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Additional Aspects Additional Aspects of Financial of Financial
Reporting and Reporting and Financial AnalysisFinancial Analysis
Additional Aspects Additional Aspects of Financial of Financial
Reporting and Reporting and Financial AnalysisFinancial Analysis
Chapter5
An electronic presentation by Douglas Cloud
Pepperdine University
An electronic presentation by Douglas Cloud
Pepperdine University
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1. Describe an auditor’s report.
2. Explain the disclosure in management’s discussion and analysis.
3. Understand the meaning of an operating segment.
4. Describe the disclosure in a segment report.
5. Explain interim reporting.
ObjectivesObjectivesObjectivesObjectives
ContinuedContinuedContinuedContinued
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6. Prepare an interim report.
7. Understand intracompany and intercompany comparisons (Appendix).
8. Prepare horizontal and vertical percentage analyses (Appendix).
9. Perform ratio analysis (Appendix).
ObjectivesObjectives
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Market EfficiencyMarket EfficiencyMarket EfficiencyMarket Efficiency
The prices of securities traded in the
capital market fully reflect all publicly
available information.
The prices of securities traded in the
capital market fully reflect all publicly
available information.
Evidence from research on an efficient market hypothesis tends to show--
These prices are adjusted almost
immediately based on new information and
in an unbiased manner.
These prices are adjusted almost
immediately based on new information and
in an unbiased manner.
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Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)
1. The auditor is independent.
2. The audit was performed on specified financial statements.
3. The financial statements are the responsibility of the company’s management; the opinion is the responsibility of the auditors.
4. The audit was conducted according to generally accepted auditing standards.
ContinuedContinuedContinuedContinued
An auditor’s standard report includes these statements...
An auditor’s standard report includes these statements...
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Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)
5. The audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatements.
6. The audit included examination, assessment, and evaluation stages.
7. The audit provides a reasonable basis for an opinion.
8. An opinion is expressed concerning the fair presentation.
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Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)
The first (introductory) paragraph lists the
financial statements that were audited, declares
that management is responsible for those
statements, and asserts that the auditor is responsible for
expressing an opinion on them.
The first (introductory) paragraph lists the
financial statements that were audited, declares
that management is responsible for those
statements, and asserts that the auditor is responsible for
expressing an opinion on them.
The second (scope) paragraph describes what
the auditor has done.
The second (scope) paragraph describes what
the auditor has done.
The third (opinion) paragraph gives the auditor’s opinion.
The third (opinion) paragraph gives the auditor’s opinion.
An unqualified opinion contains three paragraphs.
An unqualified opinion contains three paragraphs.
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1. An unqualified opinion is not a “clean bill of health.”
2. An unqualified opinion provides no assurance of the future success of the company.
3. An audit report does not provide an assurance that fraud has not been committed by a member, or members, of the company unless such fraud would cause a material misstatement in the financial statements.
Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)Auditor’s Report (Opinion)
There are three things that the audit report does not say.
There are three things that the audit report does not say.
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Management’s Discussion Management’s Discussion and Analysis (MD&A)and Analysis (MD&A)
Management’s Discussion Management’s Discussion and Analysis (MD&A)and Analysis (MD&A)
The MD&A provides a narrative explanation of the financial
statements so that investors can judge the “quality” of earnings
and the likelihood that past performance is indicative of
future performance in regard to cash flows.
The MD&A provides a narrative explanation of the financial
statements so that investors can judge the “quality” of earnings
and the likelihood that past performance is indicative of
future performance in regard to cash flows.
The MD&A provides information regarding liquidity, capital resources, and the results
of operations, as well as other information necessary to understand its financial
condition and changes in financial condition.
The MD&A provides information regarding liquidity, capital resources, and the results
of operations, as well as other information necessary to understand its financial
condition and changes in financial condition.
Where knowledge of segment information is useful to
understanding a company’s business, the discussion is to
focus on each relevant, reportable operating segment, as well as on the whole company.
Where knowledge of segment information is useful to
understanding a company’s business, the discussion is to
focus on each relevant, reportable operating segment, as well as on the whole company.
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Liquidity Capital Resources Results of Operations General Information
Major discussion issues that may involve intracompany and
intercompany comparisons.
Management’s Discussion Management’s Discussion and Analysis (MD&A)and Analysis (MD&A)
Management’s Discussion Management’s Discussion and Analysis (MD&A)and Analysis (MD&A)
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Segment ReportingSegment ReportingSegment ReportingSegment Reporting
1. that engages in business activities to earn revenues and incur expenses,
2. whose operating results are regularly reviewed by the company’s chief operating officer to make decisions about resources to be allocated to the segment and to assess its performance, and
3. for which financial information is available.
