Accounting Chapter 12: Financial Statement Analysis

Debt to equity ratio

Total liabilities divided by stockholders' equity; measures a company's solvency risk.

Average collection period

Approximate number of days the average accounts receivable balance is outstanding. It equals 365 divided by the receivables turnover ratio.

Average days in inventory

Approximate number of days the average inventory is held. It equals 365 days divided by the inventory turnover ratio.

Profitability ratios

Measure the earnings or operating effectiveness of a company.

Receivables turnover ratio

Net credit sales divided by average accounts receivable; the number of times during a year that the average accounts receivable balance is collected ("turns over").

Return on equity

Net income divided by average stockholders' equity; measures the income generated per dollar of equity.

Return on assets

Net income divided by average total assets; measures the amount of net income generated for each dollar invested in assets.

Profit margin

Net income divided by net sales; indicates the earnings per dollar of sales.

Asset turnover

Net sales divided by average total assets, which measures the sales per dollar of assets invested.

Aggressive accounting practices

Practices that result in reporting higher income, higher assets, and lower liabilities.

Conservative accounting practices

Practices that result in reporting lower income, lower assets, and higher liabilities.

Times interest earned ratio

Ratio that compares interest expense with income available to pay those charges.

Liquidity

Refers to a company's ability to pay its current liabilities.

Solvency

Refers to a company's ability to pay its long-term liabilities.

Quality of earnings

Refers to the ability of reported earnings to reflect the company's true earnings, as well as the usefulness of reported earnings to predict future earnings.

Growth stocks

Stocks that have high expectations of future earnings growth and therefore usually trade at higher PE ratios.

Value stocks

Stocks that have lower share prices in relationship to their fundamental ratios and therefore trade at lower (bargain) PE ratios.

Extraordinary item

An event that is (1) unusual in nature and (2) infrequent in occurrence.

Horizontal analysis

Analyzes trends in financial statement data for a single company over time.

Acid-test ratio

Cash, current investments, and accounts receivable divided by current liabilities; measures the availability of liquid current assets to pay current liabilities.

Price-earnings (PE) ratio

Compares a company's share price with its earnings per share.

Inventory turnover ratio

Cost of goods sold divided by average inventory; the number of times the firm sells its average inventory balance during a reporting period.

Current ratio

Current assets divided by current liabilities; measures the availability of current assets to pay current liabilities.

Vertical analysis

Expresses each item in a financial statement as a percentage of the same base amount.

Gross profit ratio

Gross profit divided by net sales; measures the amount by which the sale price of inventory exceeds its cost per dollar of sales.

Discontinued operation

The sale or disposal of a significant component of a company's operations.