Research
Chapter 4
Analysis of Financial Statements
Learning Objectives
After reading this chapter, students should be able to:
◆ Explain what ratio analysis is.
◆ List the five groups of ratios and identify, calculate, and interpret the key ratios in each group. In addition, discuss each ratio’s relationship to the balance sheet and income statement.
◆ Discuss why ROE is the key ratio under management’s control, how the other ratios affect ROE, and explain how to use the DuPont equation to see how the ROE can be improved.
◆ Compare a firm’s ratios with those of other firms (benchmarking) and analyze a given firm’s ratios over time (trend analysis).
◆ Discuss the tendency of ratios to fluctuate over time, which may or may not be problematic. Explain how they can be influenced by accounting practices and other factors and why they must be used with care.
Lecture Suggestions
Chapter 4 shows how financial statements are analyzed to determine firms’ strengths and weaknesses. On the basis of this information, management can take actions to exploit strengths and correct weaknesses. At Florida, we find a significant difference in preparation between our accounting and non-accounting students. The accountants are relatively familiar with financial statements, and they have covered in depth in their financial accounting course many of the ratios discussed in Chapter 4. We pitch our lectures to the non-accountants, which means concentrating on the use of statements and ratios, and the “big picture,” rather than on details such as seasonal adjustments and the effects of different accounting procedures. Details are important, but so are general principles, and there are courses other than the introductory finance course where details can be addressed. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 4, which appears at the end of this chapter
Analysis of Financial Statements
Learning Objectives
After reading this chapter, students should be able to:
◆ Explain what ratio analysis is.
◆ List the five groups of ratios and identify, calculate, and interpret the key ratios in each group. In addition, discuss each ratio’s relationship to the balance sheet and income statement.
◆ Discuss why ROE is the key ratio under management’s control, how the other ratios affect ROE, and explain how to use the DuPont equation to see how the ROE can be improved.
◆ Compare a firm’s ratios with those of other firms (benchmarking) and analyze a given firm’s ratios over time (trend analysis).
◆ Discuss the tendency of ratios to fluctuate over time, which may or may not be problematic. Explain how they can be influenced by accounting practices and other factors and why they must be used with care.
Lecture Suggestions
Chapter 4 shows how financial statements are analyzed to determine firms’ strengths and weaknesses. On the basis of this information, management can take actions to exploit strengths and correct weaknesses. At Florida, we find a significant difference in preparation between our accounting and non-accounting students. The accountants are relatively familiar with financial statements, and they have covered in depth in their financial accounting course many of the ratios discussed in Chapter 4. We pitch our lectures to the non-accountants, which means concentrating on the use of statements and ratios, and the “big picture,” rather than on details such as seasonal adjustments and the effects of different accounting procedures. Details are important, but so are general principles, and there are courses other than the introductory finance course where details can be addressed. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 4, which appears at the end of this chapter