Chapter Thirteen

Financial Statement Analysis

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Horizontal Analysis

Horizontal analysis (or trend analysis) refers to studying the behavior of

individual financial statement items over several accounting periods.

Absolute Amounts

Percentage Analysis

13-2

13-3

Vertical Analysis of Income Statement

In income statements, all

items are usually

expressed as a percentage of

sales.

In balance sheets, all items are usually

expressed as a percentage of total assets.

Liquidity Ratios

Liquidity ratios indicate a company’s ability to pay short-

term debts. They focus on current assets and current

liabilities.

1. Working Capital

2. Current Ratio

3. Quick Ratio

4. Accounts Receivable Ratios

5. Inventory Ratios13-4

Current Ratio

The current ratio measures a company’s short-term debt

paying ability.

A declining ratio may be a sign of deteriorating

financial condition, or it might result from eliminating

obsolete inventories.

CurrentRatio

Current Assets Current Liabilities

=

13-5

Quick (Acid-Test) Ratio

Quick Assets Current Liabilities

=Acid-Test

Ratio

Quick assets include Cash,Current Marketable Securities, and

Accounts Receivable. This ratio measures a company’s ability

to meet obligations without having to liquidate inventory.

13-6

Accounts Receivable Turnover

Net Credit Sales Average Accounts Receivable

Accounts ReceivableTurnover

=

This ratio measures how many times a company converts its

receivables into cash each year.

13-7

Inventory Turnover

Cost of Goods Sold Average Inventory

InventoryTurnover

=

This ratio measures how many times a company’s inventory has been sold

and replaced during the year.

13-8

Solvency Ratios

Solvency ratios are used to analyze a company’s long-term debt-

paying ability and its financing structure.

1. Debt to Assets Ratio

2. Debt to Equity Ratio

3. Number of Times Interest Earned

4. Plant Assets to Long-Term Liabilities

13-9

Debt to Assets Ratio

This ratio measures the percentage of a company’s assets that are financed by

debt.

Total Liabilities Total Assets

Debt to Assets Ratio

=

13-10

Debt to Equity Ratio

This ratio indicates the relative proportions of debt to equity on a

company’s balance sheet.

Stockholders like a lot of debt if the company can

take advantage of positive financial

leverage.

Total Liabilities Stockholders’ Equity

Debt to Equity Ratio

=

Creditors prefer less debt and more equity

because equity represents a buffer of

protection.

13-11

Profitability Ratios

Profitability ratios measure a company’s ability to generate

earnings.

1. Net Margin (or Return on Sales)

2. Asset Turnover Ratio

3. Return on Investment

4. Return on Equity

13-12

Net Margin

This measure describes the percent remaining of each sales dollar after

subtracting other expenses as well as cost of goods sold.

Net Margin

Net Income Net Sales

=

13-13

Return on Investment (ROI) and Return on Equity

This is the ratio of wealth generated (net income) to the amount invested (average total assets).

Return on

Investment

Net Income

Average Total Assets=

13-14

Return on Equity

Net IncomeAverage Total Stockholders’

Equity

=

This measure is often used to measure the profitability of the stockholders’ investment.

Stock Market Ratios

Stock market ratios analyze the earnings and dividends of a

company.

1. Earnings Per Share

2. Book Value per Share

3. Price-Earnings (PE) Ratio

4. Dividend Yield

13-15

Earnings Per Share Ratio and Price-Earnings Ratio

Earnings per

Share

Net Earnings Available for Common Stock Average Number of Outstanding Common

Shares

=

This measure indicates how much income was earned for each share of common stock outstanding.

13-16

Price-EarningsRatio

Market Price Per Share Earnings Per Share

=

This ratio compares the earnings of a company to the market price for a share of the company’s stock.