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F/S Analysis
F/S Analysis
F/S Analysis
Are Analyzed
A Framework for Financial
Statement Analysis
Chapter 11
Users of Financial
Information
Users of financial information may be
current or future users.
Users of Financial
Information
Some of the users of financial
information are the following:
Investors
Managers
Customers
Potential suppliers
and creditors
Sources of Financial
Information
The major source of financial
information is a firm's annual report.
Government
regulators
Employee unions
Public interest and
community groups
Other Sources of
Information
Reports filed with regulatory agencies
(special, quarterly, and annual)
Business periodicals (magazines,
newspapers, newsletters)
Investment advisory services
(Standard & Poor, Moody's, etc.)
Basis of Comparison
When analyzing financial reports, one
of the first decisions is to identify the
basis of comparison.
Restatements May Be
Necessary
The statements may need to be
restated when significant unusual
events have occurred which would
distort comparisons.
Restatements May Be
Necessary
Such events include, among others,
mergers or acquisitions, discontinued
operations, changes in accounting
principles, and extraordinary items.
More Comparability Is
Better
Comparability is enhanced when
firms' size, capital structure, and
product mix are similar.
Categories of Financial
Ratios
Ratios are usually grouped into broad
categories.
Liquidity Ratios
Liquidity ratios indicate the short-term
solvency of the firm.
Categories of Financial
Ratios
Four widely used major headings are
liquidity, profitability, capital
structure, and investor.
Liquidity Ratios
They also indicate how effectively the
firm is managing its working capital.
Liquidity Ratios
Liquidity Ratios
Current assets
Current liabilities
Liquidity Ratios
Quick ratio =
Cash + Cash equivalents + Accounts receivable
Current liabilities
Liquidity Ratios
Sales revenue
365
Liquidity Ratios
The following are commonly used
liquidity ratios:
Profitability Ratios
Profitability ratios measure how
profitable a firm is.
Profitability Ratios
This is very important for investors
who want to invest in a firm which
can return their investment to them.
Profitability Ratios
The following are commonly used
profitability ratios:
Gross profit
Net sales revenue
Profitability Ratios
The following are commonly used
profitability ratios:
Operating income percentage =
Operating income +
Extraordinary losses - unusual gains
Sales revenue
Profitability Ratios
The following are commonly used
profitability ratios:
Return on assets =
Net income +
(Interest expense [1 - Tax rate])
Sales revenue
Profitability Ratios
The following are commonly used
profitability ratios:
Return on equity =
Net income
Average shareholders' equity
Profitability Ratios
The following are commonly used
profitability ratios:
Cash return on assets =
Cash flow from operating activities +
interest paid
Average total assets
Profitability Ratios
The following are commonly used
profitability ratios:
Quality of income =
Cash flow from operating activities
Net income
Current liabilities
Total liabilities +
Shareholders equity
Total liabilities
Total assets
Shareholders' equity
Total liabilities +
Shareholders equity
Investor Ratios
Investor ratios all relate to an external
dimension of ownership interest.
Most indicate how a firm is
performing with regard to the market
value of its shares.
Investor Ratios
The following are commonly used
investor ratios:
Market to book value =
Investor Ratios
The following are commonly used
investor ratios:
Earnings per share =
Net income
Weighted average number
of shares outstanding
Investor Ratios
The following are commonly used
investor ratios:
Price to earnings =
Financial Statement
Analysis Framework
The financial statement analysis
framework includes the following
steps.
Financial Statement
Analysis Framework
Review the financial statements, notes
and audit opinion.
Financial Statement
Analysis Framework
Identify the purpose and objectives of
the analysis.
Financial Statement
Analysis Framework
Determine whether restatements are
necessary to enhance the
comparability of the statements.
Financial Statement
Analysis Framework
Determine whether the firm's size,
capital structure, and product mix are
appropriate to proceed with the ratio
calculations.
Financial Statement
Analysis Framework
Calculate the basic liquidity ratios.
Financial Statement
Analysis Framework
Conduct horizontal and vertical
analyses of each financial statement,
with special emphasis on the income
statement.
Financial Statement
Analysis Framework
Calculate profitability ratios based on
net income and on cash flow from
operating activities. Evaluate trends.
Financial Statement
Analysis Framework
Evaluate the firm's capital structure
with special emphasis on trends in the
percentage composition ratios.
Financial Statement
Analysis Framework
Examine any inconsistencies in the
ratio results, review notes, and
recalculate the ratios.
Financial Statement
Analysis Framework
Examine the firm's market
performance using the investor ratios.
Limitations of Financial
Statement Analyses
Financial statement analysis is limited
due to several items.
Limitations of Financial
Statement Analyses
GAAP presents some limits.
Limitations of Financial
Statement Analyses
Many major factors affecting
profitability and survival of the firm
are not included in the financial
statements.
Limitations of Financial
Statement Analyses
GAAP presents some limits.
Managers often have the ability to
select favorable accounting methods.
Limitations of Financial
Statement Analyses
Many major factors affecting
profitability and survival of the firm
are not included in the financial
statements.
A perfect example is human resources.
Limitations of Financial
Statement Analyses
Many major factors affecting
profitability and survival of the firm
are not included in the financial
statements.
Limitations of Financial
Statement Analyses
"Real" events are often hard to
distinguish from the effects of
alternative accounting methods or
principles.
Limitations of Financial
Statement Analyses
Financial statement analysis relies on
past numbers, and the past may not be
a reliable indication of the future.