Ratio Analysis
Financial Reporting II
Review of Ratio Analysis
Ratio analysis is a useful tool for analyzing financial statements. Calculating ratios will aid in understanding the company’s strategy and in understanding its strengths and weaknesses relative to other companies and over time. They can sometimes be useful in identifying earnings management and in understanding the effect of accounting choices on the firm’s reported profitability and growth. Finally, the ratios help in obtaining a better understanding of a firm’s current profitability, growth, and risk which can improve forecasts of future profitability and growth and estimates of the cost of capital.
In reviewing the basic financial ratios, we will examine the ratios of Best Buy for the fiscal years ended March 2, 2002 and March 3, 2001. Excerpts from Best Buy’s financial statements are included at the end of this document. Best Buy is a growing company. The following table reflects the growth in sales and income during the year ended March 2, 2002:
Year Ended
March 2, 2002
Year Ended
March 3, 2001
% Growth
Sales
19,597
15,327
28%
Net Income 570 396
44%
Average book value
2,171.5
1,459
28%
Average assets
6,107.5
3,917.5
52%
Average debt 558 163.5
177%
Note that sales and net income rose in 2002 relative to 2001. Also note, however, that total assets, book value and debt also rose during the year. Ratio analysis allows the analyst to compare the income and sales reported on the income statement relative to the assets and book value the company had to work with reported on the balance sheet. A review of the ratios follows.
Profitability Ratios
Return on Assets
Return on assets measures a firm's performance in using assets to generate earnings (independent of the financing of the assets). This measure allows one to consider the income (before financing costs) relative to the assets that the firm had to generate the income. It, therefore,
Review of Ratio Analysis
Ratio analysis is a useful tool for analyzing financial statements. Calculating ratios will aid in understanding the company’s strategy and in understanding its strengths and weaknesses relative to other companies and over time. They can sometimes be useful in identifying earnings management and in understanding the effect of accounting choices on the firm’s reported profitability and growth. Finally, the ratios help in obtaining a better understanding of a firm’s current profitability, growth, and risk which can improve forecasts of future profitability and growth and estimates of the cost of capital.
In reviewing the basic financial ratios, we will examine the ratios of Best Buy for the fiscal years ended March 2, 2002 and March 3, 2001. Excerpts from Best Buy’s financial statements are included at the end of this document. Best Buy is a growing company. The following table reflects the growth in sales and income during the year ended March 2, 2002:
Year Ended
March 2, 2002
Year Ended
March 3, 2001
% Growth
Sales
19,597
15,327
28%
Net Income 570 396
44%
Average book value
2,171.5
1,459
28%
Average assets
6,107.5
3,917.5
52%
Average debt 558 163.5
177%
Note that sales and net income rose in 2002 relative to 2001. Also note, however, that total assets, book value and debt also rose during the year. Ratio analysis allows the analyst to compare the income and sales reported on the income statement relative to the assets and book value the company had to work with reported on the balance sheet. A review of the ratios follows.
Profitability Ratios
Return on Assets
Return on assets measures a firm's performance in using assets to generate earnings (independent of the financing of the assets). This measure allows one to consider the income (before financing costs) relative to the assets that the firm had to generate the income. It, therefore,