quizzam 3

Three financial statements analysis

horizontal (trend), vertical (aka common size), ratio

horizontal analysis

looks at the percentage change in a line item from one year to the next

issues with horizontal analysis

small percentage changes can hide major dollar effects, large percentage changes from year to year may be relatively inconsequential in terms of dollar amounts

how to calculate horizontal analysis

subsequent year = previous year/ previous year

horizontal analysis things to consider

beware of looking only at the percent changes, can be used to look at multiple years of data, calculate the percentage change from the previous year over a 5 year period

trend analysis

another method of horizontal analysis, compares changes over a longer period of time
compares each year with a base year

any subsequent year - base year / base year

vertical analysis answers what question

what percentage of one line item is another line item?

vertical analysis is useful for analyzing the balance sheet

what's called common size

vertical analysis, converts every line item to a percentage, allows comparisons between the financial accounts of the organizations of different sizes

vertical analysis equation

line item of interest / base line item

preferred approach for gaining an in depth understanding of financial statements

ratio analysis

ratio analysis is an expression

of the relationship between two numbers as a single number

ratio analysis provides an indication of the organization's

ability to cover current obligations with current assets (ability to pay short term debt)

is one raito better than another

no

a ratio can be interpreteed relative to

a benchmark

ratio's should not be

too high or too low

you should also consider what with the ratio

the trend

small differences in a ratio may indicate

large percentage deviations from benchmark

liquidity

how well is the organization positioned to meet its short term obligations?

profitability

how profitable is the organization ?

activity

how efficiently is the organization using its assets to produce reveues?

capital structure

how are the organization's assets financed and ability to take on new debt ?

6 liquidity ratios

current ratio, quick ration, acid test ration, days in accounts receivable, days cash on hand, average payment period

current ratio

proportion of all current assets to all current liabilities

quick ratito

used in industries in whiich net accounts receivable is relativley liquid

acid test ratio

most stringest test of liqudiity
how much cash is avaiable to pay off all current liabilities

days in accounts receivable

how quickly a hospital is converting its receivables into cash

days cash on hand

number of days worth of expenses an organization can cover with its most liquid assets

average payment period

how long on average it takes an organization to pay its bills

operating margin ratio

measures profits earned from the organizations main line of business,
operating income/total operating revenues

longterm debt to net assets

measures the proportion of debt to net assets

long term debt/ net assets

age of plant ratio

accumulated depreciation / depreciation expense

what does age of plant ration tell us

average age of a hospiital's plant and equpment

capital structure ratios answer what questions

how are an organinzations assets financed? how able is this organization to take on new debt?

why take money today

certainty, inflation, opportunity cost

future value

present value grows to its future value

present value

an amount to be received in the future is discounted to present value

what future value depends on

length of the investment period, method to calcuate intresst, interest rate

two ways to calculate interest (2 ways)

simple vs compound

simple interest

interest paid on the principal alone

compound interest

interest earned on both the principal amount and any interest already earned

future value equation

FV=PV(1+r)^n

present value

the value today of a payment to be recieved in the future

preset value takes into account

the cost of capital or discount rate, taking future values back to the present is called discounint

present value =

FV x1/(1+i)^n

annuity

a series of equal payments made or received at regular time intervals

3 types of capital investments

strategic decisions (design to increase long term position)

expansion decisions (increase operational capability)

replacement decisions - designed to replace older assets with newer, cost - saving assets

each decision has 2 components

if its wothwhile and how to finance it

3 ways to analyze capital investments

looking at just cash flow

payback method
net present value method
internal rate of return

payback method is

calculate the time needed to recoup each investment

net pressent value method

difference between the initial amount paid for an investment and future cash flows while adjusting for the cost of capital

how to calculate NPV

takes into account time value of money and cost of capital, looking at money