Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 14 Financial Statement Analysis 635

Common-Size Statements

Horizontal and vertical analyses with both dollar and percentage amounts are useful

in assessing relationships and trends in financial conditions and operations of a busi-

ness. Vertical analysis with both dollar and percentage amounts is also useful in com-

paring one company with another or with industry averages. Such comparisons are

easier to make with the use of common-size statements. In a common-size statement,

all items are expressed in percentages. An example of common-size income statements

forPixarandDreamWorks Animation SKG, Inc., is shown later in this chapter.

Common-size statements are useful in comparing the current period with prior pe-

riods, individual businesses, or one business with industry percentages. Industry data

are often available from trade associations and financial information services.

Other Analytical Measures

In addition to the preceding analyses, other relationships may be expressed in ratios

and percentages. These relationships are described and illustrated in the following sec-

tions. Often, the items analyzed are taken from the financial statements, and thus the

analysis is a type of vertical analysis. Comparing these items with items from earlier

periods is a type of horizontal analysis.

Blockbuster Strategy

HOW BUSINESSES MAKE MONEY

Pixaremploys the blockbuster emphasis, which is
common in the film and pharmaceutical industries.
This emphasis involves investing large up-front costs
to develop a product with fewer additional costs
after the product is launched. As a result, the suc-
cess of the product is determined by the amount of
sales after the product is developed. Blockbusters
are very profitable under this strategy; however,

box office bombs can result in large development

and marketing write-offs. Pixar has earned over

$3.2 billion in worldwide box office receipts from

six feature films, achieving a blockbuster return on

every film it has produced. As stated by an invest-

ment analyst, “Pixar is in the sweet spot, you can

spend $100 million and get a $400 million profit.”

Exhibit 4

Comparative Income

Statement—Vertical

Analysis

Pixar

Income Statement (In millions)

For Periods Ended January 1, 2005, and January 3, 2004

2004 2003

Amount Percent Amount Percent

Total revenue $273.5 100.0% $262.5 100.0%

Cost of goods sold 29.9 10.9 38.0 14.5

Gross profit $243.6 89.1% $224.5 85.5%

Research and development expenses $ 17.4 6.4% $ 15.3 5.8%

Selling, general, and administrative

expenses 17.5 6.4 15.2 5.8

Total operating expenses $ 34.9 12.8% $ 30.5 11.6%

Income from operations $208.7 76.3% $194.0 73.9%

Interest income and other 12.4 4.5 10.5 4.0

Income before income taxes $221.1 80.8% $204.5 77.9%

Income tax expense 79.4 29.0 79.7 30.4

Net income $141.7 51.8% $124.8 47.5%