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Introduction To Accounting: Financial Statements Analysis

The document discusses ratio analysis and different types of financial ratios used to analyze a firm's financial condition and performance. Ratio analysis involves calculating and interpreting ratios to assess a firm over time and compare to other firms. There are several types of ratios that measure liquidity, activity, leverage/debt, profitability, and market value. Common ratios analyzed include current ratio, debt ratio, net profit margin, return on assets, and price-to-earnings ratio. Ratio analysis is useful for shareholders, creditors, and management to evaluate the firm's financial health.

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27 views

Introduction To Accounting: Financial Statements Analysis

The document discusses ratio analysis and different types of financial ratios used to analyze a firm's financial condition and performance. Ratio analysis involves calculating and interpreting ratios to assess a firm over time and compare to other firms. There are several types of ratios that measure liquidity, activity, leverage/debt, profitability, and market value. Common ratios analyzed include current ratio, debt ratio, net profit margin, return on assets, and price-to-earnings ratio. Ratio analysis is useful for shareholders, creditors, and management to evaluate the firm's financial health.

Uploaded by

Faizal Abdullah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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INTRODUCTION TO

ACCOUNTING

financial statements analysis


Basic Financial Analysis
 Ratio analysis involves methods
of calculating and interpreting
financial ratios to assess a firm’s
financial condition and
performance.
 It is of interest to shareholders,
creditors, and the firm’s own
management
BASIC FINANCIAL ANALYSIS
 Ratio analysis involves methods of calculating and
interpreting financial ratios to assess a firm’s
financial condition and performance.
 It is of interest to shareholders, creditors, and the
firm’s own management
Using Financial Ratios:
Types of Ratio Comparisons
 Trend or time-series analysis
 Used to evaluate a firm’s performance
over time

 Cross-sectional analysis
 Used to compare different firms at the same point in
time
Using Financial Ratios:
Types of Ratio Comparisons (cont.)
 Cross-sectional analysis
 Industry comparative analysis
 One specific type of cross sectional analysis. Used to compare
one firm’s financial performance to the industry’s average
performance
 Benchmarking
 A type of cross sectional analysis in which the firm’s ratio values
are compared to those of a key competitor or group of
competitors that it wishes to emulate
Using Financial Ratios:
Types of Ratio Comparisons (cont.)
 Trend or time-series analysis
 Cross-sectional analysis
 Combined Analysis
 Combined analysis simply uses a combination of both
time series analysis and cross-sectional analysis
Ratio Analysis
 Liquidity Ratios – measures capacity to meet short
term obligation
 Activity Ratios – measures effective use of resources
 Leverage (gearing) Ratios – measures indebtness
 Profitability Ratios – measures overall profitability
 Market Ratios – measures based on market price of
shares - important to investors
LIQUIDITY RATIOS
 Current Ratio – measures firm’s ability to meet its short-
term obligation
 The higher the ratio, the more liquid the firm is.
 A current ratio of 2.0 is occasionally acceptable
 Quick (acid-test) Ratio – similar to current ratio but
excludes inventory
 A quick ratio of 1.0 or greater is occasionally recommended
– but depends on the industry
ACTIVITY RATIOS

 Inventory Ratio – measures the activity/liquidity of a firm’s inventory


 The higher the better but only meaningful if compared with other firms in the same industry (20 for
grocery store, 4 for aircraft manufacturer)
 Average Collection Period – average amount of time needed to collect accounts receivable
 Meaningful only in relation to the firm’s credit terms (credit-terms 30 days and average collection
period 60days – poorly managed credit)
 Average Payment Period – average amount of time needed to pay accounts payable
 Meaningful only in relation to the average credit terms extended to the firm (credit terms 30 days,
average payment period 90 days – low credit rating)
 Total Asset Turnover – indicates the efficiency with which the firm uses its assets to generate
sales
 Generally, the higher the firm’s total asset turnover, the more efficiently its assets have been used
DEBT RATIO

 Debt Ratio – measures the proportion of total assets financed by the firm’s creditors
 The higher this ratio, the greater the firms’ degree of indebtedness, the more
financial leverage it has
 Times Interest Earned Ratio – measures the firms’ ability to make contractual interest
payments
 The higher the better – a value of at least 3.0 and preferably closer to 5.0 is often
suggested
 Fixed-Payment Coverage Ratio – measures the firms’ ability to meet all fixed-payment
obligations (loan interest and principal, lease payments, preferred stock dividend)
 The higher, the better. Also measures risk, the lower the ratio, the greater the risk
to both lenders and owners
PROFITABILITY RATIOS

 Gross Profit Margin – measures the percentage of each sales dollar


remaining after the firm has paid for its goods
 The higher, the better
 Operating Profit Margin – measures the percentage of each sales
dollar remaining after all costs and expenses other than interest, taxes,
and preferred stock dividends are deducted
 A higher operating profit margin is preferred
 Net Profit Margin - measures the percentage of each sales dollar
remaining after all costs and expenses including interest, taxes, and
preferred stock dividends are deducted
 The higher the firm’s net profit margin, the better
PROFITABILITY RATIOS (cont’d)

 Earnings per share (EPS) – represents the dollar amount earned on


behalf of each outstanding share of common stock
 The higher, the better
 Return on Total Assets (ROA) – measures the overall effectiveness of
management in generating profits with its available assets – return on
investment
 The higher, the better
 Return on Common Equity (ROE) – measures the return earned on the
common stockholders’ investment in the firm
 The higher, the better
MARKET RATIOS

 Price/Earnings (P/E) Ratio – measures the amount that


investors are willing to pay for each dollar of a firm’s
earnings
 Indicates the degree of confidence that investors have in the firm’s
future performance (the higher, the greater the confidence)
 Market/Book (M/B) Ratio – provides an assessment of how
investors view the firm’s performance
 Performing stocks – higher M/B ratios
Summarizing All Ratios
Table 2.8 Summary of Bartlett Company Ratios
(2007–2009, Including 2009 Industry Averages)
2-14
Summarizing All Ratios (cont.)
Table 2.8 Summary of Bartlett Company Ratios
(2007–2009, Including 2009 Industry Averages)
2-15

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