Financial Statement Analysis

1
Chapter 6

• Financial Statement Analysis

2
Objectives of Financial Statement Analysis

• To provide a basis for rational decision making
• Focus on analysis will vary according to type of
  decision
• To understand the numbers
• To develop a reasonable basis to forecast the
  future financial condition of the firm

3
Ratio Analysis

• Develop a set of statistics that reveal key
  financial characteristics of organization
• Compare to industry standards
• Compare to trend over time it is useful for
  examining trend through last one or two
  recessions to determine how well the company
  holds up during periods of economic adversity

4
Profitability Ratios

• Return on sales earnings after tax/net sales
• Return on investment (ROI) earnings after
  total/tax assets
• Return on equity (ROE) earnings after
  tax/stockholders equity

5
Liquidity Ratios

• Current Ratio current assets/current
  liabilities
• Quick Ratio cash marketable securities
  accounts receivables/current liabilities
• Average collection period accounts
  receivables/average daily sales
• Inventory turnover cost of goods sold/average
  inventory
• Days sales in inventory 365/inventory turnover

6
Operating Efficiency Ratios

• Net sales/inventory
• Net sales/working capital
• Net sales/total assets
• Net sales/fixed assets
• Net sales/stockholders equity

7
Capital Structure Ratios

• Debt ratio total debt/total assets
• Debt-equity ratio long-term debt/stockholders
  equity
• Times interest earned ratio earnings before
  interest and taxes/interest expense

8
Interrelationships among Ratios

• ROI Net income X Sales
• Sales total assets
• profit margin X asset
  turnover
• ROE Return on Investment
• 1 debt ratio

9
Common Size Statements

• Income statement net sales are equal to 100
  and all other accounts are computed as percent of
  net sales
• Balance sheet total assets are set equal to
  100 and all other accounts are computed as
  percent of total assets
• Common size statements provide supplement to
  ratio analysis
• Common size balance sheet shows internal
  structure and allocation of firms resources
• Distribution of resources invested
• Distribution between current and fixed assets

10
Common Size Statements

• Distribution among working capital accounts
• Distribution of financing on right-hand side
• Relationship between long-term debt and equity
• Relationship between short-term debt and
  permanent financing
• Common size income statement shows proportion of
  sales or revenue dollar absorbed by costs and
  expenses

11
Sequence of Analysis

• Specify objectives and key questions to be
  answered to reach this objective
• Prepare data needed to answer questions
• Analyze and interpret data
• Form conclusions based on data and answer key
  questions