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Financial Statement Analysis
Carter J Pollock
School of Business, Liberty University
ACCT 301-B05: Intermediate Financial Accounting
Professor Justin Miller
October 10, 2022
Financial Statement Analysis 2
One of the most important elements that is used in both internal and external decision
making for a company is financial statement analysis. Financial documents primarily look at past
performance, but the goal of analysis is to critically evaluate past and current statements to
understand the financial position of a business and allow for better economic decision making.
There are many groups of individuals who consistently use such information. Many are external
users such as investors, customers, banking partners, and financial consultants. Internal users
include managers, owners, employees, etc. Financial statement analysis is a broad and quite
intimidating objective, but fortunately there are plenty of accounting methods which assist in
analyzing information in order to paint a clear picture of the company’s financial structure. A few
of these methods that will be reviewed in this report are ratio, vertical, horizontal, and
comparative analysis; the most common of these being ratio analysis which is what we will be
exploring in this paper. Under Armour, Inc. and their financial documents from the Securities and
Exchange Commission database will be used as an example throughout this paper while all ratios
are taken from IBISWorld. The fundamentals and utilization of financial statement analysis will
be examined as well as its application to real-world scenarios.
Before diving into the abundant methods of financial statement analysis, we must first
learn the process that effective professionals use when inspecting a firm’s statements. To do this,
we need to have a solid understanding of the structure of financial statement, the economic
characteristics in which the firm operates, and the strategies that the firm uses. There are six
steps involved in this process, the first being the identification of economic characteristics. This
first step looks at the industry as a whole and the activities that are commonly used creation,
manufacturing, and delivery of a company’s goods and services. Second, company strategies are
to be identified. This action helps differentiate between strategies of the firm and those of
Financial Statement Analysis 3
competitors, while also recognizing similarities. The third step is to observe the quality of the
firm’s financial statements which include their income statements, balance sheets, and statement
of cash flows. This involves reviewing the company’s summary of significant accounting
policies and how they have chosen to financially structure their company. The fourth step is to
analyze the firm’s current profitability and risk. This is where most of the financial statement
analysis methods come into play. Here we can determine how profitable the company is relative
to its assets and to its shareholders. The fifth step in the process is to prepare forecasted financial
statements. After finding all necessary information about past trends and future outlooks, we can
apply that information to use in future statements. The more detailed the preparation, the more
accurate the projected documents will be. The last step of the process is to value the firm. There
are many valuation methods, but the goal is to assess the total economic value of the business
and its assets (Masson, 2018). Now that we understand the process, we can look deeper into the
specific methods of analysis.
The first of the significant financial statement analysis methods that we will discuss is
ratio analysis in which line items from a company’s statements are converted into ratios to
evaluate their risk and performance. There are two types of risk ratios: liquidity and long-term
solvency. Liquidity is the measure of a company’s ability to convert its assets into cash to satisfy
its current obligations. This allows us to get an idea of their ability to pay short-term debts as the
are incurred. Current assets are generally the liquid of a company’s assets and are listed on the
balance sheet in order of most to least liquid. The two most common liquidity ratios are current
ratio and acid-test/quick ratio. Current ratio is computed by dividing current assets by current
liabilities. This ratio helps in determining how cash-rich a company is and its short-term financial
strength. Current ratio is simple to calculate, analyze, and compare. A ratio or less than one
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means that a company has more current liabilities than current assets and faces risk when those
liabilities are due. Because of its popularity, it is easy to compare to other companies and even
industry averages. One disadvantage to current ratio is that it is not able to measure the financial
health of seasonal businesses. Another disadvantage is that the ratio includes inventory, which
may take more time for some businesses to convert to cash (Advantages and Disadvantages of
Current Ratio, 2021). When calculating the current ratio for Under Armour Inc. for 2021, we
need to look at their 2021 balance sheet, which is recorded in thousands of dollars. We can see
that the total current assets are $3,336,299 and the total current liabilities are $1,450,176. When
we divide total current assets by total current liabilities, we get a current ratio of 2.3. This means
that Under Armour has a little over 2.3 times the value of current assets as current liabilities. This
ratio is significantly higher than the industry average which is 1.5. We can also see that they are
becoming more liquid over the past three years as their current ratios were 1.90 in 2019, 2.28 in
2020, and now 2.3 in 2021.
The next liquidity ratio that we will be reviewing is the acid-test/quick ratio. This ratio is
computed by taking a company’s quick assets and dividing them by current liabilities. Quick
ratio is a modified version of current ratio that considers only current assets that are readily
available to pay current liabilities. This means that quick assets exclude inventories, prepaid
items, and restricted cash from current assets, which leaves the numerator with unrestricted cash,
accounts receivable, and short-term investments. Quick ratio provides a more refined look at
how liquid a company is. When examining Under Armour’s 2021 balance sheet, we can see that
quick assets equal $2,238,467. This is calculated by subtracting inventory and prepaid expenses
and other current assets from total current assets which leaves only cash and accounts receivable.
As stated before, total current liabilities equal $1,450,176. So, our quick ratio, or acid-test ratio,
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equals 1.54 which is also significantly higher than the industry average of 1.10. Under Armour is
.44 times more liquid than the industry average. They are also becoming more liquid each year as
their quick ratio was 1.05 in 2019, 1.45 in 2020, and 1.54 in 2021.
Now we are going to look at the long-term liquidity to financial statement analysis:
solvency ratios. Solvency ratios are useful for investors and creditors who are interested in long-
term agreements. Solvency shows a company’s ability to pay off its long-term debts. The first
solvency ratio that we will consider is the debt-to-equity ratio, which, like the name suggests, is
calculated by dividing total liabilities by shareholder’s equity. The higher the ratio, the higher the
risk of the company and greater the creditor claim on assets. In the case of Under Armour, its
total liabilities are equal to $2,902,402, and its total shareholder’s equity is equal to $2,088,994.
