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© PHI Learning, All rights reserved.1 Financial Accounting: A Managerial Perspective Third Edition Prepared by R. Narayanaswamy Indian Institute of Management Bangalore
© PHI Learning, All rights reserved.2 Financial Statement Analysis Chapter 11
© PHI Learning, All rights reserved.3 Objectives of Financial Statement Analysis Evaluation of past performance and financial position Prediction of future performance Chapter 11
© PHI Learning, All rights reserved.4 Standards of Comparison Rule-of-thumb indicators Can be applied across firms and industries Too general to be of use in specific companies Past performance of the company Past is a useful indicator A firm’s competition is with other firms, not with own past Industry standards Getting comparable firms is difficult Chapter 11
© PHI Learning, All rights reserved.5 Sources of Information Company reports Stock exchanges Business periodicals Information services Chapter 11
© PHI Learning, All rights reserved.6 Quality of Earnings What is quality of earnings? Accounting methods and estimates used Extraordinary items Prior period adjustments Discontinuing operations Changes in accounting policies Income from non-operating sources Chapter 11
© PHI Learning, All rights reserved.7 Using Financial Ratios Profitability Liquidity Solvency Capital market standing Chapter 11
© PHI Learning, All rights reserved.8 Profitability Profit margin Asset turnover Return on assets or return on investment The Du Pont financial analysis Return on equity Effect of leveraging Earnings per share Chapter 11
© PHI Learning, All rights reserved.9 Liquidity Current ratio All current assets Quick ratio Excludes inventories Debtor turnover Average debt collection period Inventory turnover Operating cycle Chapter 11
© PHI Learning, All rights reserved.10 Solvency Debt-to-equity ratio Use of leverage Liabilities-to-equity ratio Interest coverage ratio Chapter 11
© PHI Learning, All rights reserved.11 Capital Market Standing Price-earnings ratio Dividend-yield Price-to-book ratio Beta Chapter 11
© PHI Learning, All rights reserved.12 Corporate Disclosure Policy Voluntary disclosure Why do firms provide voluntary disclosures? Factors that influence disclosure level Capital market Competitors Managerial reputation Shareholder litigation Disclosure level and the cost of capital Chapter 11
© PHI Learning, All rights reserved.13 Efficient Market Hypothesis and Financial Statement Analysis The efficient market hypothesis Accounting information affects stock prices, but... The market is not fooled by accounting method differences Mandatory disclosures do not evoke significant stock price reaction Chapter 11
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