An operating segment is a component of a company--
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Segment ReportingSegment ReportingSegment ReportingSegment Reporting
An operating segment is considered significant and is a
reportable segment if it satisfies at least one of the following tests:
An operating segment is considered significant and is a
reportable segment if it satisfies at least one of the following tests:
1. Revenue Test. Its reported revenues are 10% or more of the combined revenues of all the company’s reported operating segments.
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Segment ReportingSegment ReportingSegment ReportingSegment Reporting
An operating segment is considered significant and is a
reportable segment if it satisfies at least one of the following tests:
An operating segment is considered significant and is a
reportable segment if it satisfies at least one of the following tests:
2. Profit Test. The absolute amount of its profit (loss) is 10% or more of the combined reported profits of all operating segments that did not report a loss.
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Segment ReportingSegment ReportingSegment ReportingSegment Reporting
An operating segment is considered significant and is a
reportable segment if it satisfies at least one of the following tests:
An operating segment is considered significant and is a
reportable segment if it satisfies at least one of the following tests:
3. Asset Test. Its segment assets are 10% or more of the combined assets of all operating segments.
15TEAL COMPANYOperating Segment Financial Resultsfor Year Ended December 31, 2004
Reportable Operating Segments All Other Total A B C Segments Results
Segment revenues $ 300 $2,530 $ 370 $ 600 $ 3,800 Segment operating profit (pretax) $ 70 $ 495 $ 105 $ 140 $ 810 General corporate expenses (100)Corporate interest expense (80) Pretax income from cont’g operations $ 630 Segment assets at 12/31/2004 $1,800 $9,400 $2,000 $2,800 $16,000 Gen. corp. assets 3,000 Total assets 12/31/2004 $19,000
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Interim Income TaxesInterim Income TaxesInterim Income TaxesInterim Income Taxes
1. Estimated Annual Income:
First quarter $ 20,000 actual incomeSecond quarter 26,000 actual incomeThird quarter 25,000 estimated incomeFourth quarter 29,000 estimated income
$100,000 estimated annual income
ContinuedContinuedContinuedContinued
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Interim Income TaxesInterim Income TaxesInterim Income TaxesInterim Income Taxes
2. Estimated Effective Income Tax Rate:
15% x $20,000 = $ 3,00030% x ($100,000 – $20,000) = 24,000
Estimated total tax = $27,000
27% Effective tax rate =$27,000 Estimated income tax$100,000 Estimated Income
ContinuedContinuedContinuedContinued
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Interim Income TaxesInterim Income TaxesInterim Income TaxesInterim Income Taxes
3. Estimated Income Tax for First Six Months:
$46,000 x 27% = $12,420 estimated income tax on first six months’ income
4. Estimated Income Tax for Second Quarter:$12,420 estimated income tax on first six months of income (5,220 ) estimated income tax on first-quarter
income$ 7,200 estimated income tax on second-quarter
income
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Preparation of Disclosure of Preparation of Disclosure of Summarized Interim Summarized Interim FinancialFinancial Data Data
Preparation of Disclosure of Preparation of Disclosure of Summarized Interim Summarized Interim FinancialFinancial Data Data
When publicly held companies report interim summaries of financial
information, the following data must be reported at a minimum.
When publicly held companies report interim summaries of financial
information, the following data must be reported at a minimum.
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Sales or gross revenues, income taxes, extraordinary
items (net of tax), the cumulative effect of a change in accounting
principle, and net income
Sales or gross revenues, income taxes, extraordinary
items (net of tax), the cumulative effect of a change in accounting
principle, and net income
Earnings per share for each
period presented
Earnings per share for each
period presented
Seasonal revenues, costs, and expenses
Seasonal revenues, costs, and expenses
Significant changes in
estimates of income taxes.
Significant changes in
estimates of income taxes.
Contingent itemsContingent itemsChanges in accounting
principles or estimates
Changes in accounting
principles or estimates
Significant changes in
financial position
Significant changes in
financial position
Preparation of Disclosure of Preparation of Disclosure of Summarized Interim Summarized Interim FinancialFinancial Data Data
Preparation of Disclosure of Preparation of Disclosure of Summarized Interim Summarized Interim FinancialFinancial Data Data
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Two SEC forms that are important to accountants are--
Two SEC forms that are important to accountants are--
Form 10-K
Form 10-Q
SEC ReportsSEC ReportsSEC ReportsSEC Reports
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SEC ReportsSEC ReportsSEC ReportsSEC Reports
Form 10-K is the most common SEC annual report form and is required to be filed with the SEC within 90 days of a company’s
fiscal year-end.
Form 10-K is the most common SEC annual report form and is required to be filed with the SEC within 90 days of a company’s
fiscal year-end.
