Financial Statement Analysis

• Focus is on understanding and analyzing financial statements, not just preparing them.
• Module equips with skills to interpret financial data and assess company performance.
• Skills are crucial for anyone in the business world, also outside traditional accounting roles.

Key Concepts Module Breakdown:

• Horizontal Analysis compares financial data across different periods (e.g., year-over-year).
• Horizontal Analysis highlights changes in account balances, allowing quick identification of significant trends.
• The change is often presented as both a dollar amount and a percentage.
• Vertical Analysis examines financial data within a single period.
• All items are expressed as a percentage of a base figure.
• Net Sales is the base figure for the Income Statement.
• Total Assets is the base figure for the Balance Sheet.
• Facilitates comparison between companies of different sizes.
• Common-size statements is another name for vertical analysis.
• Financial Ratios involve calculating and interpreting ratios to evaluate various aspects of a companys financial health.

Financial Ratios Categories:

• Liquidity Ratios assess a companys ability to meet short-term obligations (e.g., Current Ratio, Acid-Test Ratio).
• Turnover Ratios measure how efficiently a company is using its assets (e.g., Inventory Turnover, Receivables Turnover).
• Long-Term Debt Paying Ability evaluate the companys ability to meet its long-term obligations (e.g., Debt Ratio).
• Profitability Ratios assess a companys ability to generate profits (e.g., Return on Sales, Return on Equity).
• Stock Market Performance evaluate how the market views a companys performance (e.g., Price-Earnings Ratio, Dividend Yield).

Ratio Explanations:

• A higher Current Ratio (Current Assets / Current Liabilities) generally indicates a better ability to pay short-term debts; 1.5 is often considered safe.
• An Acid-Test Ratio (Cash + Marketable Securities + Net Accounts Receivable / Current Liabilities) is a more conservative measure of liquidity, excluding inventory; 0.9 is desirable.
• Inventory Turnover (Cost of Goods Sold / Average Inventory) indicates how quickly inventory is sold; a higher turnover is generally better.
• Days Sales in Inventory (365 / Inventory Turnover) represents the average number of days inventory is held; lower is better.
• Receivables Turnover (Net Sales / Average Accounts Receivable) shows how efficiently a company collects receivables; higher is better.
• Debt Ratio (Total Liabilities / Total Assets) measures the proportion of a companys assets financed by debt; lower is generally considered less risky.
• Return on Sales (Net Income / Net Sales) indicates how much profit a company generates for each dollar of sales; higher is better.
• Return on Assets (Net Income + Interest Expense / Average Total Assets) measures how efficiently a company uses its assets to generate profits; higher is better.
• Return on Equity (Net Income - Preferred Dividends / Average Common Stockholders Equity) measures the return earned for common stockholders; higher is better.
• Price-Earnings (P/E) Ratio (Market Price per Common Share / Earnings Per Share) indicates how much investors are willing to pay for each dollar of earnings.
• Higher Price-Earnings indicates higher growth expectations, but also potential overvaluation.
• Dividend Yield (Dividends Per Share / Market Price per Common Share) represents the return on investment from dividends; higher is generally attractive to income-seeking investors.

Key Takeaways:

• No single ratio tells the whole story; analysis requires examining multiple ratios.
• Context is crucial like compare ratios to industry averages, competitors, and historical trends.
• Understanding the limitations as ratios are based on accounting data, which can be subject to manipulation or different accounting methods.
• This module provides the tools to decode financial statements.
• Mastering these analytical techniques makes you better equipped to make informed business decisions.