Financial statement analysis: is the process of suing a company’s financial
statements, and other related information, to evaluate a company
Looking at numbers
Also involves understandings a company’s business and industry
Benchmarking is also an important factor in financial statement analysis
Involved comparing a company to standards set by another company
Techniques for financial analysis
Horizontal analysis: looks at increases or decreases in financial statement line
items over time
Percentage change= (current year $- prior year $)/ prior year $ x 100
For denominator:
Income statement: net sales
Balance sheet: total assets
Vertical analysis: presents the balance sheet and income statement as a
percentage of a base amount for each year
If it is performed, it creates common-size statements
Vertical analysis percentage= financial statement item $/ base amount $ x 100
On the income statement, net sales is used as the base amount
On the balance sheet, total assets is used as the base amount
Ratios- major tool of financial analysis
They help tell users about different areas of a company such as:
The ability to pay current liabilities
Turnover (efficiency)
Overall ability to pay debt
Profitability
DuPont Analysis- Formula
ROA x Leverage Ratio = ROE
Chapter 12
Financial Statement Analysis
Profit Margin x Asset Turnover x Leverage Ratio= ROE
Red flags in financial statement analysis
Earnings problems
Decreased cash flow
Too much debt
Inability to collect receivables
Buildup of inventories
Trends of sales, inventory, and receivables
Higher debt ratio, more debt a company has, the riskier it is
Ratio
Formula)
Category
Provided
Debt
Ratio
Times
Interest
Earned
Ratio
Gross
Margin
%
Gross
Profit
%
Profit
Margin
Net
Profit
Margin
Net
Income
%
Current
Ratio
Inventory
Turnover
A/R
Turnover
Total
Liabilities
/
Total
Assets
Operating
Income
/
Interest
Expense
Gross
Profit
/
Net
Sales
Net
Income
/
Net
Sales
Current
Assets
/
Current
Liabilities
COGS
/
Average
Inventory
Net
Sales
/
Average
A/R
Solvency;
Long-term
debt
Solvency;
ability
to
service
debt
Profitability
Profitability
Category
Liquidity
Efficiency
Efficiency
Indicates
the
percentage
of
assets
financed
with
debt
Measures
the
#
of
times
operating
income
can
cover
interest
expense
The
%
of
profit
made
from
merely
selling
the
product
before
any
other
operating
expenses
The
%
of
profit
made
after
considering
all
expenses
Information
Provided
Measures
ability
to
pay
current
liabilities
with
current
assets
The
#
of
times
a
company
sells
its
average
inventory
balance
during
the
year
The #
of
times
a
company
collects
its
average
A/R
balance
during
the
year;
ability
to
collect
cash
from
credit
sales
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