Chapter 13 Financial Statement Analysis. Limitations and Considerations in Financial Statement...
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Transcript of Chapter 13 Financial Statement Analysis. Limitations and Considerations in Financial Statement...
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Chapter 13
Financial Statement Analysis
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Limitations and Considerations inFinancial Statement Analysis
Watch for alternative accounting principles Selection of a inventory valuation method Changes in accounting method
Take care when making comparisons Recognizing trends in ratios Extra caution for extraordinary items and gains and
losses from discontinued operations
LO 1
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Limitations and Considerations inFinancial Statement Analysis (continued)
Understand the possible effects of inflation Financial statements are based on historical costs
and are not adjusted for the effects of increasing prices
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Analysis of Comparative Statements:Horizontal Analysis
Comparison of financial statement items over a period of time
LO 2
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Example 13.1—Preparing and Reading Comparative Balance Sheets—Horizontal Analysis
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Example 13.2—Preparing and Reading Comparative Statements of Income and Retained Earnings—Horizontal Analysis
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Example 13.3—Preparing and Reading Comparative Statements of Cash Flows—Horizontal Analysis
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Analysis of Common-Size Statements:Vertical Analysis
Comparison of various financial statement items within a single period with the use of common-size statements
Common-size statements recast items as a percentage of a selected item
LO 3
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Example 13.4—Preparing and Reading Common-Size Balance Sheets—Vertical Analysis
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Example 13.5—Preparing and Reading Common-Size Income Statements—Vertical Analysis
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Liquidity Analysis
A relative measure of the nearness to cash of the assets and liabilities of a company
LO 4
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Working Capital
The excess of current assets over current liabilities at a point in time
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Current Ratio
The ratio of current assets to current liabilities One of the most widely used financial statement
ratios
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Acid-Test Ratio
A stricter test of liquidity than the current ratio Excludes inventory and prepayments from the
numerator
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Cash Flow from Operations to Current Liabilities
A measure of the ability to pay current debts from operating cash flows
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Accounts Receivable Analysis Accounts receivable turnover ratio: a measure of the
number of times accounts receivable are collected in a period
Number of days’ sales in receivables: a measure of the average age of accounts receivable
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Inventory Analysis
Inventory turnover ratio: a measure of the number of times inventory is sold during a period
Number of days’ sales in inventory: a measure of how long it takes to sell inventory
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Cash-to-Cash Operating Cycle
The length of time from the purchase of inventory to the collection of any receivable from the sale
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Solvency Analysis
The ability of a company to remain in business over the long term The ability of the firm to stay financially healthy over
the period of time that existing debt (short- and long-term) is outstanding
LO 5
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Debt-to-Equity Ratio
The ratio of total liabilities to total stockholders’ equity
The composition of debt and equity is an important determinant of the cost of capital to a company
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Times Interest Earned Ratio
Indicates the company’s ability to meet the current year’s interest payments out of the current year’s earnings
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Debt Service Coverage Ratio
Measure of the amount of cash that is generated from operating activities during the year and that is available to repay interest due and any maturing principal amounts
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Cash Flow from Operations to CapitalExpenditures Ratio
A measure of the ability of a company to finance long-term asset acquisitions with cash from operations
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Profitability Analysis
How well management is using company resources to earn a return on the funds invested by various groups
Two frequently used profitability measures:
=
Gross Profit RatioGross Profit
=Net Sales
LO 6
Profit Margin RatioNet Income
=Net Sales
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Rate of Return on Assets
A measure of a company’s success in earning a return for all providers of capital
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Components of Return on Assets
Return on sales ratio: a variation of the profit margin ratio Measures earnings before payments to creditors
Asset turnover ratio: the relationship between net sales and average total assets
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Return on Common Stockholders’ Equity Ratio
A measure of a company’s success in earning a return for the common stockholders
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Leverage
The use of borrowed funds and amounts contributed by preferred stockholders to earn an overall return higher than the cost of these funds
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Earnings per Share
A company’s bottom line stated on a per-share basis
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Price/Earnings Ratio
The relationship between a company’s performance according to the income statement and its performance in the stock market
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Dividend Ratios
Dividend payout ratio: the percentage of earnings paid out as dividends
Dividend yield ratio: the relationship between dividend and the market price of a company’s stock
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Reporting and Analyzing Other Income Statement Items
Each of these items is shown net of their tax effects Discontinued operations Extraordinary items
Reported near the end of the income statement, after income from continuing operations
Reported separately to call the reader’s attention to their unique nature
LO 7
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Discontinued Operations
Reflect any gains or losses from the disposal of a segment Also, reflect any net income or loss from operating
that segment
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Extraordinary Items
Reflect any gains or losses that arise from an event that is both unusual in nature and infrequent in occurrence
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End of Chapter 13