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SEC ReportsSEC ReportsSEC ReportsSEC Reports
Form 10-Q is used to report a company’s quarterly
financial information to the SEC and is required to be filed within 45 days of the end of the company’s first
three fiscal quarters.
Form 10-Q is used to report a company’s quarterly
financial information to the SEC and is required to be filed within 45 days of the end of the company’s first
three fiscal quarters.
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Financial Analysis ComparisonFinancial Analysis ComparisonFinancial Analysis ComparisonFinancial Analysis Comparison
Financial Analysis
ComparisonsIntracompany Intercompany
Percentage Analyses
HorizontalVertical
Ratio
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Under international standards, reportable
segments include both business segments and geographical segments, with a business segment
providing goods or services and being different from
other business segments as to risks and returns.
International Accounting DifferencesInternational Accounting DifferencesInternational Accounting DifferencesInternational Accounting Differences
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International Accounting DifferencesInternational Accounting DifferencesInternational Accounting DifferencesInternational Accounting Differences
International standards differ from U.S. standards in that they do not allow:(1) The allocation of expenses between interim periods
(2) The deferral of manufacturing variances that are expected to be offset in a later interim period
(3) The deferral of a temporary market decline in inventory that is expected to be recovered in a later interim period
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Horizontal AnalysisHorizontal AnalysisHorizontal AnalysisHorizontal Analysis
In horizontal analysis, changes in a company’s
operating results and financial position over time are shown in percentages
as well as in dollars.
In horizontal analysis, changes in a company’s
operating results and financial position over time are shown in percentages
as well as in dollars.
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from 12/31/04 to 12/31/05
Base Year% =
Horizontal AnalysisHorizontal AnalysisHorizontal AnalysisHorizontal Analysis
Sales $138,000 $130,00012/31/05 12/31/04
$8,000
$8,000
$130,000% = = 6.2%
Now, using data from Exhibit 5-5, let’s
examines Sales from December 31, 2004 to December 31, 2005.
Now, using data from Exhibit 5-5, let’s
examines Sales from December 31, 2004 to December 31, 2005.
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from 12/31/03 to 12/31/04
Base Year% =
Horizontal AnalysisHorizontal AnalysisHorizontal AnalysisHorizontal Analysis
Gross profit $55,900 $42,000
12/31/04 12/31/03
$13,900
$13,900
$42,000% = = 33.1%
Again using data from Exhibit 5-5, let’s calculate the change in gross profit from December 31, 2003 to December 31, 2004.
Again using data from Exhibit 5-5, let’s calculate the change in gross profit from December 31, 2003 to December 31, 2004.
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Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)
In vertical analysis, the monetary relationships between items on the financial statements are shown in percentages as well as in dollars.
In vertical analysis, the monetary relationships between items on the financial statements are shown in percentages as well as in dollars.
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2005
Amount Percent
Sales $138,000 Sales returns (8,000 )Sales, net $130,000 Cost of goods sold (74,100 )Gross profit $ 55,900
Sales, net $130,000 100.0
106.2Sales, $138,000
Sales, net, $130,000=
106.2
Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)
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(6.2)%Sales returns, ($8,000)
Sales, net , $130,000=
106.2(6.2)
Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)
2005
Amount Percent
2005
Amount Percent
Sales $138,000 Sales returns (8,000 )
Cost of goods sold (74,100 )Gross profit $ 55,900
Sales, net $130,000 100.0
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(57.0)%Cost of goods sold, ($74,100)
Sales, net , $130,000=
(6.2)
(57.0)
Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)
Sales, net $130,000 100.0
2005
Amount Percent
Sales $138,000 Sales returns (8,000 )
Cost of goods sold (74,100 )Gross profit $ 55,900
106.2
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43.0%Gross profit, $55,900
Sales, net , $130,000=
106.2(6.2)
(57.0)43.0
Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)Vertical Analysis (Income Statement)
2005
Amount Percent
Sales $138,000 Sales returns (8,000 )
Cost of goods sold (74,100 )Gross profit $ 55,900
Sales, net $130,000 100.0
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Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)
2005
Amount Percent
Cash $ 3,900Receivables (net) 7,600Inventories 8,900Prepaid Items 1,000Total current assets $ 21,400Noncurrent assets (net) 107,800Total Assets $129,200
3.0%Cash, $3,900
Total Assets, $129,200=
3.0
Total Assets $129,200 100.0
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Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)
2005
Amount Percent
Cash $ 3,900Receivables (net) 7,600Inventories 8,900Prepaid Items 1,000Total current assets $ 21,400Noncurrent assets (net) 107,800Total Assets $129,200
3.0
Total Assets $129,200 100.0
5.9%Receivables (net), $7,600
Total Assets, $129,200=
5.9
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Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)
Using this approach on the rest of the assets, this section can be
completed.
Using this approach on the rest of the assets, this section can be
completed.
