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Financial Statement Analysis

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Title: Financial Statement Analysis

1
CHAPTER
18
FINANCIAL STATEMENT ANALYSIS Group Presentation
will be either Dec 17 (Wed) or Dec 18 (Thur)
2
Ratio Analysis
• Ratio Analysis expresses the relationships
between selected financial statement items.
• There are 3 types of ratio analysis
• Liquidity Ratios Measure short-term ability of
the enterprise to pay its debts and to meet
unexpected needs for cash.
• Solvency ratios Measure the ability of the
enter prise to survive over a long period of
time.
• Profitability ratios Measure the income or
operating success of an enterprise for a given
period of time.

3
Liquidity Ratio
• It measures short-term ability of the enterprise
to pay its debts and to meet unexpected needs for
cash.
• Who would be interested in finding out liquidity
ratio of a company?
• Investors, bankers, suppliers, creditors, owners,

4
LIQUIDITY RATIOS
• Working Capital ratio
• Current ratio
• Acid test ratio
• Cash current debt coverage ratio
• Receivables turnover
• Collection period
• Inventory turnover
• Days sales in inventory

5
Working Capital Ratio
• Current assets cash, accounts receivable,
inventory, marketable securities, prepaid
expenses and other liquid assets that can be
readily converted to cash in one year
• Working capital Current Assets Current
Liabilities
• It shows a companys ability to pay its short
term debts.
• Example 1 Samsung
• WC 368842 249428 119,414
• Example 2 Apple
• WC 249428 368842 -119,414
• Which company is in better situation?

6
CURRENT RATIO
• Measures short-term debt-paying ability

(Discussed in Chapter 4)
7
Current Ratio
• Current Ratio is more useful than working capital
ratio because it is difficult to compare absolute
dollar amounts by themselves.
• For example CA 368,842, CL 249,428 then
current ratio 368,842 / 249,428 1.48
• This means that this company has 1.48 of current
assets for every dollar of current liabilities.
• Generally speaking higher current ratio indicates
better liquidity.

8
Current Ratio
• What is a normal current ratio number?
• It depends on the company and the industry, but
it should be minimum of 1.
• The higher the better it is.
• Ratios should never be interpreted without
considering certain factors such as
• The ratio should be compared to the ratios for
other companies in the same or related industries
• Other specific financial information over time
needs to be consdiered.

9
ACID TEST RATIO
• Measures immediate short-term debt-paying ability

Acid test ratio Cash temporary investments
net receivables Current liabilities
(Discussed in Chapter 9)
10
Acid Test Ratio
• This ratio is similar to Current Asset Ratio
except that the numerator does not include
inventory.
• Numerator current assets - inventory
• A strict indicator that determines whether a firm
has enough short-term assets to cover its
immediate liabilities without selling inventory.
The acid-test ratio is far more strict than the
working capital ratio, primarily because the
working capital ratio allows for the inclusion of
inventory assets.

11
ACCOUNTS RECEIVABLE TURNOVER RATIO
• The ratio used to assess the liquidity of the
receivables is the receivables turnover ratio.
• This ratio measures the number of times, on
average, that receivables are collected during
the period.
• Unfortunatelly, companies rarely report the
amount of net sales made on credit in their
financial statements.

Net Credit Average Net Receivables Sales
Receivables Turnover
?

12
ACCOUNTS RECEIVABLE TURNOVER RATIO
• As a result, net sales (which includes both cash
and credit sales) is used as a substitute for Net
Credit Sales number in the formula.
• In addition, some companies do not report gross
accounts receivable, so net accounts receivable
must be used.
• As long as we use same numerator and denominator
for this ratio (year over year or company over
company), we can use this ratio.

O
13
ACCOUNTS RECEIVABLE TURNOVER RATIO
• Lets do BE8.15 (P436) together.
• 23.96 times (or 24 times) indicates that they
collected AR 24 times a year.
• If the term they allow for AR is 2,10, net 30
then you can safely assume that AR Collection
employees are doing a decent job.
• Only when you compare this number either year
over year or with competitors AR Turnover ratio
then we can see that AR collection employees are
doing a good job or bad job.

O
14
COLLECTION PERIOD
• Measures number of days receivables are
outstanding

(Discussed in Chapter 9)
15
COLLECTION PERIOD
• The collection period (in days) is a variant of
the receivables turnover ratio and makes
liquidity even more evident.
• The general rule is that the collection period
should not exceed the credit term period. (such
as 30 days)

16
Collection Period
• From previous example, the collection period
• 365 days / 23.96 times 15.2 days
• It takes them 15.2 days to collect their AR which
is shorter than their 30 days credit policy. AR
collection employees are doing a decent job.
• Both receivables turnover and collection period
are useful for judging how efficiently a company
converts its credit sales to cash.
• These measures should be compared to industry
average number and to previous years number.

17
INVENTORY TURNOVER
• Measures liquidity of inventory

(Discussed in Chapter 5)
18
Inventory Turnover
• Inventory Turnover ratio measures the number of
times, on average, inventory is sold during the
period.
• It is calculated by dividing the cost of goods
sold by average inventory.
• Inventory Turnover COGS / AI
• AI Average Inventory (BB EB)/2
• Generally speaking, the more times (the higher it
is) that inventory turns over each year, the more

19
DAYS SALES IN INVENTORY
• Measures number of days inventory is on hand

(Discussed in Chapter 5)
20
Days Sales in Inventory
• The inventory turnover ratio is complemented by
the days sales in inventory ratio.
• It converts the inventory turnover ratio into a
measure of the average age of the inventory on
hand.
• DSI 365 days / Inventory Turnover
• DSI Days Sales in Inventory

21
Days Sales in Inventory
• Lets say Inventory Turnover 2.7 then what is
the days sales in inventory?
• DSI 365 days / 2.7 135 days
• What does this 135 days mean?
• It means that it takes 135 days to sell their
product since purchase date.
• This ratio should be compared to the companys
ratio in previous years and the industry average.
• However, this average number will be different
for each type of inventory item.

22
Classwork / Homework
• P959 E18.6, E18.7, E18.11(A)
• December 17 (Wed)
• Anne, Xenia, Maryam (Tim Horton) 35 min
• Stefan, Roohulah, Scott (Wal-mart) 35 min
• December 18 (Thu)
• Muss, Sharyar, Michael 25 min
• Imran, Virginia 25 min
• Kalesh, Ameen 25 min