Chapter 3 Financial Statement Analysis

Financial Statement Analysis, Some Background Financial statements reflect the results of actions taken by the management of a company. Analysis of historical data can give perspective on past performance, and may help to predict future performance. Financial statement analysis helps to set goals for the company to attain in future periods. Financial statement analysis allows us to compare the performance of a company to its competitors, wherever possible.

Ratio Analysis, an Important Tool in Financial Statement Analysis Expresses relationship among selected items of financial statement data Relationship can be expressed in term of: Percentages – for example, gross profit as a % of net sales, gross profit percentage Rates – 365 days, Days in (Cost of Goods Sold ÷ Average Inventory) Inventory Proportions – Current Assets ÷ Current Liabilities, Current Ratio

Ratio Analysis Comparisons Intracompany comparisons - covering two years of the same company Industry average comparisons - based on average ratios for a particular industry Intercompany comparisons - based on comparisons with a competitor in the same industry

Ratio Analysis Classifications... Liquidity Ratios - measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. Solvency Ratios - Measures of the ability of the company to survive over a long period of time. Profitability Ratios - Measures of the income or operating success of a company for a given period of time.

Common Size Financial Statement Ratios Relates the components of the financial statements to some reference amount to scale dollar amounts for size. Balance sheet – the reference is usually total assets. Income Statement – the reference is usually net sales. See Table 3.3 and 3.4 for examples of common sized balance sheets and income statements. Common size financial statement exercise

For Tomorrow Read Chapter 3 Work through the T/F and Multiple Choice questions, exercises 42 (a) (b), and 44.