Chapter 13 Financial Statement Analysis Limitations and Considerations in Financial 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 Limitations and Considerations in Financial 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 Analysis of Comparative Statements: Horizontal Analysis  Comparison of financial statement items over a period of time LO Example 13.1—Preparing and Reading Comparative Balance Sheets—Horizontal Analysis Example 13.2—Preparing and Reading Comparative Statements of Income and Retained Earnings—Horizontal Analysis Example 13.3—Preparing and Reading Comparative Statements of Cash Flows—Horizontal Analysis 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 Example 13.4—Preparing and Reading Common-Size Balance Sheets—Vertical Analysis Example 13.5—Preparing and Reading Common-Size Income Statements—Vertical Analysis Times Interest Earned Ratio  Indicates the company’s ability to meet the current year’s interest payments out of the current year’s earnings 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 Cash Flow from Operations to Capital Expenditures Ratio  A measure of the ability of a company to finance longterm asset acquisitions with cash from operations 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 Ratio = Profit Margin Ratio = Gross Profit Net Sales Net Income Net Sales LO Rate of Return on Assets  A measure of a company’s success in earning a return for all providers of capital 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 Return on Common Stockholders’ Equity Ratio  A measure of a company’s success in earning a return for the common stockholders Leverage  The use of borrowed funds and amounts contributed by preferred stockholders to earn an overall return higher than the cost of these funds Earnings per Share  A company’s bottom line stated on a per-share basis Price/Earnings Ratio  The relationship between a company’s performance according to the income statement and its performance in the stock market 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 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 Discontinued Operations  Reflect any gains or losses from the disposal of a segment  Also, reflect any net income or loss from operating that segment Extraordinary Items  Reflect any gains or losses that arise from an event that is both unusual in nature and infrequent in occurrence End of Chapter 13 [...]... inventory: a measure of how long it takes to sell inventory Cash-to-Cash Operating Cycle  The length of time from the purchase of inventory to the collection of any receivable from the sale 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... 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 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 ... a return for the common stockholders Leverage  The use of borrowed funds and amounts contributed by preferred stockholders to earn an overall return higher than the cost of these funds Earnings per Share  A company’s bottom line stated on a per-share basis Price/Earnings Ratio  The relationship between a company’s performance according to the income statement and its performance in the stock market... Income Net Sales LO 6 Rate of Return on Assets  A measure of a company’s success in earning a return for all providers of capital 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 Return on Common Stockholders’ Equity Ratio  A... of the nearness to cash of the assets and liabilities of a company LO 4 Working Capital  The excess of current assets over current liabilities at a point in time Current Ratio The ratio of current assets to current liabilities  One of the most widely used financial statement ratios  Acid-Test Ratio A stricter test of liquidity than the current ratio  Excludes inventory and prepayments from the. .. from operating activities during the year and that is available to repay interest due and any maturing principal amounts Cash Flow from Operations to Capital Expenditures Ratio  A measure of the ability of a company to finance longterm asset acquisitions with cash from operations Profitability Analysis  How well management is using company resources to earn a return on the = funds invested by various... LO 5 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 Times Interest Earned Ratio  Indicates the company’s ability to meet the current year’s interest payments out of the current year’s earnings Debt Service Coverage Ratio  Measure of the amount of cash that is generated... Reported separately to call the reader’s attention to their unique nature  LO 7 Discontinued Operations  Reflect any gains or losses from the disposal of a segment  Also, reflect any net income or loss from operating that segment Extraordinary Items  Reflect any gains or losses that arise from an event that is both unusual in nature and infrequent in occurrence End of Chapter 13 ... Operations to Current Liabilities  A measure of the ability to pay current debts from operating cash flows 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 Inventory Analysis  Inventory turnover ratio: a measure of the ... time from the purchase of inventory to the collection of any receivable from the sale Solvency Analysis  The ability of a company to remain in business over the long term  The ability of the firm... making comparisons  Recognizing trends in ratios  Extra caution for extraordinary items and gains and losses from discontinued operations  LO Limitations and Considerations in Financial Statement...Limitations and Considerations in Financial Statement Analysis Watch for alternative accounting principles  Selection of a inventory valuation method  Changes in accounting method