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Chapter 2.4

chapter 2.4

Financial Accounting
Course Code
Liang Chen

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Chapter 2
Using the Financial Statements
Ratio analysis expresses the relationships between selected items of financial statement data: Liquidity,
profitability and solvency ratios. There are three comparisons that use ratios: intracompany (same over
a period time), intercompany (between competitors of the same industry), and industry average
(between industries).
Using the Statement of Earnings
Profitability ratios measure a company[s earnings or operating success for a given period of time.
Earnings per share measures the net earnings for each common share. It is calculated by taking the net
earnings available to common shareholders/weighted average number of common shares.
Price-Earnings Ratio is frequently used to measure the ratio of the stock market price of each common
share to its earnings per share. It is calculated by dividing the market price per share by earnings per
share. The price-earnings ratio shows what investors expect of a company[s future earnings.
Liquidity ratios measure the short-term ability of a company to pay its maturing obligations and to meet
unexpected needs for cash.
Working capital, which is the difference between current assets and current liabilities, is a measure of
liquidity. When working capital is positive, there is a greater likelihood that a company will pay its
Current ratio is calculated by dividing current assets and current abilities.
Solvency ratios measure a company[s ability to survive over a period of time. The debt to total assets
ratio is one source of information about debt-paying ability.
The debt to total assets measures the percentage of assets that are financed by creditors rather than by
shareholders. Debt to total assets ratio is calculated by dividing total debt (both current and long-term)
by total assets. The higher the percentage of debt to total assets, the greater the risk that the company
may be unable to pay its debts as they come due.
Using the Cash Flow Statement
Cash flow statement reports the cash effects of a company[s operating activities, investing activities, and
financing activities.
Free Cash flow is calculated by deducting net capital expenditures and dividends from cash provided by
operation activities. Net capital expenditures t representing amounts paid for the acquisition of
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