Wrap up Notes and Module quiz 10 Interpreting Financial Statements

financial statement analysis

management-uses to plan, evaluate, and control operations within the company. Investors and creditors-uses to make decisions about loans and investing.

vertical analysis

of a single financial statement, such as an income statement percentages of single items to an aggregate total, consists of the study of a single financial statement in which each item is expressed as a percentage of a significant total such as sales.

Leverage

or equity, ratios show the relationship between debt and equity financing in a company. Leverage ratios include the equity ratio and the debt to equity ratio.

Comparative financial statements

present the same company's financial statements for one or two successive periods in side-by-side columns.

Ratios

are expressions of logical relationships between items in the financial statements of a single period

The company is forecasted to make $510 more gross profit in the next year. The gross profit in Year 1 is $1,700, and the gross profit is expected to increase to $2,210 in Year 2; therefore, the company expects to make $510 more gross profit than Actual Year 1.

An accountant provides this forecasting statement, noting that sales increased by 30% this year. Income Statement Actual Year 1 Forecasted Year 2 Sales $3,000 $3,900 Cost of Goods Sold $1,300 $1,690 Gross Profit $1,700 $2,210 What can be determined by this information? The company is forecasted to make $510 more gross profit in the next year. The company is forecasted to make $510 less gross profit in the next year. The company is forecasted to have $2,210 more net profit in the next year. The company is forecasted to make $2,210 less profit in the next year.

common-sized statements.

Financial statements that show only percentages and no absolute dollar amounts are

liquidity, profitability, and leverage.

Ratios are grouped into three categories:

horizontal analysis

The calculation of dollar changes or percentage changes in the statement items or totals This analysis detects changes in a company's performance and highlights trends including positive and negative trends.

Firm B The gross profit in Year 1 is $1,700, and the gross profit is expected to increase to $2,210 in Year 2; therefore, the company expects to make $510 more gross profit than Actual Year 1. financial statement analysis

The following information is provided for four firms: Return on Sales Asset to Equity Ratio Firm A 17% 2.90 Firm B 20% 1.50 Firm C 15% 0.90 Firm D 13% 3.50 Which company has a superior profitability ratio when compared to the others? Firm A Firm B Firm C Firm D

A company's ability to pay current and future debts Solvency is the ability of a company to meet its long-term financial obligations. A company that is insolvent must often enter bankruptcy.

What do solvency measures evaluate? A company's ability to make an initial public offering A company's ability to purchase inventory A company's ability to pay current and future debts A company's ability to generate income

It calculates percentages of single items to a total. Vertical analysis reports each amount on a financial statement as a percentage of another item. On the balance sheet, each item is calculated as a percentage of total assets and on the income statement as a percentage of sales revenue.

What is a characteristic of vertical analysis? It calculates percentages of single items to a total. It is an expression of logical relationships between items in a single period. It calculates dollar changes in statement items. It calculates changes in comparative statement items or totals.

Current ratio The current ratio is a measure of liquidity. Liquidity is the ability of a company to pay off short-term loans.

Which accounting ratio should be used to determine a company's ability to pay debt in the next 12 months? Return on sales ratio Debt ratio Return on assets Current ratio

Return on sales The return on sales ratio is an indicator of the amount of net profit on each dollar of sales.

Which ratio should be used to determine the level of profitability of a company during the last quarter?

Balance sheet The quick ratio is a measure of how well a company can meet its short-term financial liabilities. Also known as the acid-test ratio, it can be calculated as follows: (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities.

Which type of financial statement contains the information needed to compute the quick ratio? Statement of stockholders' equity and income statement Income statement Income statement and balance sheet Balance sheet

Liquidity ratios The current ratio and the acid test (quick ratio) are examples of liquidity ratios.

indicate a company's short-term debt-paying ability. Thus, these ratios show interested parties the company's capacity to meet (pay) maturing current liabilities.

Profitability

is an important measure of a company's operating success. Ratios include return on assets, return on sales, and earnings per share of common stock.