1. Financial Analysis & Ratios
Chapter 12
Financial Analysis & Ratios

2. Comparative Analysis
There are three types of comparisons to provide decision usefulness of financial information:
Intra-company basis
Inter-company basis
Industry averages

3. 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.

4. Financial Statement Analysis
Three basic tools are used in financial statement analysis :
1. Horizontal analysis
2. Vertical analysis
3. Ratio analysis

5. 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

6. Horizontal Analysis P1 – P0 P0 $1,000,000
$1,300,000 – $1,000,000 = 30.00%
$1,000,000
The amount of net sales for Bello’s Bike Supply, Inc. increased approximately 30.00% from fiscal 2015 to 2016.

7. 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

8. Ratio Analysis Five types: Liquidity ratios Solvency ratios
Turnover ratios
Profitability ratios
Market value ratios

9. Liquidity Ratios WHO CARES?
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

10. Current Ratio Indicates short-term debt-paying ability Current Assets
Current Liabilities

11. Acid-Test Ratio Indicates immediate short-term debt-paying ability
Current Assets - Inventory
Current Liabilities

12. Cash Ratio Indicates short-term debt-paying ability (cash basis)
Current Liabilities

13. Solvency Ratios WHO CARES?
Measure the ability of the enterprise to survive over a long period of time
WHO CARES?
Long-term creditors and stockholders

14. Debt to Assets Ratio Total Liabilities Total Assets
Indicates % of total assets provided by creditors
Total Liabilities
Total Assets

15. Times Interest Earned Ratio
Indicates company’s ability to meet interest payments as they come due
_ EBIT _
Interest Expense

16. Cash Debt Coverage Ratio
Indicates long-term debt-paying ability (cash basis)
Cash provided by operations
Average total liabilities

17. Turnover Ratios WHO CARES?
Measure how efficiently, or intensively, a firm uses its assets to generate sales .
WHO CARES?
Short-term creditors such as bankers and suppliers

18. Inventory Turnover Ratio
Indicates liquidity of inventory
Cost of Goods Sold
Inventory

19. Average Days in Inventory Inventory Turnover Ratio
Indicates liquidity of inventory and inventory management
365 days
Inventory Turnover Ratio

20. Receivables Turnover Ratio
Indicates liquidity of receivables
Net Sales
Accounts Receivable

21. Average Collection Period
Indicates liquidity of receivables and collection success
365 days
Receivables Turnover

22. Asset Turnover Ratio Net Sales Total Assets
Indicates how efficiently assets are used to generate sales
Net Sales
Total Assets

23. 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 financing
its liquidity position
its ability to grow

24. Profit Margin Ratio Net Income Net Sales
Indicates net income generated by each dollar of sales
Net Income
Net Sales

25. Return On Assets Net Income Average Total Assets
Reveals the amount of net income generated by each dollar invested
Net Income
Average Total Assets

26. Return on Equity Net Income Average Total Equity
Indicates profitability of common stockholders’ investment
Net Income
Average Total Equity

27. Market Value Ratios WHO CARES? Deals with market value of stock. .
Stockholder’s

28. Earnings Per Share (EPS)
Indicates net income earned on each share of common stock sales
Net Income
Shares Outstanding

29. Price Earnings Ratio Stock Price Earnings Per Share
Indicates relationship between market price per share and earnings per share
Stock Price
Earnings Per Share

30. Payout Ratio Dividends Net Income
Indicates % of earnings distributed in the form of cash dividends
Dividends
Net Income

31. Addition to Retained Earnings
Retention Ratio
Indicates % of earnings plowed back into the corporation.
Addition to Retained Earnings
Net Income

32. 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.