Ch.11 Financial statement analysis

Question 1

Financial statement analysis circumstances

Answer 1

financial reporting - analysis used to explain and interpret results to stakeholders
Audit and assurance - performed as part of analytical procedures throughout assurance engagements. primarily to identify items requiring further investigation.
Strategy and governance - used during situational analysis to identify strengths, weaknesses, opportunities, and threats.
Management accounting - performance measurement systems, creating incentives to achieve ratio targets -sometimes in ways that lead to more efficient and effective operations, and sometimes in ways that lead to suboptimal or dysfunctional behaviour.
Finance- analyses of an organization’s financial state / health by providing information about the organization’s short- and long-term financial strength and its ability to use resources efficiently to generate profits and cash flow.

Question 2

Step 1: Assess the situation

Answer 2

approach a financial statement analysis:
•     horizontal trend
•     vertical trend
•     ratios
Each of these approaches involves comparing current results to an expected benchmark. The benchmark may be prior-period results, industry results, or some other amount plus what u expect

Question 3

Horizontal trend

Answer 3

compares financial information over time, looking at variances from period to period
- identify where financial items have changed significantly
-find underlying issues
dollar change= current period dollar - dollar value of an account in the benchmark
percentage change= taking the dollar change (per above) and dividing it by the dollar value of the account in the benchmark
IN EXAM DONT CALC EACH LINE, JUST CHECK TO SEE FOR MAJOR ISSUES

Question 4

Vertical trend

Answer 4

aka common-size trend
comparison of accounts with a single line item
presents each item in the income statement or balance sheet as a percentage of a base figure from the same statement (usually rev if IS, and total assets if BS)
-allows the reader to easily compare financial statement line items and identify areas where items may be outside of the benchmark.

Question 5

Vertical trend hint

Answer 5

focus on items that would be expected to change in relation to sales, such as cost of sales (through gross margin), bad debt expense, commissions, and advertising.

Question 6

Ratios

Answer 6

compare financial information by focusing on key indicators of performance and reporting them in a common way (such as a percentage) that makes the information easily comparable to other periods, companies, and industry standards
Ratios allow for comparisons between:
• organizations
• industries
• time periods for a single organization
• a single organization and an external benchmark
• responsibility centres (such as business units, departments, product lines, or employees)
• actual or forecasted results and specified criteria (such as a loan agreement constraint or the minimum acceptable return on a capital project)

Question 7

Step 2: Analyze major issue(s)

Answer 7

consider how other information presented ties into the calculations just completed eg
• a slowdown in the economy
• an expansion during the year
• new competition in the market
• a new product introduced during the year
• discontinued operations
issue identified as a result of the analysis you should discuss it.
Incorporate the result of your analysis (the WHAT) and your insight on this significance (the WHY). Ensure each discussion point has WHAT + WHY for reasonable analysis.

Question 8

Step 3: Conclude and advise

Answer 8

conclude from the perspective u r analyzing from

Question 9

current ratio

Answer 9

Current ratio: Current assets / current liabilities
measure liquidity by comparing the proportion of current assets to current liabilities.
concept of the current ratio is based on the assumption that all current assets can be liquidated to meet current liabilities.
higher is not always better

Question 10

Quick ratio

Answer 10

(Current assets – prepaid expenses – inventory) / current liabilities)
liquidity measure that refines the current ratio by comparing only the most liquid current assets with current liabilities.
higher ratio means a more liquid current position
higher not always better= high ratio might indicate that the organization maintains excessive amounts of liquid assets.

Question 11

Asset turnover ratios

Answer 11

measure a company’s efficiency in utilizing assets