Financial Statement Analysis Flashcards

Flashcards on Financial Statement Analysis

Financial Statement Analysis

Enables the financial statement user to make informed decisions about a company. Involves the evaluation of an entity’s past performance, present condition, and business potentials by way of analyzing the financial statements.

Three major characteristics of a company generally evaluated

• Liquidity

• Profitability

• Solvency

Intracompany basis

Compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years.

Industry averages

Compares an item or financial relationship of a company with industry averages.

Intercompany basis

Compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.

Three basic tools of Financial Analysis

• Horizontal

• Vertical

• Ratio

Horizontal Analysis

• also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time to determine the increase or decrease that has taken place, expressed as either an amount or a percentage.

• In trend analysis, a base year is selected, and changes are expressed as percentages of the base year amount.

Vertical Analysis

also called common size analysis, expresses each item within a financial statement as a percent of a base amount. Generally, the base amount is total assets for the balance sheet, and net sales for the income statement.

Liquidity ratios

Measures of the short-term debt-paying ability.

Profitability ratios

Measures of the income or operating success of an enterprise for a given period of time.

Solvency ratios

Measures of the ability of the enterprise to survive over a long period of time.

Four liquidity ratios

Current ratio, Acid test ratio, Receivables turnover, and Inventory turnover

Current Ratio

Expresses the relationship of current assets to current liabilities. It is a widely used measure for evaluating a company’s liquidity and short-term debt paying ability

Acid-Test or Quick Ratio

Relates cash, short-term investments, and net receivables to current liabilities. This ratio indicates a company’s immediate liquidity. It is an important complement to the current ratio.

Receivables Turnover Ratio

Used to assess the liquidity of the receivables. This ratio measures the number of times, on average, receivables are collected during the period.

Inventory Turnover

Measures the number of times, on average, the inventory is sold during the period. Companies compute the inventory turnover by dividing cost of goods sold by the average inventory during the year. One computes the average days in inventory by dividing the inventory turnover into 365 days.

Profit Margin

A measure of the percentage of each peso of sales that results in net income. Companies compute it by dividing net income by net sales.

Asset Turnover

Measures how efficiently a company uses its assets to generate sales. It is computed by dividing net sales by average assets.

Return on Assets

An overall measure of profitability, computed by dividing net income by average assets.

Return on Common Stockholders’ Equity

Shows how many pesos of net income the company earned for each peso invested by the owners. Companies compute it by dividing net income by average common stockholders’ equity.

Earnings Per Share

A measure of the net income earned on each share of common stock. It is computed by dividing net income by the number of weighted average common shares outstanding during the year.

Price-Earnings Ratio

A measure of the ratio of the market price of each share of common stock to the earnings per share. One computes it by dividing the market price per share of the stock by earnings per share.

Payout Ratio

Measures the percentage of earnings distributed in the form of cash dividends. Companies compute it by dividing cash dividends by net income

Debt to Total Assets Ratio

Measures the percentage of the total assets that creditors provide. One computes it by dividing total debt (both current and long-term liabilities) by total assets.

Times Interest Earned (Interest Coverage Ratio)

Provides an indication of the company’s ability to meet interest payments as they come due. Companies compute it by dividing income before interest expense and income taxes by interest expense.

Current ratio formula

Current assets / Current liabilities

Quick ratio formula

Quick assets / Current liabilities

Receivables turnover formula

Net credit sales / Average receivables

Average age of receivables (Average collection period) formula

360 days / Receivables turnover

Inventory turnover formula

Cost of goods sold / Average merchandise inventory

Average age of inventory (Inventory conversion period) formula

360 days / Inventory turnover

Accounts payable turnover formula

Net credit purchases / Average trade payables

Average age of accounts payable formula

360 days / payables turnover

Normal operating cycle formula

Average age of inventory + Average age of receivables

Cash conversion cycle formula

Average age of inventory + Average age of receivables + Average age of accounts payable

Return on Sales (Net Profit Margin) formula

Income / Net Sales

Return on Assets formula

Income / Average Asset

Return on Equity formula

Income / Average Equity

Earnings Per Shares formula

Net Income – Preferred Dividends / Weighted Ave. Common Shares Outstanding

Operating Profit Margin formula

Operating Profit / Net Sales

Cash Flow Margin formula

Operating Cash Flow / Net Sales

Price-Earnings (PE) Ratio formula

Price Per Share / Earnings Per Share

Dividend Yield formula

Dividend Per Share / Price Per Share

Dividend Payout Ratio formula

Dividend Per Share / Earnings Per Share

Times Interest Earned formula

EBIT / Interest Expense

Debt-Equity Ratio formula

Total Liabilities / Total Equity

Debt Ratio formula

Total Liabilities / Total Assets

Equity Ratio formula

Total Equity / Total Assets

Comparative analysis may be made on a number of different bases

• Intracompany basis

• Industry averages

• Intercompany basis

Ratio

Expresses the mathematical relationship between one quantity and another as either a percentage, rate, or proportion.

Classification of ratios

• Liquidity ratios

• Profitability ratios

• Solvency ratios