ANALYSIS OF FINANCIAL STATEMENTS Flashcards
IMPORTANCE OF STATEMENT ANALYSIS
The purpose of financial statement analysis is to assist statement users in predicting the future.
Three techniques commonly used to make comparisons and to detect trends:
- Peso and percentage changes in financial statement items
- Common-size statements
- Financial Ratios
The financial statements are placed side by side (comparative form).
HORIZONTAL (TREND) ANALYSIS
Restate a time-series of financial data in terms of a base year. It indicates business direction and shows how have things changed over the years (year to year comparison).
TREND PERCENTAGES
The ____ ____ is the earliest year and set equal to 100%. __________ ____ are expressed as a percentage of the base period.
base year, Subsequent years
The difference (increase or decrease) between two statements can be shown in separate columns in both peso and percentage forms.
PESO AND PERCENTAGE CHANGES ON STATEMENTS
It shows each item as a percentage of a total rather than in peso form. These kinds of statements make it much easier to compare firms of different sizes and to track balance sheet and income statement relationships within a company over time as its size changes.
VERTICAL (COMMON-SIZE) ANALYSIS
These ratios measure the firm’s ability to pay off debts that are maturing within a year or within the next operating cycle
LIQUIDITY RATIOS
The capital of a business used in day-to-day operations.
WORKING CAPITAL
A measure of short-term paying ability; a test of ability to meet current obligations from current assets; measure of adequacy of working capital.
CURRENT RATIO
This is a more severe test of immediate liquidity. Quick Assets = Cash, Marketable Securities and Accounts Receivable.
Inventories and Prepaid Assets are excluded from the total current assets leaving only the more liquid assets to be divided by current liabilities.
QUICK RATIO OR ACID-TEST RATIO
These ratios measure the efficiency of a firm in using its assets.
ACTIVITY RATIOS AND ASSET MANAGEMENT RATIOS
A measure of the efficiency of management to generate sales and thus earn more profit for the firm.
ASSET TURNOVER
Measures the efficiency and velocity of collection of accounts receivable. It indicates how many times a company’s accounts receivable have been turned into cash during the year.
ACCOUNTS RECEIVABLE TURNOVER
It is the average number of days required to convert receivable into cash. It helps evaluate the liquidity of accounts receivable and the firm’s credit policies.
AVERAGE COLLECTION PERIOD
It measures the efficiency of the firm in managing and selling inventories. It shows how many times inventory was sold during the period.
INVENTORY TURNOVER
It is the average number of days to sell or consume the average inventory.
AVERAGE SALE PERIOD
These ratios measure how the firm has financed its assets with debt relative to equity as well as the firm’s ability to repay its long-term debt, interest and other fixed charges (such as rent, sinking fund payments, etc.)
It indicates how risky the firm is and how much of its operating income must be paid to bondholders rather than stockholders.
LEVERAGE OR DEBT MANAGEMENT RATIOS
It shows proportion of all assets that are financed with debt. The higher the proportion of debt, the greater the risk because creditors must be satisfied before owners in the event of bankruptcy.
DEBT RATIO
Indicates proportion of assets provided by investors/owners.
EQUITY RATIO
It shows the debt relative to amounts of resources provided by owners. It measures the riskiness of the firm’s capital structure in terms of relationship between the funds supplied by creditors and investors.
DEBT-TO-EQUITY RATIO
Measures how many times interest expense is covered by operating profit. It is the most common measure of the ability of a firm’s operations to provide protection to long-term creditors.
TIMES-INTEREST-EARNED
These are ratios that measure the overall performance of the firm and its efficiency in managing assets, liabilities, and equity.
PROFITABILITY RATIOS
Measures profit generated after consideration of cost of products sold. It measures the ability of a company both to control costs and inventories or manufacturing of products and to pass along price increases through sales to customers.
GROSS MARGIN RATIO
Measures profitability after considering all revenues and expenses, including interest, taxes and nonoperating items.
NET PROFIT MARGIN
Measures the overall efficiency of the firm in managing assets and generating profits.
RETURN ON ASSETS
Measures rate of return on resources provided by owners.
RETURN ON EQUITY
These ratios consider the stock price that gives and idea of what investors think about the firm and its future prospects.
MARKET-BOOK RATIOS
