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Financial Statement Analysis

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1 Financial Statement Analysis
Chapter 13 Financial Statement Analysis

2 Limitations and Considerations in Financial Statement Analysis
Watch for alternative accounting principles Selection of a inventory valuation method Changes in accounting method Take care when making comparisons Recognizing trends in ratios Extra caution for extraordinary items and gains and losses from discontinued operations LO 1

3 Limitations and Considerations in Financial Statement Analysis (continued)
Understand the possible effects of inflation Financial statements are based on historical costs and are not adjusted for the effects of increasing prices

4 Analysis of Comparative Statements: Horizontal Analysis
Comparison of financial statement items over a period of time LO 2

5 Example 13.1—Preparing and Reading Comparative Balance Sheets—Horizontal Analysis

6 Example 13.2—Preparing and Reading Comparative Statements of Income and Retained Earnings—Horizontal Analysis

7 Example 13.3—Preparing and Reading Comparative Statements of Cash Flows—Horizontal Analysis

8 Analysis of Common-Size Statements: Vertical Analysis
Comparison of various financial statement items within a single period with the use of common-size statements Common-size statements recast items as a percentage of a selected item LO 3

9 Example 13.4—Preparing and Reading Common-Size Balance Sheets—Vertical Analysis

10 Example 13.5—Preparing and Reading Common-Size Income Statements—Vertical Analysis

11 Liquidity Analysis A relative measure of the nearness to cash of the assets and liabilities of a company LO 4

12 Working Capital The excess of current assets over current liabilities at a point in time

13 Current Ratio The ratio of current assets to current liabilities
One of the most widely used financial statement ratios

14 Acid-Test Ratio A stricter test of liquidity than the current ratio
Excludes inventory and prepayments from the numerator

15 Cash Flow from Operations to Current Liabilities
A measure of the ability to pay current debts from operating cash flows

16 Accounts Receivable Analysis
Accounts receivable turnover ratio: a measure of the number of times accounts receivable are collected in a period Number of days’ sales in receivables: a measure of the average age of accounts receivable

17 Inventory Analysis Inventory turnover ratio: a measure of the number of times inventory is sold during a period Number of days’ sales in inventory: a measure of how long it takes to sell inventory

18 Cash-to-Cash Operating Cycle
The length of time from the purchase of inventory to the collection of any receivable from the sale

19 Solvency Analysis The ability of a company to remain in business over the long term The ability of the firm to stay financially healthy over the period of time that existing debt (short- and long-term) is outstanding LO 5

20 Debt-to-Equity Ratio The ratio of total liabilities to total stockholders’ equity The composition of debt and equity is an important determinant of the cost of capital to a company

21 Times Interest Earned Ratio
Indicates the company’s ability to meet the current year’s interest payments out of the current year’s earnings

22 Debt Service Coverage Ratio
Measure of the amount of cash that is generated from operating activities during the year and that is available to repay interest due and any maturing principal amounts

23 Cash Flow from Operations to Capital Expenditures Ratio
A measure of the ability of a company to finance long-term asset acquisitions with cash from operations

24 Profitability Analysis
How well management is using company resources to earn a return on the funds invested by various groups Two frequently used profitability measures: = Gross Profit Gross Profit Ratio = Net Sales Net Income Profit Margin Ratio = Net Sales LO 6

25 Rate of Return on Assets
A measure of a company’s success in earning a return for all providers of capital

26 Components of Return on Assets
Return on sales ratio: a variation of the profit margin ratio Measures earnings before payments to creditors Asset turnover ratio: the relationship between net sales and average total assets

27 Return on Common Stockholders’ Equity Ratio
A measure of a company’s success in earning a return for the common stockholders

28 Leverage The use of borrowed funds and amounts contributed by preferred stockholders to earn an overall return higher than the cost of these funds

29 Earnings per Share A company’s bottom line stated on a per-share basis

30 Price/Earnings Ratio The relationship between a company’s performance according to the income statement and its performance in the stock market

31 Dividend Ratios Dividend payout ratio: the percentage of earnings paid out as dividends Dividend yield ratio: the relationship between dividend and the market price of a company’s stock

32 Reporting and Analyzing Other Income Statement Items
Each of these items is shown net of their tax effects Discontinued operations Extraordinary items Reported near the end of the income statement, after income from continuing operations Reported separately to call the reader’s attention to their unique nature LO 7

33 Discontinued Operations
Reflect any gains or losses from the disposal of a segment Also, reflect any net income or loss from operating that segment

34 Extraordinary Items Reflect any gains or losses that arise from an event that is both unusual in nature and infrequent in occurrence

35 End of Chapter 13

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