FIN 3320 Financial Statement Analysis

Dr. Bobby Merriman Finance 3320 Financial Statement Analysis

financial statement analysis

the process of analyzing a company's financial statements for decision-making purposes

profitability analysis

the methods and techniques we use to measure how profitable the company has been, to understand why the firm was profitable, and to estimate how profitable we expect the company to be in the future

risk analysis

the methods and techniques we use to measure uncertainties that could impact a company's financial health, to understand the vulnerabilities the company has, and to estimate the likelihood of an adverse event that may negatively affect the company in the future

valuation

the process of determining the true, economic value of a business

financial ratios

numerical values calculated from a company's financial statements that are used to evaluate: (1) the profitability and performance of a company, (2) the financial health and risk of a company, and (3) the value and future expectations of a company

profitability ratio

the ability of a company to generate profit

margin ratios

how well a company converts sales into profit by managing their expenses; measured by dividing a profit line item on the income statement by revenue

gross margin

the percentage of revenue left after deducting cost of good sold; higher values imply the company is managing its variable costs well (lower cost of good sold) or is charging premium prices for its product (higher sales due to higher prices)

operating margin

the percentage of revenue left after deducting operating expenses; higher values imply the company is managing its fixed costs well

profit margin

the percentage of revenue left after deducting all expenses; higher values imply the company is managing all costs well

return ratios

how well a company generates returns for their investors by comparing the company's profitability relative to how much cash the investors gave the company

earnings per share (EPS)

the amount of net income available to each share of common stock if all profit was distributed to the owners; higher values imply the company is making more money for its owners

return on assets (ROA)

the amount of profit before financing costs relative to the amount of assets used to produce those profits; higher values imply the company is making more money for both its lenders (debt) and owners (equity)

return on equity (ROE)

the amount of profit belonging to shareholders relative to the amount of equity used to produce those profits; higher values imply the company is making more money for its owners (equity)

financial performance

how well a company can use assets from its primary mode of business and generate revenues and how well a company makes profit for its shareholders

efficiency ratio

how well a company is using its resources both in the long term (non current assets) and in the short term (working capital) to generate sales and cash for the business (also called turnover ratios, activity ratios, and asset management ratios)

operational efficiency

how well a company uses its resources to generate sales

asset turnover ratio

the amount of revenue a company generates relative to the amount of assets used to generate the revenue; higher values imply the company is using its assets efficiently to produce sales

working capital efficiency

how quickly a company can turn sales into cash

inventory turnover ratio

the number of times a company sells and replaces inventory each year; higher values imply the company sells its inventory quickly

financial turnover

how quickly a company uses assets to generate sales and cash for the business (also known as financial efficiency)

liquidity ratio

how well the company can pay its bills in the short term (over the next 12 months)

current ratio

how well a company can pay off all its short term obligations; higher values imply the company can meet short term obligations, while lower values are signs of financial distress

financial liquidity

how quickly and easily an asset can be converted into cash; high liquidity indicates a company can readily cover its short term obligations while low liquidity may indicate financial distress

solvency ratio

how well the company can pay its bills in the long term (1+ years), measuring the sustainability of the companies operations over time

leverage ratio

how much debt the company is using to finance its operations and growth (also known as debt level ratios) (usually based off the balance sheet)

debt to equity ratio

the amount of total obligations relative to shareholders' equity used to finance a company's assets; higher values imply the company relies more heavily on debt than equity when purchasing assets and could have a higher chance of insolvency

coverage ratio

how well the company can pay off its debt (also known as debt management ratios) (usually based off the income statement)

interest coverage ratio (accrual basis)

how many interest expense payments can be made with the company's earnings before interest and taxes (EBIT) (an accrual-based measure); higher values imply the company can more easily pay off its interest payments

financial leverage

borrowing money to invest in assets

financial solvency

having assets in excess of liabilities

financial distress

when a company is struggling to meet financial obligations

insolvent

when a company is unable to pay debts owed

valuation ratio

how valuable investors perceive the company to be; the value of the company relative to the price that investors are willing to pay

market value ratio

how investors perceive the value of a company's existing resources (normally based off the balance sheet); the value of the company's resources relative to the price that investors are willing to pay for those resources

book to market ratio

the proportion of the book value of equity (on the balance sheet) to the market value of equity (the current price in the market); higher values may imply the company is undervalued

market expectation ratio

investors' expectations for future performance and growth (normally based on the income statement); the value of the company's profit relative to the price that investors are willing to pay to have a share in that profit

price to earnings (P/E) ratio

the proportion of the current stock price per share relative to earnings per share; higher values imply the company is more expensive relative to the amount of profit it produces for investors and therefore may be overvalued

overvalued

when the market price is higher than the true, economic value; normally considered a bad deal

undervalued

when the market price is lower than the true, economic value; normally considered a good deal