Chapter 23: Financial Statement Analysis

industry averages

Financial ratios and percentages reflecting averages for similar companies

Number of Times Bond Interest Earned

(Income before bond interest and income taxes)/(Bond interest cash requirement) 1. compute the income before bond interest and income taxes. 2. Compute the cash required to pay bond interest 3 compute ratio.

Return on common stockholders' equity

(income available to common stockholders) / (common stockholders' equity) = return on common stockholders' equity. key measure of how well the corporation is making a profit for its shareholders.

Steps to compute return on stockholders' equity

1. Compute income available to common stockholders. Dividends - net income after taxes = income available to stockholders 2. Compute the common stockholders' equity. total stockholders' equity - less preferred stock equity = common stockholders' equity 3. divide the income available to common stockholders by the common stockholders' equity

ratios that measure financial strength

1. Number of times bond interest earned 2. ratio of stockholders' equity to total equities 3. ratio of stockholders' equity to total liabilities 4. book value per share of common stock

financial ratios classifications

1. Profitability, operating results, and efficiency 2. Financial strength 3. Liquidity

Ratios that measure liquidity

1. Working Capital 2. current ratio 3. acid-test ratio 4. inventory turnover 5. accounts receivable turnover average collection period

Phases of Financial Statement analysis

1. compute differences, percentages, and ratios 2. interpret the results

Ratios that Measure profitability, operating results and efficiency

1. rate of return on net sales 2. rate of return on common stockholders' equity 3. earnings per share of common stock 4. price-earnings ratio 5. yield on common stock 6. rate of return on total assets 7. asset turnover

Computation phase

1: Vertical analysis 2. Horizontal analysis 3. Ratio analysis

average collection period

365/accounts receivable turnover

common size statements

A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statement items as a percentage of sales.

comparative statements

Lists two or more years of figures side by side

liquidity ratios

Measures of the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.

Return on Sales

Net Income/ Net Sales measures what part of each sales dollar remains as net income. Also measures operating efficiency and profitability.

ratio of stockholders' equity to total liabilities aka ratio of owned capital to borrowed capital

Stockholder's equity/ Total Liabilities

Total Equities

The sum of a corporation's liabilities and stockholders' equity

Accounts Receivable Turnover

a measure of reasonableness of the accounts outstanding. net credit sales/average receivables = accounts receivable turnover 1. compute the average accounts receivable 2. Divide net credit sales by average accounts receivable.

Yield on Common Stock

cash dividend per share/market price per share = yield on common stock

acid test ratio

cash+receivables+marketable securities/current liabilities = acid test ratio

book value per share

common equity / shares outstanding 1. compute the claims of preferred stockholders 2. deduct the claims of preferred stockholders from total stockholders' equity to compute the claims of common stockholders. 3. divide the total claims of common stockholders by the number of share of common stock outstanding.

price-earnings ratio

compares the market value of common stock with earnings per share of that stock market price per share of common stock/earnings per share of common stock = price-earnings ratio

Inventory Turnover Ratio

cost of goods sold/average merchandise inventory = inventory turnover 1. compute average inventory 2. divide the cost of goods sold by the average inventory.

Net Working Capital

current assets - current liabilities

current ratio

current assets/ current liabilities

Earnings per share of common stock

income available to common stock holders/average number of shares of common stock outstanding during year = earnings per share 1. compute income available to common stockholders. net income after tax - less dividend requirements on preferred stock = income available on common stock holder 2. determine the average number of share of common stock outstanding during the year. 3. divide the income available to common stockholders by the average number of shares of common stock outstanding.

rate of return on total assets

income before interest expense and income taxes/total assets = rate of return on total assets

horizontal analysis

is the percentage change for individual items in the financial statement from year to year. Also compares the items on each line to determine the change in dollar amounts

Interpretation phase

requires and understanding of financial statements and knowledge of operations of the business and the industry. Analyst develops an understanding of the significance of the percentages and ratios computed. Analysts compare the ratios for the current year to prior year's ratios, budgeted ratios, and industry averages.

ratio of stockholders' equities to total equities

stockholders' equity/total equities

ratio analysis

the calculation and interpretation of a financial ratio. Form of analytical review

Leveraged Buyout (LBO)

the purchasers of a business buy the corp's stock by having the acquired corp incur debt to pay the sellers

Asset Turnover

the ratio of net sales to total assets measure the effective use of assets in making sales. net sales/total assets = asset turnoever

vertical analysis

the relationship of each item on a financial statement to some base amount on the statement. - the income statement, each item is expressed as a percentage of net sales. - balance sheet each item is expressed as a percentage of total assets or total liabilities and stockholder's equity