (21.8) 3.6% 2.8 112.8 120.7 9.5 537.5% 170.6% 391.7% 39.1% 19.4 26.1 51.3 25.5 75.1 79.8 537.5% 170.6% 100.0% 100.0% (91.6) (49.2) (0.9) (3.9) (10.7) (23.9) (2.6) 21.0 (1.7) (5.1) 0.7 14.3% 4.6 (6.9) 4.2 15.2% 18.7 24.6% 6 1.1% 4.1 10.6 15.4 (6.1) Exhibit 1.16 (Continued) 7 8 9 1.6% 14.7% 8.3% 2.7 10.5 66.1 (26.6) 2.2% 1.4 15.7 - 6.9 (3.7) 9.3% 3.1% 6.0 2.6 4.1 4.7 35.2% 27.8% 18.7% 10.3% 2.5 0.9 3.6 2.7 10.3 13.9 35.2% 27.8% 100.0% 100.0% (75.6) (82.5) (1.8) (0.8) (18.2) (15.3) - (0.2) (1.5) (0.5) (0.5) (0.1) 0.8% 1.6 43.2 5.0 13.1 (7.7) 7.4% 1.3 5.4% 10 27.3% 39.5% 55.7 40.9 12.9 12.0 26.7 80.5% 129.6% 794.3% 12.7% 73.0% 122.1% 2.8 22.9 565.5 12.8 7.4 20.2 52.1 26.4 86.5 80.5% 129.6% 794.3% 100.0% 100.0% 100.0% (33.3) (87.4) (29.1) (5.1) (1.8) (1.7) (49.4) (25.0) 1 0.3 (0.6) (32.7) (5.0) (4.1) (3.7) 1.2 (3.3) 7.5% 6.6 697.5 - 3.2 (1.3) 1.9% 4.5% 100.9 11 8.8% 4.0 0.5 132.4 (46.3) 86.1% 9.5 12.2 121.0% 10.8% 43.3 10.0 56.9 121.0% 100.0% (63.3) (5.1) (4.9) (2.2) (7.8) 1.7 18.3% 2.8 12 11.6% 16.8 5.3 18.3 (8.5) 9.8% 34.7 22.0 100.2% 37.5% 12.2 15.1 35.4 100.2% 100.0% (76.4) (4.2) (6.0) (2.5) (0.6) (1.5) (2.1) 6.7% 3.6 1.11 Effect of Industry Characteristics on Financial Statement Relations. Effective financial statement analysis requires an understanding of a firm's eco- nomic characteristics. The relations between various financial statement items provide evidence of many of these economic characteristics. Exhibit 1.16 (pages 54-55) presents common-size condensed balance sheets and income statements for 12 firms in different industries. These common-size balance sheets and income statements express various items as a percentage of operating revenues. (That is, the statement divides all amounts by operating revenues for the year.) Exhibit 1.16 also shows the ratio of cash flow from operations to capital expenditures. A dash for a particular financial statement item does not necessarily mean the amount is zero. It merely indicates that the amount is not sufficiently large for the firm to disclose it. The 12 com- pany names and brief descriptions follow. A. Abercrombie & Fitch: Sells retail apparel primarily through stores to the fashion-con- scious young adult and has established itself as a trendy, popular player in the specialty retailing apparel industry. B. Allstate Insurance: Sells property and casualty insurance, primarily on buildings and automobiles. Operating revenues include insurance premiums from customers and reve- nues earned from investments made with cash received from customers before Allstate pays customers' claims. Operating expenses include amounts actually paid or expected to be paid in the future on insurance coverage outstanding during the year. C. Best Buy: Operates a chain of retail stores selling consumer electronic and entertain- ment equipment at competitively low prices. D. 3M: Manufactures a wide variety of industrial and consumer products (the firm lists 45 product categories on its website), ranging from home, office, and school products (such as Post-it Notes and Scotch Tape), to wound and skin care (such as Ace bandages), to adhesives for the aerospace and aircraft industries. E. Hewlett-Packard: Develops, manufactures, and sells computer hardware. The firm out- sources manufacturing of many of its computer components. F. HSBC Finance: Lends money to consumers for periods ranging from several months to several years. Operating expenses include provisions for estimated uncollectible loans (bad debts expense). G. Kelly Services: Provides temporary office services to businesses and other firms. Operat- ing revenues represent amounts billed to customers for temporary help services, and operating expenses include amounts paid to the temporary help employees of Kelly. H. McDonald's: Operates fast-food restaurants worldwide. A large percentage of McDonald's restaurants are owned and operated by franchisees. McDonald's frequently owns the res- taurant buildings of franchisees and leases them to franchisees under long-term leases. 