Financial Statement Analysis tools
Financial Statement
Analysis Tools
CHAPTER 4
After studying this chapter, you should be able to:
1.
Describe the purpose of financial ratios and who uses them.
2.
Define the five major categories of ratios (liquidity, efficiency, leverage, coverage, and profitability).
3.
Calculate the common ratios for any firm by using income statement and balance sheet data.
4.
Use financial ratios to assess a firm’s past performance, identify its current problems, and suggest strategies for dealing with these problems.
5.
Calculate the economic profit earned by a firm.
In previous chapters we have seen how the firm’s basic financial statements are constructed.
In this chapter we will see how financial analysts can use the information contained in the income statement and balance sheet for various purposes.
Many tools are available for use when evaluating a company, but some of the most valuable are financial ratios. Ratios are an analyst’s microscope; they allow us to get a better view of the firm’s financial health than just looking at the raw financial statements. A ratio is simply a comparison of two numbers by division. We could also compare numbers by subtraction, but a ratio is superior in most cases because it is a measure of relative size. Relative measures
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CHAPTER 4: Financial Statement Analysis Tools
are more easily compared to previous time periods or other firms than changes in dollar amounts. Ratios are useful to both internal and external analysts of the firm. For internal purposes, ratios can be useful in planning for the future, setting goals, and evaluating the performance of managers. External analysts use ratios to decide whether or not to grant credit, to monitor financial performance, to forecast financial performance, and to decide whether to invest in the company.
We will look at many different ratios, but you should be aware that these are, of necessity, only a sampling of the ratios
Analysis Tools
CHAPTER 4
After studying this chapter, you should be able to:
1.
Describe the purpose of financial ratios and who uses them.
2.
Define the five major categories of ratios (liquidity, efficiency, leverage, coverage, and profitability).
3.
Calculate the common ratios for any firm by using income statement and balance sheet data.
4.
Use financial ratios to assess a firm’s past performance, identify its current problems, and suggest strategies for dealing with these problems.
5.
Calculate the economic profit earned by a firm.
In previous chapters we have seen how the firm’s basic financial statements are constructed.
In this chapter we will see how financial analysts can use the information contained in the income statement and balance sheet for various purposes.
Many tools are available for use when evaluating a company, but some of the most valuable are financial ratios. Ratios are an analyst’s microscope; they allow us to get a better view of the firm’s financial health than just looking at the raw financial statements. A ratio is simply a comparison of two numbers by division. We could also compare numbers by subtraction, but a ratio is superior in most cases because it is a measure of relative size. Relative measures
105
CHAPTER 4: Financial Statement Analysis Tools
are more easily compared to previous time periods or other firms than changes in dollar amounts. Ratios are useful to both internal and external analysts of the firm. For internal purposes, ratios can be useful in planning for the future, setting goals, and evaluating the performance of managers. External analysts use ratios to decide whether or not to grant credit, to monitor financial performance, to forecast financial performance, and to decide whether to invest in the company.
We will look at many different ratios, but you should be aware that these are, of necessity, only a sampling of the ratios