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BUSN210 Week 7-8 Analysis of Financial Statement

The document provides an analysis of financial statements through various ratios categorized into liquidity, asset management, debt management, profitability, and market value. It explains key liquidity ratios such as the current ratio and quick ratio, as well as asset management ratios including inventory turnover and days sales outstanding. Additionally, it covers profitability ratios like operating margin, profit margin, return on total assets, return on common equity, and return on invested capital, which reflect the firm's financial performance and efficiency.

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4 views

BUSN210 Week 7-8 Analysis of Financial Statement

The document provides an analysis of financial statements through various ratios categorized into liquidity, asset management, debt management, profitability, and market value. It explains key liquidity ratios such as the current ratio and quick ratio, as well as asset management ratios including inventory turnover and days sales outstanding. Additionally, it covers profitability ratios like operating margin, profit margin, return on total assets, return on common equity, and return on invested capital, which reflect the firm's financial performance and efficiency.

Uploaded by

undusfakerlol
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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Analysis of

Financial
Statements
BUSN210 - WEEK 5-6
Ratios help us evaluate financial statements.
We divide the ratios into five categories:

1. Liquidity ratios, which give an idea of the firm’s ability to pay off
debts that are maturing within a year.
2. Asset management ratios, which give an idea of how efficiently the
firm is using its assets.
3. Debt management ratios, which give an idea of how the firm has
financed its assets as well as the firm’s ability to repay its long-term
debt.
4. Profitability ratios, which give an idea of how profitably the firm is
operating and utilizing its assets.
5. Market value ratios, which give an idea of what investors think about
the firm and its future prospects.
Liquidity Ratios
The liquidity ratios help answer this question: Will the firm be able to
pay off its debts as they come due and thus remain a viable
organization? If the answer is no, liquidity must be addressed.
Liquidity Ratios
Ratios that show the relationship of a firm’s cash and other current
assets to its current liabilities.
Current Ratio
Quick (Acid Test) Ratio
4-2A CURRENT RATIO
The primary liquidity ratio is the current ratio, which is calculated by
dividing current assets by current liabilities:

It indicates the extent to which current liabilities are covered by those


assets expected to be converted to cash in the near future.
Current assets include cash, marketable securities, accounts receivable,
and inventories. Current liabilities consist of accounts payable, accrued
wages and taxes, and short-term notes payable to its bank, all of which
are due within one year.
4-2B QUICK, OR ACID
TEST, RATIO
Quick (Acid Test) Ratio: This ratio is calculated by deducting inventories
from current assets and then dividing the remainder by current liabilities.
The quick ratio measures the firm’s ability to pay off short-term
obligations without relying on the sale of inventories.

Inventories are typically the least liquid of a firm’s current assets; and if
sales slow down, they might not be converted to cash as quickly as
expected. Also, inventories are the assets on which losses are most likely
to occur in the event of liquidation.
4-3 Asset
Management Ratios
The second group of ratios, the asset management ratios, measure how
effectively the firm is managing its assets. These ratios answer this
question:
◦ Does the amount of each type of asset seem reasonable, too high, or too low
in view of current and projected sales?
4-3A INVENTORY
TURNOVER RATIO
As the name implies, these ratios show how many times the particular
asset is “turned over” during the year. Here is the inventory turnover
ratio:
4-3B DAYS SALES
OUTSTANDING
Accounts receivable are evaluated by the days sales outstanding (DSO)
ratio, also called the average collection period (ACP). It is calculated by
dividing accounts receivable by the average daily sales to find how many
days’ sales are tied up in receivables. Thus, the DSO represents the average
length of time the firm must wait after making a sale before receiving cash.
Allied has 46 days’ sales outstanding, well above the 36-day industry
average:
4-3C FIXED ASSETS TURNOVER
RATIO

The fixed assets turnover ratio, which is the ratio of sales to net fixed
assets, measures how effectively the firm uses its plant and equipment:
4-3D TOTAL ASSETS
TURNOVER RATIO
The final asset management ratio, the total assets turnover ratio,
measures the turnover of all of the firm’s assets, and it is calculated by
dividing sales by total assets:
4-5 Profitability
Ratios
Accounting statements reflect events that happened in the past, but
they also provide clues about what’s really important—that is, what’s
likely to happen in the future. The liquidity, asset management, and
debt ratios covered thus far tell us something about the firm’s policies
and operations. Now we turn to the profitability ratios, which reflect
the net result of all of the firm’s financing policies and operating
decisions.
4-5A OPERATING
MARGIN
The operating margin, calculated by dividing operating income (EBIT) by
sales, gives the operating profit per dollar of sales:
Operating Margin
This ratio measures operating income, or EBIT, per dollar of sales; it is
calculated by dividing operating income by sales.
4-5B PROFIT MARGIN
The profit margin, also sometimes called the net profit margin, is
calculated by dividing net income by sales:
Profit Margin
This ratio measures net income per dollar of sales and is calculated by
dividing net income by sales.
4-5C RETURN ON
TOTAL ASSETS
Net income divided by total assets gives us the return on total assets
(ROA):
Return on Total Assets (ROA): The ratio of net income to total assets.
4-5D RETURN ON
COMMON EQUITY
Another important accounting ratio is the return on common equity
(ROE), which is found as follows:
Return on Common Equity (ROE)
The ratio of net income to common equity; measures the rate of return
on common stockholders’ investment.
4-5E RETURN ON INVESTED
CAPITAL

The return on invested capital (ROIC) measures the total return that
the company has provided for its investors:
Return on Invested Capital (ROIC)

Note: EBIT represents earnings before interest and tax


(in other words operating income) while T indicates tax rate

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