Question

AMERICAN APPAREL: DROWNING IN DEBT?1

Prepare the company’s common-size balance sheets and common-size income statements for the recent three years 2011-2013 (including all subtotals and totals and round to 2 numbers after the decimal). Analyze three major components based on the common-size balance sheets and the trends of those components over the three years. Analyze two major components based on the common-size income statements and the trends of those components over the three years. Use 10.00% as a threshold.

Answer 1

A icommon isize ifinancial istatement idisplays iline iitems ias ia ipercentage iof ione iselected ior icommon ifigure. iCreating icommon isize ifinancial istatements imakes iit ieasier ito ianalyze ia icompany iover itime iand icompare iit iwith iits ipeers. iUsing icommon isize ifinancial istatements ihelps iinvestors ispot itrends ithat ia iraw ifinancial istatement imay inot iuncover.

· A icommon isize ifinancial istatement idisplays iitems ion ia ifinancial istatement ias ia ipercentage iof ia icommon ibase ifigure.

· For iexample, iif itotal isales irevenue iis iused ias ithe icommon ibase ifigure, ithen iother ifinancial istatement iitems—such ias ioperating iexpenses iand icost iof igoods—will ibe icompared ias ia ipercentage iof itotal isales irevenue.

· Investors iuse icommon isize ifinancial istatements ito imake iit ieasier ito icompare ia icompany ito iits icompetitors iand ito iidentify isignificant ichanges iin ia icompany's ifinancials.

Balance iSheet iAnalysis

The icommon ifigure ifor ia icommon isize ibalance isheet ianalysis iis itotal iassets. iBased ion ithe iaccounting iequation, ithis ialso iequals itotal iliabilities iand ishareholders’ iequity, imaking ieither iterm iinterchangeable iin ithe ianalysis. iIt iis ialso ipossible ito iuse itotal iliabilities ito iindicate iwhere ia icompany’s iobligations ilie iand iwhether iit iis ibeing iconservative ior irisky iin imanaging iits idebts.

The icommon isize istrategy ifrom ia ibalance isheet iperspective ilends iinsight iinto ia ifirm’s icapital istructure iand ihow iit icompares ito iits irivals. iAn iinvestor ican ialso ilook ito idetermine ian ioptimal icapital istructure ifor ia igiven iindustry iand icompare iit ito ithe ifirm ibeing ianalyzed. iThen ithe iinvestor ican iconclude iwhether ithe idebt ilevel iis itoo ihigh, iexcess icash iis ibeing iretained ion ithe ibalance isheet, ior iinventories iare igrowing itoo ihigh. iThe igoodwill ilevel ion ia ibalance isheet ialso ihelps iindicate ithe iextent ito iwhich ia icompany ihas irelied ion iacquisitions ifor igrowth.

Analyzing ithe iIncome iStatement

The icommon ifigure ifor ian iincome istatement iis itotal itop-line isales. iThis iis iactually ithe isame ianalysis ias icalculating ia icompany's imargins. iFor iinstance, ia inet iprofit imargin iis isimply inet iincome idivided iby isales, iwhich ialso ihappens ito ibe ia icommon isize ianalysis.

The isame igoes ifor icalculating igross iand ioperating imargins. iThe icommon isize imethod iis iappealing ifor iresearch-intensive icompanies, ifor iexample, ibecause ithey itend ito ifocus ion iresearch iand idevelopment i(R&D) iand iwhat iit irepresents ias ia ipercent iof itotal isales.

Common iSize iand iCash iFlow

In ia isimilar ifashion ito ian iincome istatement ianalysis, imany iitems iin ithe icash iflow istatement ican ibe istated ias ia ipercent iof itotal isales. iThis ican igive iinsight ion ia inumber iof icash iflow iitems, iincluding icapital iexpenditures ias ia ipercent iof irevenue.

Share irepurchase iactivity ican ialso ibe iput iinto icontext ias ia ipercent iof ithe itotal itop iline. iDebt iissuance iis ianother iimportant ifigure iin iproportion ito ithe iamount iof iannual isales iit ihelps igenerate. iBecause ithese iitems iare icalculated ias ia ipercent iof isales, ithey ihelp iindicate ithe iextent ito iwhich ithey iare ibeing iutilized ito igenerate ioverall irevenue.

The ikey ibenefit iof ia icommon isize ianalysis iis iit iallows ifor ia ivertical ianalysis iby iline iitem iover ia isingle itime iperiod, isuch ias ia iquarterly ior iannual iperiod, iand ialso ifrom ia ihorizontal iperspective iover ia itime iperiod i.

A icommon isize iincome istatement iis ian iincome istatement iin iwhich ieach iline iitem iis iexpressed ias ia ipercentage iof ithe ivalue iof irevenue ior isales. iIt iis iused ifor ivertical ianalysis, iin iwhich ieach iline iitem iin ia ifinancial istatement iis irepresented ias ia ipercentage iof ia ibase ifigure iwithin ithe istatement.

Common isize ifinancial istatements ihelp ito ianalyze iand icompare ia icompany's iperformance iover iseveral iperiods iwith ivarying isales ifigures. iThe icommon isize ipercentages ican ibe isubsequently icompared ito ithose iof icompetitors ito idetermine ihow ithe icompany iis iperforming irelative ito ithe iindustry.

the iCommon iSize iIncome iStatement iIs iUsed

Generally iaccepted iaccounting iprinciples i(GAAP) iare ibased ion iconsistency iand icomparability iof ifinancial istatements. iA icommon isize iincome istatement imakes iit ieasier ito isee iwhat's idriving ia icompany’s iprofits. iThe icommon isize ipercentages ialso ihelp ito ishow ihow ieach iline iitem ior icomponent iaffects ithe ifinancial iposition iof ithe icompany. iAs ia iresult, ithe ifinancial istatement iuser ican imore ieasily icompare ithe ifinancial iperformance ito ithe icompany's ipeers.

By ianalyzing ihow ia icompany's ifinancial iresults ihave ichanged iover itime, icommon isize ifinancial istatements ihelp iinvestors ispot itrends ithat ia istandard ifinancial istatement imay inot iuncover. iThe icommon isize ipercentages ihelp ito ihighlight iany iconsistency iin ithe inumbers iover itime–whether ithose itrends iare ipositive ior inegative. iLarge ichanges iin ithe ipercentage iof irevenue ias icompared ito ithe ivarious iexpense icategories iover ia igiven iperiod icould ibe ia isign ithat ithe ibusiness imodel, isales iperformance, ior imanufacturing icosts iare ichanging.