1. Analyzing financial statements
Accounting ii

2. How a business discloses information about how it is doing financially
Financial Statements
How a business discloses information about how it is doing financially
Government (SEC) requires certain reports for public companies (including an auditor’s report)
Investors – use to make investment decisions
SEC = Securities and Exchange Commission – government commission that regulates securities (stock) markets and protects investors.

3. Public v. Private Companies
Public – stock is traded on a major stock exchange (AMEX, NASDAQ). Can sell stock to raise money (capital), but must answer to stockholders. Must disclose financial information

4. Public v. Private
Private – privately held; owners are usually the founders of the company or their descendants, or a group of private investors. Can’t sell stock to raise cash, but do not have to answer to stockholders and do not have to disclose financial information.

5. Annual Reports
Companies must file an annual report with the SEC
10-K (quarterly reports are less detailed – 10-Q)
Available on-line

6. Financial statements
Balance Sheet – Assets = Liabilities + Owner’s Equity
Income Statement -- Profits = Revenue - Expenses

7. Analyzing Financial Statements
Horizontally – between companies and across industries
Vertically – using ratios (mathematical expressions that relate one number to another
Trend – time–series analysis; look at historical data; compare data over time

8. Apples to apples (e.g., similar companies)
Horizontally
Apples to apples (e.g., similar companies)
“Benchmarking” – comparing to other companies

9. Vertically
Activity
Liquidity
Solvency
Profitability

10. How efficiently a company uses its assets Inventory turnover
Activity
How efficiently a company uses its assets
Inventory turnover
Asset turnover
“Turnover” relates a IS item to a Balance Sheet item

11. Inventory turnover COGS_____ Average Inventory
The higher the ratio, the faster the rate that inventory is sold; less company resources are tied up inventory
COGS = cost of goods sold (expense item)

12. Formula = net revenue / average total assets
Asset Turnover
Formula = net revenue / average total assets
How efficiently a business uses its total assets to generate revenue
Low turnover = inefficient OR capital intensive (rather than labor intensive
Capital intensive business – require a lot of capital to operate, e.g., airlines, auto manufacturers, drillers; Labor intensive - require a lot of labor to operate (restaurants, hotels, agriculture, mining). Net revenue:
Capital costs are considered fixed, while labor is variable

13. Liabilities Liquidity
Current Ratio
Formula: Current Assets / Current
Liabilities
Indicates if the company can pay off short-term liabilities by liquidating current assets

14. Solvency Calculate Working Capital – Formula:
Current Assets – Current Liabilities

15. Profitability Gross Profit Ratio (Margin)
Formula = Gross Profit (income) /Net Income
Revenues = all the money a company brought in during the time period
Gross Profit = Revenue - COGS
COGS = cost of goods sold; -- expenses most directly related to creating revenue

16. Profitability Operating Profit Ratio (Margin) =
Operating Income / Net revenue
Operating Income = gross income less operating expenses (e.g., administrative expenses – “overhead” – can’t be attributed to single product units
Looks at sales v. management-controlled costs; should be consistent

17. Profitability Net Profit Ratio (Margin) =
Net Income (“bottom line”) / Revenue
Shows the ability to translate sales into earnings – should be consistent

18. Return on Equity
Formula: Net Income / average stockholder’s equity (for the same time period)
Looks at level of income attributed to shareholders, against their investment

19. Return on Assets Net Income / Total Assets
Measures how efficiently the company uses its assets. A high ratio means that the company is able to operate efficiently