Analyze financial indicators and ratios to make business decisions. Objective 5.04 Analyze financial indicators and ratios to make business decisions.
Compare the same items on a financial statement for two or more periods. Ex: 2009 Sales = $500,000; 2009 Sales = $400,000. Analysis determines the cause of the change. Horizontal Analysis
Vertical Analysis Also called component percentages Show each amount as a percentage of another amount on the same financial statements. Income statement items are shown as a percentage of sales. Asset items are shown as a percentage of total assets. Liability and equity items are shown as a percentage of total liabilities and stockholders’ equity. Vertical Analysis
Compare to percentages of previous years or companies in the same industry. Analysis determines the cause of favorable or unfavorable changes. Vertical Analysis
Liquidity Ratios – measure the ability of a business to pay its current debts and provide cash for unexpected needs. The higher the ratio, the more likely a company can meet its cash outflow needs. Changes in the ratios need to be investigated for signs of downward trends. Analysis determines the reasons behind increases and decreases to help management with decision making. Ratio Analysis
Profitability Ratios – evaluate the earnings performance of the business during the accounting period. Companies look for consistent or increasing ratios as a sign of stable or increasing profitability. Changes in the ratio need to be investigated for signs of downward trends. Ratio Analysis
Financial Strength Ratios – measure the ability of a business to pay its debts in order to maintain credit standing and borrow funds in the future. Creditors look for a high ratio. Decreasing ratios need to be investigated for signs of downward trends. Ratio Analysis
Debt ratios - measure the amount of debt in relation to total assets. Therefore, favorable ratios would be lower. As the ratio increases, the less favorable the ratio becomes. Ratio Analysis