Week 5 Financial Statement Analysis Flashcards
Horizontal analysis
Study of percent change year to year. Completed for each line item in financial statement
Computing percent change
Horizontal analysis
Change in account = current year- prior year
Percent change in account = change in account / Prior year balance
Vertical analysis
Relationship of financial statement item to its base. All items shown as % of total.
Income statement base: total revenue
Balance statement base: total assets
Benchmarking
Compares a company to some standard set by others. Allows comparison of companies form same industry of different size
5 Categories of computing standard financial ratios
- Ability to pay current liabilities
- Ability to sell inventory and collect receivables
- Ability to pay debts
- Measuring profitability
- Analyzing stock investments
Ratios that measure ability to pay current liabilities
- Working capital
- Current Ratio
- Acid test (quick ratio)
Working capital
RATIO
=Current assets- current liabilities
-ability to pay current liabilities with current assets
Current ratio
RATIO
=Current assets/current liabilities
- Generally, 1.5 considered good
- ability to pay current liabilities with current assets
Acid test (quick ratio)
RATIO
=(Cash + ST investments + net current receivables)/Current liabilities
- Generally 0.9 - 1 acceptable
- Similar to current ratio with narrower base to measure liquidity
- EXCLUDES inventory and prepaid expense
Ratios that measure ability to sell inventory and collect receivables
- Inventory turnover
- Accounts receivable turnover
- Days sales in receivables
Inventory turnover
RATIO
=Cost of goods sold/Average inventory for a period
- Number of times company sells its average level of inventory per year
- Strive for profitable turnover
- Cost of goods sold and inventory used because they are reported at cost
Days inventory outstanding
365/inventory turnover
-Days it takes to sell average current inventory levels
Accounts receivable turnover
RATIO
=net sales/ average net accounts receivable
- Measures ability to collect cash from customers
- ratio of 12 indicates AR balance collected once a month
- high is good but too high may indicate credit is too tight
Days Sales in Receivables
RATIO
one day sales = net sales/365
days sales in receivables= average net accounts receivable/ one day sales
- Number of days sales in accounts receivable
- Lower indicates higher cashflow (compare to industry average)
Ratios used to measure ability to pay debts
- Debt ratio
2. Times interest earned
Debt ratio
RATIO
=Total assets/total liabilities
- Tells portion of assets financed with debt
- 0.62 is average (professor likes 0.5)
Times interest earned
RATIO
=Income from operations/ interest expense
-Shows number of times company could cover interest expense with operating income in a given period
Income from operations
Income earned from core of business without looking at other areas of business that may incur income/expense
Ratios used to measure profitability
- Rate of return on sales
- Rate of return on total assets (ROA)
- Return on common stockholders equity (ROE)
- Earnings per share
Rate of return on sales
RATIO
=net income/net sales
-Shows percent sales dollar is earned as net income
Rate of return on total assets
RATIO
=(net income + interest expense)/average total assets
- Company’s success at turning assets into profit
- Used by investors to see what they would get out of investing
Return on common stockholder’s equity
RATIO
=(net income - preferred dividends)/average common stockholder’s equity
- How much is earned for every dollar invested
- Relationship between net income and stockholder’s investment in company
Earnings per share
RATIO
=(net income - preferred dividends)/average # of shares outstanding
- Key measure of company’s success
- Income earned for each share of common stock
Ratios analyzing stock investments
- price earnings ratio (P/E)
- Dividends yield
- Book value per share common stock
Price earnings ratio (P/E)
RATIO
=(market price per share of common stock)/earnings per share
- shows market price of $1 of earnings
- 10 is minimum, 20 is better
Dividends yield
RATIO
=Dividends per share/market price per share
- % of stock market value returned annually to stockholders as dividends
- *preferred stockholders pay attention here as their primary reason to invest is dividends
Book Value per share of common stock
RATIO
=(Total stockholder’s equity - preferred dividends)/# shares outstanding
- Shown as $
- not based on market value
