Financial statement analysis and ratios

Accounts recievable turnover

Net credit sales to average recievables

Return on stockholders equity

Net income available to common stock holders equity

Liquidity

The ability of a business to pay its debts when due

Liquidity(debt)

measures the ability of a business to pay its debts when due. Many businesses fail because they cannot pay their debts, even though they are profitable and have long-term financial strength.

Balance sheet

All types of Assets, liabilities and equities. Total liabilities and stockholders equity = total assets.

... Description of acid test ratios

Acid-test ratios vary widely from industry to industry. A general guideline is that the acid-test ratio should be at least 1 to 1. The due dates of current liabilities, composition of quick assets, and various operating factors are considered when evaluating the adequacy of the ratio. Comparisons with the industry average and with the company's ratio in prior years can be helpful.

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Assets are considered current if they will be converted to cash or used within one year.

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Changes in the percentages might reveal situations that need investigation. For example, the comparative balance sheet of Special Products, Inc., shows that cash has increased from 15.5 percent of total assets in 2012 to 20.7 percent of total assets in 2013. The accountant may suggest that this increase be studied.

Industry averages

Comparing similar companies using ratios and percentages

Horizontal analysis

Comparison of individual item percentages on the financial statement from year to year.

Two phases of financial statement analysis

Computation and interpretation

Example of horizontal analysis

Each amount for 2013 is compared to the corresponding amount for 2012. The increase or decrease of the change and the percentage of change are shown in the right two columns. The balance sheet and income statement can both be horizontally an analyzed.

Income statement

Expenses and income costs of goods sold and revenue

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Financial statements with items expressed as percentages of a base amount are called common-size statementsFinancial statements with items expressed as percentages of a base amount. The last two columns in the comparative income statement are referred to as a comparative common-size statement.

Current assets/current liabilities ratio

From the viewpoint of a short-term creditor, the higher the current ratio, the greater the amount of protection afforded. However, the current ratio can be too high. A very high current ratio indicates that excess current assets are on hand and are not earning income

Asset turnover ratio

Net sales to total assets (shows the effectiveness of using assets in making sales)

Vertical analysis on the balance sheet

On the balance sheet everything is recorded as a percentage of total assets or liabilities and stockholders equity

Horizontal analysis

Percentage change for individual items on the financial statement analysis from year to year

Leveraged buyout

Purchasing a business by buying a significant amount of its stock

Price earnings ratio

The current market value of common stock over the earnings per share of that stock.

Working capital(obligations)

The measure of the ability of a company to meet its current obligations; the excess of current assets over current liabilities

Average collection period

The ratio of 365 days to the accounts recievable turnover. Also called the number of days sales in recievables.

Current ratio

The ratio of current assets to current liabilities. measures a companies ability of a company to pay it's current debts.

Ratio analysis

The relationship between various items in the financial statements. They can be comparing items in the same statement or different statements

Total equities

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

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The usual practice is to round percentages to the nearest one-tenth of a percent. The computation in the example is made to the fourth decimal (0.5903). That decimal fraction is converted to a percentage by moving the decimal point two places to the right (59.03 percent). The percentage is then rounded to the nearest one-tenth of a percent; hence, 59.03 is rounded to 59.0.

How do you compute book value per share of common stock

The value is determined by dividing the common stockholders' equity (total stockholders' equity minus the book value of preferred stock) by the number of shares of common stock outstanding.

Computation phase

Vertical analysis horizontal n ratio analysis

Net credit sales over average recievables ratio

a measure of the reasonableness of the accounts outstanding. This measurement uses net credit sales, which includes notes receivable from sales transactions. The accounts receivable turnover is computed as follows:

Acid test ratio

cash+ recievables+marketable securities /current liabilities

Vertical analysis on the income statement

everything is recorded as percentage of net sales.

... The interpretation phase

the interpretation phase, is the more difficult and important step. Financial statement interpretation requires an understanding of financial statements and knowledge of the operations of the business and the industry. In the interpretation phase, the analyst develops an understanding of the significance of the percentages and ratios computed. Analysts compare the ratios for the current year to prior years' ratios, budgeted ratios, and industry averages.