Chapter 15 Financial Statement Analysis

Chapter Objectives

  • Describe techniques and tools for financial statement analysis.
  • Illustrate basic analytical methods.
  • Assess liquidity, solvency, and profitability using financial statement analysis.
  • Understand contents of corporate annual reports.

Analyzing Financial Statements

  • Financial statements provide crucial information for decision-making for users like bankers and investors.
  • Users evaluate information primarily on:
    • Liquidity
    • Solvency
    • Profitability

Key Concepts in Analysis

  • Liquidity: Ability to convert assets to cash.
  • Solvency: Ability to repay long-term debts and meet interest payments.
  • Profitability: Ability to generate earnings.

Analytical Techniques

  • Analytical methods analyze changes in financial statement items.
  • Ratios provide measures of economic relationships.
  • Comparisons are made:
    • Over time (trend identification)
    • Among companies (benchmarking)

Analytical Methods

  • Horizontal Analysis: Compares financial statement items across periods for change.
  • Vertical Analysis: Analyzes each item as a percentage of a total within the statement.
  • Common-Sized Statements: Express items as percentages, aiding in cross-company comparison.

Liquidity Analysis

  • Evaluates the ability to pay current liabilities.
  • Key components:
    • Working capital = Current Assets - Current Liabilities
    • Current ratio = Current Assets / Current Liabilities
    • Quick ratio evaluates near-cash assets.

Solvency Analysis

  • Assesses ability to meet long-term debts.
  • Important ratios:
    • Ratio of Fixed Assets to Long-Term Liabilities
    • Ratio of Liabilities to Stockholders’ Equity
    • Times Interest Earned to assess risk of default.

Profitability Analysis

  • Focuses on potential for future earnings.
  • Key ratios:
    • Asset Turnover
    • Return on Total Assets
    • Return on Stockholders' Equity
    • Earnings per Share
    • Price-Earnings Ratio
    • Dividends per Share and Dividend Yield.

Corporate Annual Reports

  • Summarize corporate operations and future plans including:
    • Financial statements and notes
    • Management’s Discussion and Analysis (MD&A)
    • Reports on internal control
    • Independent audit findings
    • Environmental, Social, and Governance (ESG) considerations.

Summary

  • Analyze financial statements using defined techniques, focusing on liquidity, solvency, and profitability, while understanding corporate reporting standards.