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Chapter 3

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Outline

What is financial analysis

4 categories of financial ratios

techniques of ratio analysis

distortion in financial reporting

summary and conclusions

Learning Objectives

1. Calculate 13 financial ratios that measure profitability, asset

utilization, liquidity and debt utilization

2. Assess a company’s source of profitability using the DuPont system

of analysis

3. Examine the ratios in comparison to industry averages

4. Examine the ratios and company performance by means of trend

analysis

5. Interpret ratios and identify corrective action for abnormal results

6. Identify sources of distortion in reported income

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Notes 01/27/2016

LO 1:

Ratio Analysis

What is Financial Analysis?

Financial Ratios are used to

oWeigh and evaluate the operating performance of the firm

now and in the past

oJudge comparative performance between firms

oDetermine relative as opposed to absolute performance

Calculating ratios to reveal relationships between different accounts

of financial statements, and to measure and judges acceptability in

relation to other values.

Should be supplemented with an evaluation of company

management, physical facilities, and other factors.

Linking ratios to reveal the factors determining a firms profitability

and value. We often use ratios of the past financial performance to

determine our expectations regarding the firms future success.

Financial analysis may not answer questions, but leads to further

inquiry

Techniques of Ratio Analysis

DuPont Analysis

Comparative Analysis

Trend Analysis

Common-Size Statements

Ratios for Comparative Purposes

Comparative ratios are available from many sources, usually for a

fee, these include;

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oD&B: data on 1.5 million different Canadian business.

“industry Norms and Key Business Ratios”

oRobert Morris: data on over 100,000 commercial bank

borrowers, 600 categories

oFinancial Post DataGroup: SIC, publicly traded companies,

industry reports in 24, S&P, GICS (global industry

classification standard)

oStatistics Canada: ratios for major industry groups in

“Financial Performance Indicators for Canadian Business” also

available at Regional Reference Centers

oIndustry Association: i.e. the Canadian Association of

Broadcasters

Classification System of Financial Ratios

A. Profitability Ratios

B. Asset Utilization Ratios

C. Liquidity Ratios

D. Debt Utilization Ratios

A. Profitability Ratios

1. A. Profit Margin

1. B. Gross Profit Margin

2. Return on Assets (ROA) (investment ROI)

3. Return on Equity (ROE) (common shareholders)

Shows how profitable a company is and the efficiency or

performance of the firm

Measure return (profit) on sales, total assets, and shareholders

capital

Examine the effective employment of resources

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