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BUSI 1003 (12)
Chapter 9

Chapter 9

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BUSI 1003
Patti Proulx

Chapter 9 - Financial Statement Analysis Companies Financial Statements are analyzed using a the following methods: 1. Horizontal analysis 2. Vertical Analysis 3. Common-sized statements Horizontal Analysis ● Each item on the most recent statement is compared with the related item on one or more earlier statements in terms of the following: ○ Amount of increase or decrease ○ Percent of increase or decrease ● When comparing statements, the earlier statement is normally used as the base for computing increases and decreases Vertical Analysis ● The percentage analysis of the relationship of each component in a financial statement to a total with a statement ● Applied only to a single statement ● The percentages for vertical analysis of a balance sheet are computed as follows: ○ Each asset item is stated as a percent of total assets ○ Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity ● In vertical analysis of an income statement, each item is stated as a percent of net sales Common-Sized Statements ● All items are expressed as percentages with no dollar amounts shown ● Useful for comparing one company with another company, and comparing one company with the industry average ● Other relationships may be expressed as percentages and ratios All users of financial statements are interested in the ability of a company to do the following: 1. Maintain liquidity and solvency 2. Earn income, called profitability ● Liquidity - The ability to convert an asset into cash ● Solvency - Ability of a business to pay its debts Liquidity and Solvency are normally assessed using the following: Current Position Analysis ● A company’s ability to pay its current liabilities ● It is of particular interest to short term creditors and is analyzed using the following: a. Working Capital b. Current Ratio c. Quick Ratio Accounts Receivable Analysis ● Measures efficiency of collection ● Reflects liquidity. Analyzed using: a. Accounts Receivable Turnover b. Number of Days’ Sales in Receivables Inventory Analysis ● Measures Inventory Efficiency ● Avoid tying up funds in inventory and avoid obsolescence ● Reflects Liquidity. Analyzed using: ○ Inventory Turnover ○ Number of Days’ Sales in Inventory Ratio of Fixed Assets to Long-Term Liabilities ● Provides a measure of whether noteholders or bondholders will be paid ● Indicates the ability to borrow additional funds on a long-term basis ● Shows how many times over fixed assets can cover long-term liabilities Ratio of Liabilities to Stockholders’ Equity ● Indicates the margin of safety for creditors ● Indicates the ability to withstand adverse business conditions Number of Times Interest Charges Earned ● Indicates the the general financial strength of the business ● Indicates the ability to withstand adverse business conditions Profitability Analysis is Assessed using the Following: Ratio of Net Sales to Assets ● Shows how effectively a firm utilizes its assets Rate Earned on Total Assets ● Measures the profitability of total assets without considering how the assets are financed Rate Earned on Stockholders’ Equity ● Emphasizes the rate of income earned on the amount invested by stockholders Rate Earned o
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