Download - Chapter-3- Firm's Financial Perform Ace
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Why Do We Analyze Financial Statements?
A firms financial statements can be analyzed
internally (by employees, managers) and
externally (by bankers, investors, customers,
and other interested parties).
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Why Do We Analyze Financial Statements?
(cont.) An internal financial analysis might be done:
To evaluate the performance of employees and determine their pay
raises and bonuses.
To compare the financial performance of the firms different
divisions.
To prepare financial projections, such as those associated with the
launch of a new product.
To evaluate the firms financial performance in light of its
competitors and determine how the firm might improve its
operations.
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Why Do We Analyze Financial Statements?
(cont.) A variety of firms and individuals that have an
economic interest might also undertake an
external financial analysis: Banks and other lenders deciding whether to loan
money to the firm.
Suppliers who are considering whether to grant credit
to the firm.
Credit-rating agencies trying to determine the firms
creditworthiness.
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Why Do We Analyze Financial Statements?
(cont.) Professional analysts who work for investment
companies considering investing in the firm or
advising others about investing.
Individual investors deciding whether to invest
in the firm.
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Using Financial Ratios
Financial ratios provide a second method for standardizing
the financial information on the income statement and
balance sheet.
A ratio by itself may have no meaning. Hence, a given ratiois compared to: (a) ratios from previous years; or (b) ratiosof other firms in the same industry.
If the differences in the ratios are significant, more in-depth
analysis must be done.
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Using Financial Ratios (cont.)
Question Category of Ratios Used
1. How liquid is the firm? Will it beable to pay its bills as theybecome due?
Liquidity ratios
2. How has the firm financed thepurchase of its assets?
Capital structure ratios
3. How efficient has the firmsmanagement been in utilizing itassets to generate sales?
Asset management efficiencyratios
4. Has the firm earned adequatereturns on its investments? Profitability ratios
5. Are the firms managers creatingvalue for shareholders?
Market value ratios
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Liquidity Ratios
Liquidity ratios address a basic question: How
liquid is the firm?
A firm is financially liquid if it is able to pay its
bills on time. We can analyze a firms liquidity
from two perspectives:
Overall or general firm liquidity
Liquidity of specific current asset accounts
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Liquidity Ratios (cont.)
Overall liquidity is analyzed by comparing the
firms current assets to the firms current
liabilities.
Liquidity of specific assets is analyzed by
examining the timeliness in which the firms
primary liquid assets accounts receivable andinventories are converted into cash.
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Liquidity Ratios: Current Ratio
The overall liquidity of a firm is analyzed bycomputing the current ratio and acid-test ratio.
Current Ratio: Current Ratio compares a firmscurrent (liquid) assets to its current (short-term)liabilities.
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Liquidity Ratios: Quick Ratio
The overall liquidity of a firm is also analyzed by
computing the Acid-Test (Quick) Ratio. This ratio
excludes the inventory from current assets as
inventory may not always be very liquid.
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Liquidity Ratios: Accounts Receivable
Average Collection Period measures the
number of days it takes the firm to collects its
receivables.
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Liquidity Ratios: Accounts Receivable
Turnover Ratio Accounts Receivable Turnover Ratio measures
how many times accounts receivable are rolled
over during a year.
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Liquidity Ratios:
Inventory Turnover Ratio
Inventory turnover ratio measures how many
times the company turns over its inventory
during the year. Shorter inventory cycles lead to
greater liquidity since the items in inventory are
converted to cash more quickly.
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Liquidity Ratios:
Days Sales in Inventory We can express the inventory turnover ratio in terms of the
number of days the inventory sits unsold on the firms
shelves.
Days Sales in Inventory= 365 inventory turnover ratio
= 365 8.63 = 42.29 days
The firm, on average, holds it inventory for about 42 days.
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Checkpoint 4.1