According to this information, their debt-to-equity ratio is equal to 1.39. This is quite lower than
the industry average of 3.0. This means that Under Armour relies less on financing with debt
than most companies in the industry. Their debt-to-equity ratios for the previous two years are
1.25 in 2019 and 2.00 in 2020. They relied more on debt during 2020, and not as much in 2021.
The second solvency ratio we will discuss is the times interest earned ratio which is
calculated by finding the sum of net income, interest expense, and income taxes and dividing that
total by its interest expense. The aim of this ratio is to uncover the company’s ability to cover its
interest charges during the current period. When income is many times greater than interest
expense, creditors are much more protected than if income barely covers interest expense. The
numerator of the times interest earned when looking at Under Armour’s financial statements is
equal to $486,290 and its interest expense is $44,300. When calculated, the times interest earned
ratio is equal to 10.98 which means that they can cover their interest expense almost eleven times
over.
Financial Statement Analysis 6
Another category of ratios included in financial statement analysis are activity ratios.
These ratios measure a company’s efficiency in managing its assets. These include asset turnover
ratio, receivables turnover ratio, and inventory turnover ratio. The higher the turnover rate the
fewer the assets required to maintain a given activity (Masson, 2018). Asset turnover ratio is
computed by dividing net sales by average total assets for a given period and shows how
effectively a company uses its assets. Average total assets is computed by adding beginning and
ending total assets and dividing by two. The net sales for Under Armour for 2021 are $5,683,466
and its average assets are $5,011,012 resulting in asset turnover ratio of 1.13 which is just
slightly greater than the industry average of 1.00. The next activity ratio is receivables turnover
ratio which is equal to net sales divided by average accounts receivable. It is used in showing the
effectiveness of a company to collect cash from its customers. The higher the ratio, the shorter
the time between sales and cash collection. As stated before, the net sales for Under Armour in
2021 are $5,683,466 and its average accounts receivable is $548,177 which is equal to a
receivables turnover ratio of 10.37. This is over twice the industry average of 5.60. This shows
that they are very efficient in collecting cash from customers. The last activity ratio that we will
examine is inventory turnover ratio which is calculated by dividing cost of goods sold by average
inventory and shows the number of times a company sells its average inventory balance during a
period. Under Armour has a cost of goods sold of $2,821,967 and an average inventory of
$853,692 which results in an inventory turnover ratio of 3.31. This ratio is slightly under the
industry average of 3.70. These activity ratios are helpful for companies in viewing what specific
areas of their company are doing the best and what areas need improvement.
The last group of ratios that we will look at about is profitability ratios which measure the
different areas of a company’s profit-making activities. These ratios include profit margin on
Financial Statement Analysis 7
sales, return on assets, and return on equity. Profit margin on sales is net income divided by net
sales and it shows the portion of each sales dollar that is available after all expenses are paid. In
2021, Under Armour had a net income of $360,060 and net sales of $5,683,466 which equals a
profit margin on sales of 0.063 or 6.3%. This means that 6.3 cents of every dollar in sales is pure
profit to Under Armour. The industry average is 4.3%, which means that they are also more
efficient in this aspect of financial statement analysis. Return on assets is equal to net income
divided by average total assets or profit margin times asset turnover. This ratio is used to measure
the earning power of a company’s assets. Since we already know Under Armour’s profit margin
(6.3%) and its asset turnover (1.13), we can just multiply the two to find our return on assets
which is 0.071 or 7.1%. This is lower than the industry average of 12.7%. The last profitability
ratio is return on shareholder’s equity which is calculated by dividing net income by average
shareholder’s equity. As stated previously, Under Armour had a net income of $360,060 and it
had an average shareholder’s equity of $1,882,494 which equals a return on equity of 19.13%
while the industry average is 37.9%.
After taking an in-depth look at the many ratios involved in financial statement analysis,
we can see why projecting future financial statements can be quite complicated. There are many
variables involved in just these few ratios that were discussed in this report. No one will ever be
able to perfectly predict a company’s financial position for a future period because of this
variability and uncertainty of future circumstances. That being said, when meticulously applying
all of these ratios to a company’s financial documents, we start to see a glimpse of what their
future position might look like. Using this technique allows for internal users to make decisions
that will be most beneficial to the financial strength of a company in future periods, and help
external users make the most out of who they are going to loan money to or invest in. Overall,
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advanced financial statement analysis is extremely advantageous for companies and those who
deal with them on a daily basis.
Financial Statement Analysis 9
References
Advantages and Disadvantages of Current Ratio. (2021, August 7). Accountinguide. Retrieved
October 10, 2022, from https://accountinguide.com/advantages-and-disadvantages-of-
current-ratio/
Masson, D. (2018, March 9). 6 Steps to an Effective Financial Statement Analysis. Retrieved
October 10, 2022, from https://www.afponline.org/ideas-
inspiration/topics/articles/details/6-steps-to-an-effective-financial-statement-analysis
Ristoff, J. (2022, July). Athletic & Sporting Goods Manufacturing in the US. IBISWorld.
Retrieved October 10, 2022, from https://my.ibisworld.com/us/en/industry/33992a/key-
statistics#key-ratios
Spiceland, Nelson, Thomas, Winchel. (2020). Intermediate Accounting (Eleventh Edition).
McGraw Hill, LLC. https://prod.reader-ui.prod.mheducation.com/epub/sn_fc2dc/data-
uuid-1237dfedf91b49a1bf05d39fb23d9f3c
SEC.gov | EDGAR | Company Filings. (2022, July 22). Retrieved October 10, 2022, from
https://www.sec.gov/edgar/searchedgar/companysearch
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