Chapter 12

Financial Analysis & Ratios

 Comparative Analysis
There are three types of comparisons to provide
decision usefulness of financial information:

• Intra-company basis
• Inter-company basis
• Industry averages
 Comparative Analysis
• Intra-company basis – comparisons within the
company.

• Inter-company basis – comparisons with other

companies.

• Industry averages – comparisons with other

companies in the same industry.
 Financial Statement Analysis
Three basic tools are used in financial statement
analysis :

1. Horizontal analysis
2. Vertical analysis
3. Ratio analysis
 Horizontal Analysis
• Is a technique for evaluating a series of financial
statement data over a period of time.

• Did an increase or decrease take place?

– Pages 574 - 575

 Horizontal Analysis

P1 – P0
P0

$1,300,000 – $1,000,000 = 30.00%

$1,000,000
The amount of net sales for Bello’s Bike Supply, Inc. increased
approximately 30.00% from fiscal 2015 to 2016.
 Vertical Analysis
• Expresses each item in a financial statement as a
percent of a base amount.

• Total Assets is the base amount on a Balance

Sheet.
• Common-size balance sheet

• Net Sales is the base amount on an Income

Statement.
• Common-size income statement

Pages 573 - 574

 Ratio Analysis
 Five types:

 Liquidity ratios
 Solvency ratios
 Turnover ratios
 Profitability ratios
 Market value ratios
Liquidity Ratios
Measure the short-term ability of the
enterprise to pay its maturing
obligations and to meet unexpected
needs for cash.
WHO CARES?
Short-term creditors such as
bankers and suppliers
 Current Ratio

Indicates short-term debt-paying

ability
Current Assets
Current Liabilities
 Acid-Test Ratio

Indicates immediate short-term debt-

paying ability

Current Assets - Inventory

Current Liabilities
 Cash Ratio
Indicates short-term debt-paying ability
(cash basis)

_ Cash _
Current Liabilities
Solvency Ratios
Measure the ability of the enterprise
to survive over a long period of time
WHO CARES?
Long-term creditors and
stockholders
 Debt to Assets Ratio

Indicates % of total assets provided by

creditors

Total Liabilities
Total Assets
 Times Interest Earned Ratio

Indicates company’s ability to meet

interest payments as they come due

_ EBIT _
Interest Expense
 Cash Debt Coverage Ratio
Indicates long-term debt-paying ability
(cash basis)

Cash provided by operations

Average total liabilities
Turnover Ratios
Measure how efficiently, or
intensively, a firm uses its assets to
generate sales
.
WHO CARES?

Short-term creditors such as

bankers and suppliers
 Inventory Turnover Ratio

Indicates liquidity of inventory

Cost of Goods Sold

Inventory
Average Days in Inventory
Indicates liquidity of inventory and
inventory management

365 days
Inventory Turnover Ratio
 Receivables Turnover Ratio
Indicates liquidity of receivables

Net Sales
Accounts Receivable
 Average Collection Period
Indicates liquidity of receivables and
collection success

365 days
Receivables Turnover
 Asset Turnover Ratio
Indicates how efficiently assets are
used to generate sales

Net Sales
Total Assets
 Profitability Ratios
Measure the income or operating success of an
enterprise for a given period of time
WHO CARES? Everybody
WHY? A company’s income affects:
 its ability to obtain debt and equity financing
 its liquidity position
 its ability to grow
 Profit Margin Ratio
Indicates net income generated by each
dollar of sales

Net Income
Net Sales
 Return On Assets
Reveals the amount of net income
generated by each dollar invested

Net Income
Average Total Assets
 Return on Equity
Indicates profitability of common
stockholders’ investment

Net Income
Average Total Equity
Market Value Ratios
Deals with market value of stock.
.
WHO CARES?
Stockholder’s
 Earnings Per Share (EPS)
Indicates net income earned on each
share of common stock sales

Net Income
Shares Outstanding
 Price Earnings Ratio
Indicates relationship between market
price per share and earnings per share

Stock Price
Earnings Per Share
 Payout Ratio
Indicates % of earnings distributed in
the form of cash dividends

Dividends
Net Income
 Retention Ratio
Indicates % of earnings plowed back
into the corporation.

Addition to Retained Earnings

Net Income
 Limitations Of
Financial Analysis
• Horizontal, vertical, and ratio analysis are
frequently used in making significant
business decisions.
• One should be aware of the limitations of
these tools and the financial
statements.