Chapter 13 Financial Analysis & Ratios. Comparative Analysis There are three types of comparisons to...
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Transcript of Chapter 13 Financial Analysis & Ratios. Comparative Analysis There are three types of comparisons to...
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Chapter 13
Financial Analysis & Ratios
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Comparative Analysis
There are three types of comparisons to provide decision usefulness of financial information:
• Intra-company basis
• Inter-company basis
• Industry averages
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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.
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Financial Statement AnalysisThree basic tools are used in financial statement analysis :
1. Horizontal analysis
2. Vertical analysis
3. Ratio analysis
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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 613 - 614
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Horizontal Analysis
P1 – P0 P0
$245 – $281 = (12.81)%
$281The amount of cash for Lowe’s decreased approximately 12.81%
from fiscal 2007 to 2008.
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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 615 - 616
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Ratio AnalysisFive types:
Liquidity ratios
Solvency ratios
Turnover ratios
Profitability ratios
Market value ratios
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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
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Current Ratio
Indicates short-term debt-paying ability
Current AssetsCurrent Liabilities
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Acid-Test Ratio
Indicates immediate short-term debt-paying ability
Current Assets - Inventory Current Liabilities
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Cash Ratio
Indicates short-term debt-paying ability (cash basis)
_ Cash _Current Liabilities
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Solvency Ratios
Measure the ability of the enterprise to survive over a long period of time
WHO CARES?Long-term creditors and stockholders
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Debt to Assets Ratio
Indicates % of total assets provided by creditors
Total Liabilities
Total Assets
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Times Interest Earned Ratio
Indicates company’s ability to meet interest payments as they come due
_ EBIT _
Interest Expense
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Cash Debt Coverage Ratio
Indicates long-term debt-paying ability (cash basis)
Cash provided by operations Average total liabilities
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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
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Inventory Turnover Ratio
Indicates liquidity of inventory
Cost of Goods SoldInventory
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Average Days in Inventory
Indicates liquidity of inventory and inventory management
365 days
Inventory Turnover Ratio
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Receivables Turnover Ratio
Indicates liquidity of receivables
Net SalesAccounts Receivable
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Average Collection Period
Indicates liquidity of receivables and collection success
365 daysReceivables Turnover
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Asset Turnover Ratio
Indicates how efficiently assets are used to generate sales
Net Sales
Total Assets
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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 financingits liquidity positionits ability to grow
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Profit Margin Ratio
Indicates net income generated by each dollar of sales
Net IncomeNet Sales
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Return On Assets
Reveals the amount of net income generated by each dollar invested
Net IncomeAverage Total Assets
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Return on Equity
Indicates profitability of common
stockholders’ investment
Net IncomeAverage Total Equity
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Market Value Ratios
Deals with market value of stock.
.
WHO CARES?Stockholder’s
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Earnings Per Share (EPS)
Indicates net income earned on each share of common stock sales
Net IncomeShares Outstanding
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Price Earnings Ratio
Indicates relationship between market price per share and earnings per share
Stock PriceEarnings Per Share
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Payout Ratio
Indicates % of earnings distributed in the form of cash dividends
DividendsNet Income
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Retention Ratio
Indicates % of earnings plowed back into the corporation.
Addition to Retained EarningsNet Income
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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.