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Objectives will vary depending on the perspective of the financial statement user specific questions that are addressed by the analysis The identity of the user helps define what information is needed.
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Objectives of Analysis
Financial statements provide insight into the companys current status lead to the development of policies and strategies for the future
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Objectives of Analysis
Management prepares financial statements. Analyst should be alert to potential for management to influence reporting to make data more appealing to creditors, investors, and other users. It may be helpful to supplement analysis with other material in the annual report and other sources of information apart from the annual report.
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Sources of Information
Financial statement user has access to a wide range of data sources. Objective of analysis dictates the approach and resources used. Beginning point should be financial statements and the notes.
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Sources of Information
The analyst will want to consider the following resources:
Proxy statement Auditors report Management discussion and analysis Supplementary schedules From 10-K and From 10-Q Other Sources
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Current liabilities
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Profitability ratios measure the overall performance of a firm and its efficiency in managing assets, liabilities, and equity.
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Profitability Ratios
Overall Efficiency and Performance
Operating Profit Margin Measures overall operating efficiency and incorporates all of the expenses associated with ordinary business activities
Profitability Ratios
Overall Efficiency and Performance
Net Profit Margin Measures profitability after consideration of all revenue and expense, including interest, taxes, and nonoperating items
Profitability Ratios
Overall Efficiency and Performance
Cash Flow Margin Measures ability to translate sales into cash
Profitability Ratios
Overall Efficiency and Performance
Return on Total Assets (ROA) or Return on Investment (ROI) Measures overall efficiency of firm in managing investment in assets and generating profits Net earnings Total assets
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Profitability Ratios
Overall Efficiency and Performance
Return on Equity (ROE) Measures rate of return on stockholders investment Net earnings Stockholders equity
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Profitability Ratios
Overall Efficiency and Performance
Cash Return on Assets Measures firms ability to generate cash from the utilization of its assets
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Short-Term Liquidity
Especially important to creditors, suppliers, management, and others who are concerned with the ability of a firm to meet near-term demands for cash Should include analysis of selected financial ratios and a comparison with industry averages Predicts the future ability of the firm to meet prospective needs for cash
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Operating Efficiency
Turnover ratios measure the operating efficiency of a firm. The efficiency in managing a companys accounts receivable, inventory, and accounts payable is discussed in the shortterm liquidity analysis.
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Profitability
Analysis of how well the firm has performed in terms of profitability, beginning with the evaluation of several key ratios
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Net income
Net sales
(3) Return on investment
Net sales
X Total assets
(4) Financial leverage
Net income
= Total assets
(5) Return on equity
Total assets
Net income
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Summary of Analysis
Analysis of any firms financial statements consists of a mixture of steps and pieces that interrelate and affect each other. No one part of the analysis should be interpreted in isolation. The last step of analysis is to integrate the separate pieces into a whole, leading to conclusions about the business enterprise.
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