Financial Statement Analysis (Reviewer)

• Looks at the percentage distribution of the components of some financial aggregate, to detect structural differences

  Common size analysis
• for balance sheet, common size analysis involves expressing each balance sheet item as a percentage of total assets
• for income statement, common size analysis involves expressing each income statement item as a percentage of net sales
• the technique of establishing relationships between and among two or more items presented in the financial statements has proven to be a powerful and informative analytical device

  ratio analysis
• measures the ability of a company to generate income on its investments in excess of costs incurred

  Profitability ratios
• Profitability Ratios

  • Gross Profit Margin
  • Operating Profit margin
  • Net Profit Margin
  • Return on Assets
  • Return on Equity
• measures profitability by comparing its gross profit to its net sales and understanding what it left after COGS

  Gross profit margin
• Gross Profit Margin = Gross Profit / Sales
• measures, as a percentage of sales, the excess of revenues from sales over cost of normal operations excluding financing

  Operating Profit Margin
• Operating Profit Margin = Operating Profit / Sales
• measures, as a percentage of sales, the excess of all revenues over all costs

  Net Profit Margin
• Net Profit Margin = Net Income / Sales
• measures the rate of return bases on the total investments of the company, prior to consideration of the cost of the company's financing policies

  Return on Asset
• Return on Asset = Operating income / Average Total Assets
• measures the rate of return on the investment of common stockholders in the company

  Return on Equity
• Return on Equity = Net Income / Average Stockholders' Equity
• Measures the ability of a company to maximize output given a certain level of inputs. They are indicators of asset, investment and cost management and are of primary interest to owners and managers

  Operating Efficiency Ratios
• Operating Efficiency Ratios


  • Inventory Turnover
  • Average Age of Inventory
  • Accounts Receivable Turnover
  • Average Age of Receivables
  • Asset Turnover
  • Fixed Asset Turnover
• measures the number of times a company is able to move ts inventory during a year

  Inventory Turnover
• Inventory Turnover = Cost of Goods Sold / Average Inventories
• Average Inventories = (Beginning Inventory + Ending Inventory) / 2
• Average Age of Inventory = 360 (365) / Inventory Turnover
• measures the average number of days a company's inventory is in the warehouse or on the shelves before they are sold

  Average Age of Inventory
• measures the number of times during the year the company's receivable was collected

  Accounts Receivable Turnover
• Accounts Receivable Turnover = Credit Sales / Average Accounts Receivable
• Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
• measures the average number of days that it takes a company to collect its accounts receivables

  Average Age of Accounts Receivables
• significant since investment in fixed assets generally involve large amounts and are not easily reversible

  Fixed Asset Turnover
• Fixed Asset Turnover = Sales / Average Investment in Fixed Assets
• Average Age of Accounts Receivables = 360 (365) / Accounts Receivable Turnover
• an indicator of how well the company's assets are being utilized to generate sales for the company

  Asset Turnover
• Asset Turnover = Sales / Average Total Assets
• Financial policy measures to highlight the fact that these ratios are influenced to a large extent by financial policies adopted by management

  Financial Leverage Ratios
• indicates the extent of non-owner claims on the firm's profits and assets as well as the firm's operating capability to meet its interest obligations

  Financial Leverage Ratios
• Why Leverage Ratios are closely monitored

  • claims of creditors on profits and assets should take precedence over claims of common shareholders
  • claims of creditors are largely fixed obligations. They have to be paid regardless of the financial performance of the firm
  • Loan covenants usually make it costly for firms to default on their loan obligations
• measures the extent to which earnings "cover" the interest obligations of the company

  Interest Coverage Ratio
• Interest Coverage = Operating Income / Annual Interest Expense
• Debt Ratio = Total Liabilities / Total Assets
• Equity Ratio = Total Equity / Total Assets
• a profitable company will generally be able to meet its debt and other fixed obligations. Profits however, is non cash and a firm may still encounter difficulties if its cash or near cash resources are inadequate in the period when such obligations become due.