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Commonsize analysis expresses line items or accounts in the financial statements as
percentages

The two forms of commonsize analysis are
horizontal analysis and vertical analysis

Horizontal Analysis
Also called trend analysis, horizontal analysis expresses a line item as a
 percentage of some priorperiod amount
 (allows the trend over time to be assessed)

In horizontal analysis, line itmes are expressed as a percentage of a
base period amount.

Vertical Analysis
While horizontal analysis involves relationships among items over time, vertical analysis is concerned with the relationships among items within
a particular time period

Vertical analysis expresses the line item as a percentage of some other
line item for the same period

Vertical Analysis
With this approach, within period relationships
can be assessed.

Vertical Analysis
Line items on income statements often are expressed as
percentages of net sales.

Line items on the balance sheet often are expressed as a
percentage of total assets.

Ratio Analysis
Ratio analysis is the second major technique for financial statement analysis.
Ratios are fractions or percentages computed
by dividing one account or lineitem amount by another.

Standards for Comparison
Ratios by themselves tell little about the financial wellbeing of a company.
For meaningful analysis, the ratios should be
compared with a standard.

Only through comparison can someone using a financial statement
assess the financial health of a company.

Two standards commonly uses are the
past history of the company and industrial averages

Classification of Ratios
Ratios generally are classified into on of three categories:
1. Liquidity
2. Leverage (borrowing capacity)
3. Profitability

Liquidity ratios measure
the ability of a companion to meet its current obligations.

Leverage ratios measure
measure the ability of a company to meet its long and shortterm obligations. These ratios provide a measure of the degree of protection provided to a company's creditors.

Profitability ratios measure the
earning ability of a company. These ratios allow investors, creditors, and managers to evaluate the extent to which invested funds are being used efficiently.

Liquidity ratio
Current Ratio=
 Current Assets
 Current Liabililtes

Liquidity Ratio
Quick Ratio=
 (Cash+Marketable Securities+Accounts Receivable)
 Current Liabilities

Liquidity Ratios
Accounts Receivable Turnover Ratio=
 Net Sales
 Average Accounts Receivable

Liquidity Ratios
Average Accounts Receivable=
 (Beginning Receivables + Ending Receivables)
 2

Liquidity Ratios
Turnover in Days=
 365
 Receivables Turnover Ratio

Liquidity Ratios
Inventory Turnover Ratio=
 Cost of Goods Sold
 Average Inventory

Liquidity ratios
Average Inventory=
 (Beginning Inventory + Ending Inventory)
 2

Liquidity Ratio
Turnover in Days=
 365
 Inventory Turnover Ratio

Leverage ratio
Debt Ratio=
 Total Liabilities
 Total Assets

Leverage ratio
Debt to Equity Ratio=
 Total Liabilities
 Total Stockholder's Equity

Profitability ratios
Return on Sales=

Profitability ratios
Average Total Assets=
 (Beginning Total Assets + Ending Total Assets)
 2

Profitability ratios
Return on Stockholders Equity=
 (Net Income  Preferred Dividends)
 Average Common Stockholder's Equity

Profitability ratios
Earnings per Share=
 (Net Income  Preferred Dividends)
 Average Common Shares

Profitability ratio
Price Earnings ratio=
 Market Price per Share
 Earnings per Share

Profitability ratio
Dividend Yield=
 Dividends per Common Share
 Market Price per Common Share

Profitability ratio
Dividend Payout Ratio=
 Common Dividends
 (Net Income  Preferred Dividends)

The most common liquidity ratios are:
 current ratio
 quick or acid test ratio
 accounts receivable turnover ratio
 inventory turnover ratio

Current Ratio is a measure of the ability of a company to pay
its short term liabilities out of short term assets
 Current Ratio= Current Assets
 Current Liabilities

Current Ratio
Current liabilites must be paid within an
operating cycle (usually within a year) and current assets can be converted to cash within an operating cycle.

The current ratio provides a direct measure of the ability of a company to meet its
shortterm obligations.

Current Ratio
Many creditors use the rule of thumb that a
2.0 ratio is needed to provide good debtpaying ability.

Current Ratio
A high current ratio may signal
excessive investment in current resources.

Current Ration
A declining current ratio may signal a move
toward more efficient utilization of resources.

The quick or acidtest ratio is a measure of
liquidity that compares only the most liquid assets with current liabilites

Excluded from the quick ratio are
nonliquid current assets such as inventories.

The numerator of the quick ratio includes only the most liquid assets.
Quick ratio=
 (Cash + Marketable Securities + Accounts Receivable)
 Current Liabilites

Accounts Receivable Turnover Ratio
A company's liquidity problem can be investigated by examining the liquidity of its receivable or how long it takes the company to turn its receivables into
cash
Accounts Receivable Turnover Ratio=
 Net Sales
 Average Accounts Receivable

Accounts Receivable Turnover in Days
The accounts receivable turnover ration can be taken further to determine the number of days the average balance of accounts receivable is outstanding before
being converted into cash.
 Turnover in Days= 365
 Receivables Turnover Ratio

A low turnover ratio may suggest a need to
modify credit and collection policies to speed up the conversion of receivables to cash.

Inventory Turnover Ratio
This ratio tells an analyst how many times the average inventory
turns over, or is sold, during the year.
 Inventory Turnover Ratio= Cost of Goods Sold
 Average Inventory

Inventory Turnover Ratio
A low turnover ratio may signal
the presence of too much inventory or sluggish sales.

Inventory Turnover Ratio
The number of days inventory is held before being sold can be computed as:
 Turnover in Days= 365
 Inventory Turnover Ratio

