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RSM220H1 (54)
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lec 5 - Ratio Analysis - Worksheet-2.docx

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Rotman Commerce
Xin Baohua

RSM22014S Financial Accounting TOPIC 5 WORKSHEET FINANCIAL ANALYSIS TECHNIQUES RATIO ANALYSISLEARNING GOALS LGAfter this unit you should be able to1Explain the usefulness and limitations of the tools and techniques used in financial analysis 2Perform basic horizontal and vertical commonsize ratio analyses and interpret the results3Calculate and interpret activity liquidity solvency profitability and valuation ratios 4Evaluate the organization using ratio analysis LG1 EXPLAIN THE USEFULNESS AND LIMITATIONS OF THE TOOLS AND TECHNIQUES USED IN FINANCIAL ANALYSISKEY POINTS TO KNOW1Financial analysis is ultimately contextual and purposedriven In other words there is always a reason why you are performing the analysis You need to be clear about the objective of the analysis 2The tools and techniques that you use will depend on your purpose As we discussed earlier analyzing the company as an investment opportunity which generally focuses on indicators of profitability of growth is often different from analyzing the company from the perspective of a credit lend or not decision which generally focuses on indicators of risk liquidity and solvency 3Financial analysis will seldom provide an answer to your objective or starting question eg invest or not lend or not The usefulness of financial analysis is to provide valuable insights and additional questions to ask in arriving at a particular decision Each individual ratio is a basic indicator but it does not by itself provide an explanation of why something happened To get the most value out of financial analysis you need to understand how these ratios relate to one another and to the business model and industry of the company you are analyzing This requires experience4There is no single authoritative source providing rules about how particular ratios are calculated While there are standards of practice that we will follow there is also significant variation between how practitioners calculate and interpret particular ratios This primarily relates the points 1 and 2 above The ratios we will discuss are a starting point Any advanced application of them could include adjustments and modification LG2 PERFORM BASIC HORIZONTAL AND VERTICAL COMMONSIZE RATIO ANALYSES AND INTERPRET THE RESULTSKEY POINTS TO KNOW1Commonsize analysis removes the effect of company size and provides another lens when analyzing one company over time or multiple companies for the same periods 2Horizontal analysis shows the change in particular financial statement items over time Therefore it shows a change from one period to another It is calculated as Period2Period 1Period1 For example PotashCorp cash balance increased to 628m in 2013 from 562m in 2012 Thereforechange is calculated as 628m562m562m123Vertical analysis shows the relative value of a particular financial statement items with reference to the total balance On the income statement this generally means presenting all items with reference to revenues eg SGARevenues or 3 in case of PotashCorp in 2013 On the balancesheet this generally means representing all items with reference to total assets eg CashTotal Assets or 3 in case of PotashCorp in 2013 Page12014 Dragan Stojanovic
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