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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
