Financial Statement Analysis

Financial Statement Analysis

• Involves evaluating a company's recent and projected financial performance.
• Aids in preparing for potential changes and factors to consider in future decisions.

Horizontal Analysis

• Determines the percentage change increase or decrease in a financial statement item from one year to the previous.
• Formula: ((Current Year) - (Base Year)) / (Base Year)
• Numerator: Current year minus the base year to find the "difference of change."
• Denominator: Divide by the base year to establish a basis for change.

Vertical Analysis

• Determines the percentage of an account compared to the "total amount" in a financial statement.
• Helps analyze each component of a statement and its totality.
• Formula for Income Statement Analysis: (Income Statement Account / Total Net Sales) x 100
• Formula for Balance Sheet Analysis: (Asset Account / Total Assets) x 100 or (Liability/Equity Account / Total Liability & Equity Account) x 100
• Divide the account by entirety to find the total amount inside a 100% amount (TOTAL).

Liquidity Ratio

• Determines a business's capability to pay current liabilities.
• Types:
  • Current Ratio: Tests the ability to pay short-term debts.
  • Acid Test: Tests the ability to pay short-term debts without reliance on inventory and liquidating assets.
  • Working Capital: Measures the company’s ability to repay with only using current assets.
  • Working Capital Ratio: Testing the ability to pay short-term debts with the working capital

Solvency/Leverage Ratio

• Tests the capability of the business to pay long-term debts.
• Types:
  • Debt Ratio: Indicates how much of a company's assets are financed by debts.
  • Equity Ratio: Indicates how much of a company's assets are financed by equity.
  • Debt to Equity Ratio: Shows the debts a company uses to finance its assets relative to shareholders' equity.
  • Times Interest Earned: Measures the ability to make interest payments.

Profitability Ratio

• Checks the ability of how much the company can generate income (profit).
• Types:
  • Gross (before interest) Profit Margin: Checks the ability of how much a company can generate gross profit from sales.
  • Operating Profit Margin: To check the company's profitability from operations before tax is subtracted.
  • Net Profit Margin: Checks the profitability of the company considering all factors (i.e. net income).
  • Return on Sales: Checks the net income provided by sales.
  • Return on Assets: Checks the net income provided by total assets.
  • Return on Equity: Checks the net income based on the stockholders' investments.
  • Return on Investment: Evaluates the profitability of an investment.
  • Return on Common Equity: Checks how much a company profits from each investment dollar.

Management Efficiency Ratio

• Measures the efficiency of management in controlling working capital or other resources.
• Types:
  • Accounts Receivable Turnover: Checks how many times a receivable is converted into cash during the year.
  • Average Collection Period: Checks how much a company collects accounts receivable within a year.
  • Inventory Turnover Ratio: Checks how many times inventory is sold during the year.
  • Days Sales Inventory: Checks the average time a company takes to sell inventory.
  • Accounts Payable Turnover Ratio: Rough estimate how many times accounts payables are paid within a year.
  • Average Payable Period: Indicates the time payables remain "unpaid."
  • Operating Cycle: Determines a company's ability to complete a full operation cycle.
  • Cash Conversion Cycle: Measures how much they convert cash used to buy inventory back into cash by selling the inventory.
  • Total Asset Turnover Ratio: Measures overall efficiency of a company to generate sales by assets.

Break-Even Analysis

• Helps a company determine how much they need to sell to earn back the total costs they've spent for that product.
• Types of costs:
  • Fixed Costs: Costs that remain constant over time, regardless of sales or production fluctuations (e.g., rent, salary, membership).
  • Variable Costs: Costs that change over time and are directly proportional to production costs and sales (e.g., raw materials, labor wages, utility expenses).
• Formula for Fixed Costs: (Selling Price Per Unit) - (Variable Cost PER UNIT)
  • Determines the number of units needed to be sold to reach the "break-even" point.
• Formula for Contribution Margin Ratio: (Selling Price Per Unit) - (Variable Cost Per Unit) / Selling Price Per Unit
  • Determines how much the company needs to EARN to be considered at "break-even".