Chapter 3

Analyzing Financial Statement

Five major areas to analyze.

(1) Liquidity Position
(2) Management of Assets
(3) Management of Debt
(4) Company's Profitability
(5) Market's View of Company

(1) Liquidity Ratios - use to investigate the relationship between a firm's current (short-
term) assets and current (short-term) liabilities.

a) Current Ratio = Current Assets

Current Liabilities

b) Quick Ratio (Acid-test) = Current Assets - Inventory

Current Liabilities

c) Cash Ratio = Cash + Marketable Securities

Current Liabilities

(2) Asset Management Ratios - Use to evaluate how efficiently management employs assets.

Inventory Management

a) Inventory Turnover = Cost of Goods Sold (or Sales)

Inventory

Accounts Receivable Management

a) Average Collection Period (ACP) = Accounts Receivable

Average Sales/day
Accounts Payable Management

a) Accounts Payable
Average Payment Period (APP) = Cost of Goods Sold / day

Fixed Asset Management

a) Fixed Asset Turnover = Sales

Net Fixed Assets

Total Asset Management

Sales
a) Total Asset Turnover =
Total Assets

(3) Debt Ratios - use to evaluate riskiness of company (remember higher risk equates to
higher required return)
Debt vs. Equity Financing

a) Debt = Total Debt

Total Assets

b) Debt-to- Equity = Total Debt

Total Equity

Coverage Ratios

a) Times-Interest-Earned = EBIT
Interest
(4) Profitability Ratios - Are the owner's earning an adequate return on their investment.

a) Profit Margin = Net Income

Sales

b) Return on Assets (ROA) = Net Income

Total Assets

c) Return on Equity (ROE) = Net Income

Common Stockholders’ Equity

(5) Market Ratios - use to determine how market views company

b) Price-Earnings (PE) = Stock Price

EPS

Keys to using Ratio Analysis

(1) Compare ratios to industry
(2) Look at trend of ratios over time
(3) Be aware of the limitations in using ratio analysis