Analyzing Financial Statements

Financial Statements enhance the decision making ability and offer a means to assess the status of a business. They are not a substitute for common sense.

Analyzing Financial Statements Analyzing Financial Statements 4 Key Financial Criteria ▸ Liquidity ▸ Solvency ▸ Profitability ▸ Financial Efficiency

Analyzing Financial Statements Analyzing Financial Statements Liquidity Ability to meet financial obligations without disrupting normal ongoing operations.

Analyzing Financial Statements Analyzing Financial Statements Liquidity 1. Working capital Total current assets - Total current liabilities Working capital should be positive!

Analyzing Financial Statements Liquidity Liquidity 1. Working capital Current Assets = $34,000 - Current Liabilities = $23,000 TOTAL $11,000

Analyzing Financial Statements Analyzing Financial Statements Liquidity Liquidity 2. Current Ratio (CA) $65,000 (CL) $20,000 = 3.25:1 Expressed as xx:1

Analyzing Financial Statements Analyzing Financial Statements Liquidity Liquidity 2. Current Ratio a.If the ratio is greater than (1:1), the business is considered liquid.” b.If the ratio is less than 1:1, the business is considered “Not liquid” reflecting a high degree of short-term cash flow risks. c.The higher the ratio, the more liquid the business d.As a ratio, it is not dependent on the size of a business and comparisons to other businesses can be made.

Analyzing Financial Statements Solvency Solvency Ability of a business’ debt repayment capacity if all assets are liquidated. Ability to continue as a viable business after financial adversity.

Analyzing Financial Statements Analyzing Financial Statements Solvency Solvency 1. Debt to Asset Ratio Total Liabilities Total Assets

Analyzing Financial Statements Analyzing Financial Statements Solvency Solvency 1. Debt to Asset Ratio Total liabilities Total Assets The higher the ratio, the greater the risk exposure.

Analyzing Financial Statements Analyzing Financial Statements Solvency Solvency 1. Debt to Asset Ratio (TL) $ 560,000 =.51:1 (TA) $1,100,000

Analyzing Financial Statements Analyzing Financial Statements Solvency Solvency 2. Equity to Asset Ratio (% ownership) Total Equity Total Assets the lower the ratio, the more creditors have in the business. (Higher is better)

Analyzing Financial Statements Solvency Solvency 3. Debt to Equity Ratio (Leverage) Total Liabilities Total Equity

Analyzing Financial Statements Solvency Solvency 3. Debt to Equity Ratio (Leverage) $345,000 = 1.47:1 $234,000

Analyzing Financial Statements Analyzing Financial Statements Solvency 3. Debt to Equity Ratio (leverage) Total Liabilities Total Equity the lower the ratio, then creditors have less money in the business that the owner (lower is better)

Analyzing Financial Statements Profitability Measures the extent to which a business generates a profit from the use of labor, management, and capital

Analyzing Financial Statements Profitability 1. Return on Assets Net income from operation +interest expense - value of unpaid operator and family labor and management Average total assets the higher the ratio, the more profitable the business

Analyzing Financial Statements Profitability Profitability 2. Return on Equity Net income from operation - value of unpaid operator and family labor and management Average total equity

Analyzing Financial Statements Profitability 2. Return on Equity Net income from operation - value of unpaid operator and family labor and management Average total equity the higher the ratio, the more profitable the business

Analyzing Financial Statements Profitablity 2. Return on Equity $75,000 - $23,000 = 9 % $560,000

Analyzing Financial Statements Financial Efficiency Measures the degree of efficiency in using labor, management, and capital Financial Efficiency analysis deals with the relationships between inputs and outputs.

Analyzing Financial Statements Financial Efficiency 1. Asset Turnover Ratio Gross revenues Average total assets

Analyzing Financial Statements Financial Efficiency 1. Asset Turnover Ratio $300,000 =.23:1 $1,300,000

Analyzing Financial Statements Financial Efficiency 1. Asset turnover ratio Gross revenues Average total assets measures how effective assets generate revenue the higher the ratio, the more efficiently assets are being used to generate revenue.