Chapter Thirteen Financial Statement Analysis Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Horizontal Analysis Horizontal analysis (or trend analysis) refers to studying the behavior of individual financial statement items over several accounting periods. Absolute Amounts Percentage Analysis 13-1

13-2 Vertical Analysis of Income Statement In income statements, all items are usually expressed as a percentage of sales. In balance sheets, all items are usually expressed as a percentage of total assets.

Liquidity Ratios Liquidity ratios indicate a company’s ability to pay short- term debts. They focus on current assets and current liabilities. 1.Working Capital 2.Current Ratio 3.Quick Ratio 4.Accounts Receivable Ratios 5.Inventory Ratios 13-3

Current Ratio The current ratio measures a company’s short-term debt paying ability. A declining ratio may be a sign of deteriorating financial condition, or it might result from eliminating obsolete inventories. Current Ratio Current Assets Current Liabilities = 13-4

Quick (Acid-Test) Ratio Quick Assets Current Liabilities = Acid-Test Ratio Quick assets include Cash, Current Marketable Securities, and Accounts Receivable. This ratio measures a company’s ability to meet obligations without having to liquidate inventory. 13-5

Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable Accounts Receivable Turnover = This ratio measures how many times a company converts its receivables into cash each year. 13-6

Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover = This ratio measures how many times a company’s inventory has been sold and replaced during the year. 13-7

Solvency Ratios Solvency ratios are used to analyze a company’s long-term debt- paying ability and its financing structure. 1.Debt to Assets Ratio 2.Debt to Equity Ratio 3.Number of Times Interest Earned 4.Plant Assets to Long-Term Liabilities 13-8

Debt to Assets Ratio This ratio measures the percentage of a company’s assets that are financed by debt. Total Liabilities Total Assets Debt to Assets Ratio = 13-9

Debt to Equity Ratio This ratio indicates the relative proportions of debt to equity on a company’s balance sheet. Stockholders like a lot of debt if the company can take advantage of positive financial leverage. Total Liabilities Stockholders’ Equity Debt to Equity Ratio = Creditors prefer less debt and more equity because equity represents a buffer of protection

Profitability Ratios Profitability ratios measure a company’s ability to generate earnings. 1.Net Margin (or Return on Sales) 2.Asset Turnover Ratio 3.Return on Investment 4.Return on Equity 13-11

Net Margin This measure describes the percent remaining of each sales dollar after subtracting other expenses as well as cost of goods sold. Net Margin Net Income Net Sales = 13-12

Return on Investment (ROI) and Return on Equity This is the ratio of wealth generated (net income) to the amount invested (average total assets). Return on Investment Net Income Average Total Assets = Return on Equity Net Income Average Total Stockholders’ Equity = This measure is often used to measure the profitability of the stockholders’ investment.

Stock Market Ratios Stock market ratios analyze the earnings and dividends of a company. 1.Earnings Per Share 2.Book Value per Share 3.Price-Earnings (PE) Ratio 4.Dividend Yield 13-14

Earnings Per Share Ratio and Price-Earnings Ratio Earnings per Share Net Earnings Available for Common Stock Average Number of Outstanding Common Shares = This measure indicates how much income was earned for each share of common stock outstanding Price-Earnings Ratio Market Price Per Share Earnings Per Share = This ratio compares the earnings of a company to the market price for a share of the company’s stock.