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Financial Statement Analysis: Financial Management-Tenth Edition

This chapter discusses financial statement analysis using financial ratios. It aims to show how ratios can provide useful information from financial statements by highlighting a company's financial condition, strengths, and weaknesses over time or compared to competitors. The chapter outlines the four main dimensions analyzed through ratios: liquidity, leverage, activity, and profitability. It also lists various types of financial ratios and their calculations. Finally, it notes that ratio analysis provides clues to investigate managerial issues but requires careful interpretation due to accounting adjustments and policies.

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32 views

Financial Statement Analysis: Financial Management-Tenth Edition

This chapter discusses financial statement analysis using financial ratios. It aims to show how ratios can provide useful information from financial statements by highlighting a company's financial condition, strengths, and weaknesses over time or compared to competitors. The chapter outlines the four main dimensions analyzed through ratios: liquidity, leverage, activity, and profitability. It also lists various types of financial ratios and their calculations. Finally, it notes that ratio analysis provides clues to investigate managerial issues but requires careful interpretation due to accounting adjustments and policies.

Uploaded by

anon_427723504
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Financial Management-Tenth Edition

CHAPTER 25

FINANCIAL STATEMENT ANALYSIS

Chapter Objectives

• Show the use of financial ratios to get useful information from financial
statements
• Recognize the diagnostic role of financial ratios
• Highlight the utility of financial ratios in credit analysis and competitive analysis
as well as in determining the financial capability of the firm
• Understand the limitations of financial ratios

Chapter At A Glance

• A financial ratio is a relationship between two financial variables. It helps to


ascertain the financial condition of a firm.

• Ratio analysis is a process of identifying the financial strengths and weaknesses of


the firm. This may be accomplished either through a trend analysis of the firm’s
ratios over a period of time or through a comparison of the firm’s ratios with its
nearest competitors and with the industry averages.

• The four most important financial dimensions, which a firm would like to analyse,
are: liquidity, leverage, activity and profitability.

• Liquidity ratios measure the firm’s ability to meet current obligations, and are
calculated by establishing relationships between current assets and current
liabilities.
Financial Management-Tenth Edition

• Leverage ratios measure the proportion of outsiders’ capital in financing the


firm’s assets, and are calculated by establishing relationships between borrowed
capital and equity capital.

• Activity ratios reflect the firm’s efficiency in utilizing its assets in generating
sales, and are calculated by establishing relationships between sales and assets.

• Profitability ratios measure the overall performance of the firm by determining


the effectiveness of the firm in generating profit, and are calculated by
establishing relationships between profit figures on the one hand, and sales and
assets on the other.

• Ratio analysis is a very useful tool to raise relevant questions on a number of


managerial issues. It provides clues to investigate those issues in detail.

• However, caution needs to be applied while interpreting ratios as they are


calculated from the accounting numbers. Accounting numbers suffer from
accounting policy changes, arbitrary allocation procedures and inflation.
Financial Management-Tenth Edition

Summary of Ratios
Financial Management-Tenth Edition

Key Concepts

Activity ratios Financial analysis Operating leverage


Aging schedule Financial gearing or Payout ratio
Assets turnover leverage Price-earnings ratio
Bonus shares Financial risk Pro forma analysis
Cash ratio Fixed-charges Profitability ratios
Collection period coverage Quick ratio
Common-size statement Gross profit margin Replacement costs
Contingent liabilities Industry analysis Retention ratio
Cross-sectional ratio Interest coverage Return on capital
analysis Interest tax shield employed (ROCE)
Current ratio Inter-firm analysis Return on equity (ROE)
Debt ratio Interval measure Return on investment
Debt-equity ratio Inventory holding period (ROI)
Debtors turnover Inventory profit Return on net assets
Debt–trap Inventory turnover (RONA)
Discriminant analysis Lease Rights shares
Dividend yield Leverage factor Short-term solvency
DuPont analysis Leverage ratios Time series ratio
Earnings power Liquidity ratios analysis
earnings yield Long-term solvency Tobin’s q
Earnings–price ratio Net profit margin Trading on equity
Ex-bonus price Net working capital Vertical analysis
Ex-rights price ratio Z-score

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