04 IFSA

• Types of ratios


  • Liquidity ratios
  • Borrowing capacity (leverage) ratios
  • Profitability ratios
  • Cash flow ratios
• Liquidity ratios


  Measures a firm's ability to meet its current obligations
• Borrowing capacity (leverage) ratios


  Measures the degree of protection for long-term creditors
• Profitability ratios


  Measures the earning ability of a firm
• Ratio analysis must be interpreted in comparison with prior ratios, competitor's ratios, industry ratios, and predetermined standards
• Trend and variability of a ratio are important considerations in ratio analysis
• Use of average data from balance sheet is necessary when comparing with income statement data, but does not eliminate seasonal or cyclical variations or reflect changes that occur unevenly throughout the year
• Ratio analysis must be performed and understood within the context of native accounting principles and native business practices and culture
• Vertical analysis


  All amounts of a year expressed as a percentage of a base amount of the same year (e.g., net sales revenue, total assets)
• Horizontal analysis


  Amounts for comparative years are expressed as a percentage of the base year amount
• The use of percentages is usually preferable to the use of absolute amounts in common-size analysis
• Exhibit 5-1: Melcher Company—Vertical Common Size


  • Each financial statement element is presented as a percentage of a designated base which is sales revenue on the income statement
• Exhibit 5-1: Melcher Company—Horizontal Common Size


  • Each financial statement element is presented as a percentage of a base amount from a selected year
• Year-to-year change analysis


  Use both absolute and percentages, following guidelines for meaningful percent changes
• Financial components that vary by type of industry

  • Merchandising (inventory as principal asset, sales for cash or on credit)
  • Service (low or no inventory)
  • Manufacturing (large inventory holdings, substantial investment in plant assets, cost of sales as major expense)
• Descriptive information


  Narrative data (annual report, trade periodicals, industry reviews) that further explains the financial position of a firm, including Management Discussion and Analysis (MD&A) overview

  
• Types of comparisons


  • Trend analysis
  • Standard Industrial Classification (SIC) Manual
  • North American Industry Classification System (NAICS)
  • Industry Averages and Comparison with Competitors
• Trend analysis


  A study of the financial history of a firm, revealing whether a ratio is falling, rising, or relatively constant
• SIC


  Classifies business by industry, defining industries in accordance with the composition and structure of the economy, with a coding structure of two-digit major group number, three-digit industry group number, and four-digit industry number
• NAICS


  Jointly created by the U.S., Canada, and Mexico, defining industry by similar production processes, with the U.S. Census Bureau providing a website with details
• Industry comparison is complicated by highly diversified companies, with financial services basing their analysis on industry placement and providing composite industry data
• Financial services publications


  • The Department of Commerce Financial Report
  • Annual Statement Studies
  • Standard & Poor's Industry Surveys
  • Almanac of Business and Industrial Financial Ratios
  • Industry Norms and Key Business Ratios
  • Value Line Investment Survey
• Ratios are subject to variance from differing data, inconsistent formula construction, optional accounting treatment, different fiscal year-ends, varying financial policies, and inconsistent basis (before or after tax)
• Relative size of firm

  Comparison of disparate size firms is complicated by capital market access, economy of scale, and wider customer base, with common-size analysis and percent of market helping to define relative size
• Factors that can cause variance in ratios

  • Differing data
  • Inconsistent formula construction
  • Optional (elective) accounting treatment
  • Different fiscal year-ends
  • Varying financial policies
  • Inconsistent basis (before or after tax)
• Caution is needed when using industry averages for comparisons
• Comparison of disparate size firms

  • Capital market access
  • Economy of scale (purchasing)
  • Wider customer base
• Common-size analysis


  Helps to eliminate some of the difficulty in comparing absolute numbers
• Percent of market helps to define relative size
• Ward's Business Directory


  • Covers domestic private and public companies
  • Up to 20 items of information are provided for each company listed
  • Went digital in 2007 under Gale Directory Library
• Standard & Poor's Stock Reports

  • Companies listed on various stock exchanges
  • Arranged Alphabetically by stock exchanges
  • Contains brief analysis of companies regularly traded
• Standard & Poor's Register Of Corp., Directors, And Executives

  • Volume 1 contains an alphabetical list of approximately 75,000 corporations
  • Volume 2 contains an alphabetical list of over 70,000 individuals serving as officers, directors, trustees, partners, and so on
• Standard & Poor's Analyst's Handbook

  • Contains selected income statement and balance sheet items
  • Related ratios
  • Applicable to Standard & Poor's industry group stock price indexes
  • Brief monthly updates for selected industries supplement the annual editions
• Standard & Poor's Standard Corporation Descriptions

  • Provides background information and detailed financial statistics on U.S. corporations
  • The contents and the index are updated throughout the year

  
• Standard & Poor's Security Owner's Stock Guide

  • Covers 5,300 common and preferred stocks
  • Contains trading activity, price range, dividends, and so on, for companies traded on various exchanges
• Standard & Poor's Statistical Service

  • Provides industry statistics on industries such as agriculture, metals, building, transportation
  • Includes additional statistics such as price indexes and daily highs, lows, and closes for stock
• Standard & Poor's Net Advantage

  • Available at many academic, public, and corporate libraries, and information centers
  • Provides access to other Standard & Poor's publications
• Mergent and Standard & Poor's Dividend Record

  • Provides a dividend record of payments on virtually all publicly owned American and some foreign companies
• D&B® Million Dollar Directory®

  • Companies must meet at least one of two inclusion requirements: $9 million or more in sales volume, or 180 or more employees if company is a headquarters single location, 900 or more if employees if company is a branch
  • Company listings in Volumes: Alphabetical, Geographically, SIC
• Directory Of Corporate Affiliates

  • Gives an in-depth view of companies and their divisions, subsidiaries, and affiliates
  • Contains an alphabetical index, geographical index, and SIC classifications
  • Provides information on the parent company such as address, telephone number, stock ticker symbol, stock exchange(s), approximate sales, number of employees, type of business, and top corporate officers