1. Merck: A leading research-driven pharmaceutical products and services company. Merck discovers, develops, manufactures, and markets a broad range of products to improve human and animal health directly and through its joint ventures. J. Omnicom Group: Creates advertising copy for clients and is the largest marketing serv- ices firm in the world. Omnicom purchases advertising time and space from various media and sells it to clients. Operating revenues represent commissions and fees earned by creating advertising copy and selling media time and space. Operating expenses include employee compensation. K. Pacific Gas & Electric: Generates and sells power to customers in the western United States. L. Procter & Gamble: Manufactures and markets a broad line of branded consumer products. Exhibit 1.16 Common-Size Financial Statement Data for Firms in 12 Industries (Problem 1.11) 1 2 6.7% 23.0% 48.4 9.6 101.2 (50.9) BALANCE SHEET Cash and marketable securities Receivables Inventories Property, plant, and equipment, at cost Accumulated depreciation Property, plant, and equipment, net Intangibles Other assets Total Assets Current liabilities Long-term debt Other long-term liabilities Shareholders' equity Total Liabilities and Shareholders' Equity INCOME STATEMENT Operating revenues Cost of sales (excluding depreciation) or operating expenses* Depreciation and amortization Selling and administrative Research and development Interest (expense)/income Income taxes All other items, net Net Income Cash flow from operations/capital expenditures "See the problem narrative for items included in operating expenses. 13.7 11.6 76.3 (48.2) 38.1% 39.1 4.1 108.1% 23.5% 28.9 16.8 38.8 108.1% 100.0% (46.1) (4.7) (20.4) (5.8) (0.4) (6.5) (0.0) 16.1% 4.3 50.3% 8.2 58.4 197.9% 60.0% 16.5 42.7 78.7 197.9% 100.0% (23.4) (6.8) (24.1) (20.1) (1.1) (8.4) 16.7 32.7% 5.1 3 9.2% 25.0 2.9 272.3 (92.8) 179.5% 60.5 277.1% 51.2% 70.1 88.9 66.9 277.1% 100.0% (60.7) (12.6) (4.8) (3.3) (10.6) 8.1% 0.8 362.6% 47.7 10.3 (6.7) 5 6.0% 8.9 8.7 46.4 (21.8) 3.6% 2.8 112.8 120.7 9.5 537.5% 170.6% 391.7% 39.1% 19.4 26.1 51.3 25.5 75.1 79.8 537.5% 170.6% 100.0% 100.0% (91.6) (49.2) (0.9) (3.9) (10.7) (23.9) (2.6) 21.0 (1.7) (5.1) 0.7 14.3% 4.6 (6.9) 4.2 15.2% 18.7 24.6% 6 1.1% 4.1 10.6 15.4 (6.1) Exhibit 1.16 (Continued) 7 8 9 1.6% 14.7% 8.3% 2.7 10.5 66.1 (26.6) 2.2% 1.4 15.7 - 6.9 (3.7) 9.3% 3.1% 6.0 2.6 4.1 4.7 35.2% 27.8% 18.7% 10.3% 2.5 0.9 3.6 2.7 10.3 13.9 35.2% 27.8% 100.0% 100.0% (75.6) (82.5) (1.8) (0.8) (18.2) (15.3) - (0.2) (1.5) (0.5) (0.5) (0.1) 0.8% 1.6 43.2 5.0 13.1 (7.7) 7.4% 1.3 5.4% 10 27.3% 39.5% 55.7 40.9 12.9 12.0 26.7 80.5% 129.6% 794.3% 12.7% 73.0% 122.1% 2.8 22.9 565.5 12.8 7.4 20.2 52.1 26.4 86.5 80.5% 129.6% 794.3% 100.0% 100.0% 100.0% (33.3) (87.4) (29.1) (5.1) (1.8) (1.7) (49.4) (25.0) 1 0.3 (0.6) (32.7) (5.0) (4.1) (3.7) 1.2 (3.3) 7.5% 6.6 697.5 - 3.2 (1.3) 1.9% 4.5% 100.9 11 8.8% 4.0 0.5 132.4 (46.3) 86.1% 9.5 12.2 121.0% 10.8% 43.3 10.0 56.9 121.0% 100.0% (63.3) (5.1) (4.9) (2.2) (7.8) 1.7 18.3% 2.8 12 11.6% 16.8 5.3 18.3 (8.5) 9.8% 34.7 22.0 100.2% 37.5% 12.2 15.1 35.4 100.2% 100.0% (76.4) (4.2) (6.0) (2.5) (0.6) (1.5) (2.1) 6.7% 3.6