Analysis Of Financial Statements 3 
Analysis of Financial
Statements
Ratio Analysis
DuPont Equation
Potential Misuse of ROE
Use Financial Ratios to performance
Uses and Limitations of Financial Ratios
• Ratios help us to evaluate financial statements. Ratios are used to make comparisons.
• There are many different ratios, with different ones used to examine different aspects of the firm’s operations.
• Ratios can be divided into 5 categories:
1.
2.
3.
4.
5.
Liquidity ratios,
Asset management ratios,
Debt management ratios,
Profitability ratios, and
Market value ratios.
Why are ratios useful?
1. Liquidity ratios
•
Firm’s ability to pay off debts that are maturing within a year.
2. Asset management ratios
•
How efficiently the firm is using its assets?
3. Debt management ratios
•
How the firm has financed its assets as well as the firm’s ability to repay its long term debt?
4. Profitability ratios
•
•
How profitably the firm is operating and utilizing its assets?
E.g., do sales prices exceed unit costs?
5. Market value ratios
•
What investors think about the firm and its future prospects?
Categories of Ratios
Current Ratio
Quick Ratio
LIQUIDITY RATIOS
WILL THE FIRM BE ABLE TO PAYOFF ITS DEBT AS THEY COME DUE?
•• Current
Ratio indicates the extent to which current liabilities (CL) are covered by the current assets (CA).
Current Ratio =
• CA include cash, marketable securities, accounts receivable and inventories. All assets can be converted into cash within a year.
• CL include accounts payable, accrued wages and taxes, and notes payable, all of which are due within a year.
• If the firm is having financial difficulty, its current liabilities will increase. If CL are rising faster than CA, the current ratio will fall; and this is a sign of possible trouble.
Current Ratio
• High current ratio implies less risk of the firm experiencing a cash shortfall in the near future, indicating a very strong and safe liquidity position.
• However, it may also indicate that …
• The firm has
Statements
Ratio Analysis
DuPont Equation
Potential Misuse of ROE
Use Financial Ratios to performance
Uses and Limitations of Financial Ratios
• Ratios help us to evaluate financial statements. Ratios are used to make comparisons.
• There are many different ratios, with different ones used to examine different aspects of the firm’s operations.
• Ratios can be divided into 5 categories:
1.
2.
3.
4.
5.
Liquidity ratios,
Asset management ratios,
Debt management ratios,
Profitability ratios, and
Market value ratios.
Why are ratios useful?
1. Liquidity ratios
•
Firm’s ability to pay off debts that are maturing within a year.
2. Asset management ratios
•
How efficiently the firm is using its assets?
3. Debt management ratios
•
How the firm has financed its assets as well as the firm’s ability to repay its long term debt?
4. Profitability ratios
•
•
How profitably the firm is operating and utilizing its assets?
E.g., do sales prices exceed unit costs?
5. Market value ratios
•
What investors think about the firm and its future prospects?
Categories of Ratios
Current Ratio
Quick Ratio
LIQUIDITY RATIOS
WILL THE FIRM BE ABLE TO PAYOFF ITS DEBT AS THEY COME DUE?
•• Current
Ratio indicates the extent to which current liabilities (CL) are covered by the current assets (CA).
Current Ratio =
• CA include cash, marketable securities, accounts receivable and inventories. All assets can be converted into cash within a year.
• CL include accounts payable, accrued wages and taxes, and notes payable, all of which are due within a year.
• If the firm is having financial difficulty, its current liabilities will increase. If CL are rising faster than CA, the current ratio will fall; and this is a sign of possible trouble.
Current Ratio
• High current ratio implies less risk of the firm experiencing a cash shortfall in the near future, indicating a very strong and safe liquidity position.
• However, it may also indicate that …
• The firm has