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