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Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)
2005
Amount Percent
Cash $ 3,900Receivables (net) 7,600Inventories 8,900Prepaid Items 1,000Total current assets $ 21,400Noncurrent assets (net) 107,800Total Assets $129,200
3.0
Total Assets $129,200 100.0
5.9 6.9 .8
16.6 83.4
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In calculating vertical analysis amounts for liabilities and
stockholders’ equity, all items are divided by “total liabilities
and stockholders’ equity.”
In calculating vertical analysis amounts for liabilities and
stockholders’ equity, all items are divided by “total liabilities
and stockholders’ equity.”
Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)Vertical Analysis (Balance Sheet)
3.9%Accounts Payable, $5,000
Total L& SE, $129,200=
20052005
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Stockholders’ Profitability Ratios
Earnings per share is probably the most frequently cited ratio in a financial analysis.
Net Income – Preferred Dividends
Average Common Shares Outstanding
$11,000 $1,200
5,400
= $1.81
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Stockholders’ Profitability Ratios
Price/earnings is used by actual and potential stockholders to evaluate the attractiveness of an
investment in the stock of a company.
Market Price per Common Share
Earnings per Share
$14.25
$1.81
= 7.9 times
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Stockholders’ Profitability Ratios
Dividend yield provides the stockholders’ their individual rates of return based on the actual dividends received as
compared with the ending market price of the stock.
Dividends per Common Share
Market Price per Common Share
$1.00
$14.25
= 7.0%
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Profit margin is used to evaluate a company’s efficiency in controlling costs
and expenses in relation to sales.
Net Income
Net Sales
$11,000
$130,000
= 8.5%
Company Profitability Ratios
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Return on total assets indicates how efficiently a company uses its economic resources.
Net Income + Interest Expense (net of tax)
Average Total Assets
$11,000 + ($3,000 x 0.7)
($129,200 + $112,000)/2
= 10.9%
Company Profitability Ratios
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Return on stockholders’ equity shows the residual returns on the owners’ equity.
Company Profitability Ratios
Net Income
Average Stockholders’ Equity
$11,000
($93,000 + $79,000)/2
= 12.8%
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
The current ratio is used to evaluate a company’s short-run liquidity.
Liquidity Ratios
Current Assets
Current Liabilities
$21,400
$11,200
= 1.91 times
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
The acid-test ratio is a more severe test of a company’s short-term debt-paying abilities.
Liquidity Ratios
Quick Assets
Current Liabilities
$11,500
$11,200
= 1.03 times
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Inventory turnover indicates the number of times the inventory is “turned over” or
sold during that period.
Activity Ratios
Cost of Goods Sold
Average Inventory
$74,100
($8,900 + $10,100)/2
= 7.8 times or 47 days365
7.8
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Receivables turnover indicates how many times receivables are “turned
over” or collected each period.
Activity Ratios
Net Credit Sales
Average Net Receivables
$130,000 x 0.70
($7,600 + $8,600)/2
= 11.2 times or 33 days365
11.2
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
The payables turnover ratio measures the number of times accounts payable
turns over during the year.
Activity Ratios
Cost of Goods Sold
Average Accounts Payable
$74,100
($5,000 + $6,600)/2
= 12.8 times or 29 days 365
12.8
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
The debt ratio indicates the percentage of total assets contributed by creditors.
Stability RatiosStability Ratios
Total Liabilities
Total Assets
$36,200
$129,200
= 28%
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Times interest earned is used to evaluate the ability of a company to cover its interest obligations through its annual earnings.
Stability RatiosStability Ratios
Pretax Operating Income
Interest Expense
$15,700 + $3,000
$3,000
= 6.2 times
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Book value per common share shows the net assets per share of stock.
Stability RatiosStability Ratios
Common Stockholders’ Equity
Outstanding Common Shares
$93,000 – ($140 x 150)
5,400
= $13.33 per common share
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Cash flow from operations to sales ratio is used to evaluate the cash generated from sales.
Cash Flow RatiosCash Flow Ratios
Cash Flow From Operations
Sales
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Cash flow from operations to net income ratio enables users to understand how the earnings of net income relates to the cash
flow from operations.
Cash Flow RatiosCash Flow Ratios
Cash Flow From Operations
Net Income
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Cash flow from operations per share is expressly prohibited. However, users
may wish to compute it for internal use.
Cash Flow RatiosCash Flow Ratios
Cash Flow From Operations
Average Shares of Common Stock Outstanding
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Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis
Cash flow from operations divided by the amount of debt maturing next year ratio measures the
ability of a company to make principal payments.
Cash Flow RatiosCash Flow Ratios
Cash Flow From Operations
Debt Maturing Next Year
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Chapter5
The EndThe EndThe EndThe End
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