Chapter 13: Financial Statement Analysis

Profitability ratios

are ratios to examine the entitys ability to generate a profit

comparative financial statements

Show financial amounts in side-by-side columns on a single statement, called a comparative format.

Solvency Ratios

are used to examine the entitys ability to pay all debt and generate future revenues-the debt ratio and equity ratio assesses a companys mix of debt and equity financing

Earnings Per Share (EPS)

reports the amount of net income (loss) for each share of the company's outstanding common stock. It is the most widely quoted of all financial statistics. It is the only ratio that must appear on the financial statements

Asset turnover

measures a companys ability to use its assets to generate sales. Another way to look at it is the amount of net sales generated for each average $1 of total assets invested

Acid Test or Quick Ratio

measures ability to pay if they came due immediately. With highly liquid assets

Accounts Receivable Turnover

measures how frequently a company converts its receivables into cash. It approximates the number of times the company collects the average receivables balance during the year

Inventory Turnover

measures how long a company holds its inventory before selling it. It approximates the number of times a company sells its average level of inventory during the year

ratio analysis

measures key relations between financial statement items

Rate of Return on Total Assets

measures the ability of a firm to earn a return on its assets. That is, provides a measure of how efficiently assets are used

Current ratios

measures the ability to pay current liabilities with current assets

Gross margin or gross profit ratio

measures the profitability of each sales dollar above cost of goods sold

Debt to equity ratio

measures the relative proportion of financing provided by creditors as opposed to stockholders

remaining noncurrent assets

plant assets can also be called property, plant, and equipment or fixed assets

Ratio Analysis

ratios express the mathematical relationships between two or more amounts.

common size financial statements

report only percentages to remove any dollar value bias we see when comparing numbers. The percentages come from vertical analysis

Internal Users

(managers, officers, and internal auditors) the purpose is to get information to improve efficiency and effectiveness

Guidelines

(rules of thumb) can be used as standards- they are from past experience

3 basic tools of analysis

1. Horizontal Analysis 2. Vertical Analysis 3. Ratio Analysis

External Users

1.) Stockholders and creditors need to assess performance for making investing and lending decisions 2.) the board of directors assess financial statements to monitor managements performance 3.) external auditors assess the fair presentation of the financial statements in their report

2 steps in horizontal analysis

1.) compute the dollar amount of the change in a line item from the earlier (base) period to the later period 2.) Divide that dollar amount of change by the base period

Financial Statement Analysis

applies analytical tools to financial statements and related data for making business decisions

Competitors standards

are available for comparison- you can look up your competitors and see what their financial statement analysis numbers were

Industry Standards

can be used for comparison within the same industry

intracompany comparisons

can include comparing items in the financial statements from year to year- can compare items on the same statement

4 assets that are current assets

cash, accounts receivable, inventory, and prepaid expenses

vertical analysis

compares financial condition and performance to a base amount- taking a number, and you're going back to the base and making a comparison

horizontal analysis

compares financial conditions and performance across time- a financial statement that has more than one year- you can horizontally across it and compare from year to year

vertical analysts

expresses each item within a financial statement as a percent of a selected item (base) on the statement. For every item on the income statement, net sales revenue as its base. For the balance sheet, total assets is the base

Notes to the financial statements

include a summary of significant accounting policies and explanations of specific items on the financial statements

general-purpose financial statements

include income statement, the balance sheet, the statement of stockholders equity (or statement of retained earnings), statement of cash flows, and the notes to the financial statements

trend analysis

is a form of horizontal analysis. Are computed by selecting a base period as 100% and expressing amounts for following periods as a percentage

Efficiency Ratios

is how productive a company is in using its assets

Liquidity Ratios

is the availability of resources to pay short-term obligations

financial reporting

is the communication of financial information useful for making investment, credit, and other business decisions.

Vertical analysis

is used to evaluate the relationships within a single financial statement. Also, it can be used to compare to prior years and / or other companies

rate of return on stockholders equity

shows how much income was earned for each $1 invested by common stockholders

Profit Margin Ratio

shows how much net income is earned on every dollar of sales

Debt ratio

shows the proportion of assets financed with debt. The higher this ratio is, the higher the companys financial risk

Equity Ratio

shows the proportion of assets financed with equity