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- 1. Chapter 13Financial Statement Analysis
- 2. Chapter 13: Key Concepts• Learn how to calculate and interpret a variety of ratios and other measures from the financial statements. o Learn which amounts of a ratio or other measure is preferred (higher or lower).• Categories of measures: o Measures to analyze a company’s ability to sell inventory and collect receivables. o Measures to analyze a company’s ability to pay current liabilities. o Measures to analyze a company’s ability to pay all liabilities. o Measures to analyze a company’s profitability. Financial Accounting-Eiler 1
- 3. Inventory Turnover Ratio• Calculation: Inventory COGS = Turnover Ratio Average Inventory• Interpretation: o Measures how quickly a company is selling inventory. o Ratio needs to be in line with industry average (not too much higher or lower). • Ratios _________ the average mean the company is selling out quickly (can’t keep the shelves stocked). Financial Accounting-Eiler 2
- 4. Working Capital• Calculation: Working Capital = Current Assets - Current Liabilities• Interpretation: o Measures the company’s ability to pay current liabilities with current assets, i.e. the ability to pay future (short-term) debts. o Do companies prefer Higher or Lower amounts of working capital? Financial Accounting-Eiler 3
- 5. Current Ratio• Calculation: Current Assets Current Ratio = Current Liabilities• Interpretation: o Measures the company’s ability to pay current liabilities with current assets, i.e. the ability to pay future (short-term) debts. o Current ratio of 1.95 tells you that for every ______ of current liabilities, the company has _______ dollars of current assets. o Do companies prefer higher or lower current ratios? Financial Accounting-Eiler 4
- 6. Quick Ratio• Calculation: Cash + ST Investments + Net Current ReceivablesQuick Ratio = Current Liabilities• Interpretation: o Measures the company’s ability to pay current liabilities with quick assets, i.e. the ability to pay future (short-term) debts. o Exclude inventory and prepaids because these cannot be converted into cash quickly. o Quick ratio of 1.75 means that for every ______ of current liabilities, the company has _______ dollars of quick assets. o Do companies prefer higher or lower current ratios?• Also known as the acid-test ratio. Financial Accounting-Eiler 5
- 7. Debt Ratio• Calculation: Total Liabilities Debt Ratio = Total Assets• Interpretation: o Measures the portion of the company’s assets that are financed with debt. Also known as the leverage ratio. • Any portion not financed with debt, is financed with equity. o Debt ratio of 0.75 means that ______% of assets are financed with debt. o Does a higher or lower debt ratio suggest the company is more risky? Financial Accounting-Eiler 6
- 8. Times Interest Earned Ratio• Calculation: Times Interest Income from Operations = Earned Ratio Interest Expense• Interpretation: o Measures the number of times operating income can pay interest expense. Also known as the interest coverage ratio. o A ratio of 3.50 means that the company generates enough income from operations to pay interest expense _______ times. o Which is preferred - higher or lower times interest earned ratios? Financial Accounting-Eiler 7
- 9. Gross Profit Percentage• Calculation: Gross Profit Gross Profit = Percentage Net Sales• Interpretation: o Measures the portion of Net Sales that contributes to Gross Profit. Also known as the gross margin percentage. o A gross profit percentage of 25% means that for every dollar of Net Sales, the company generates $_______ of Gross Profit. In other words, the company “marks up” inventory by $______. o Which is preferred - higher or lower gross profit percentages? • Be mindful of industry averages though. Not all retailers can make the same margins. Financial Accounting-Eiler 8
- 10. Return on Assets• Calculation: (Net Income + Interest Expense) Return on Assets = Average Total Assets• Interpretation: o Measures the company’s ability to generate a profit (for the shareholders) and pay interest (to the debt holders) with their assets. o ROA of 0.09 tells you that for every ______ the company has invested in assets, the company generates $_______ of profit. o Do companies prefer to have a higher or lower ROA? Financial Accounting-Eiler 9
- 11. Earnings Per Share• Calculation: (Net Income – Preferred Dividends) Earnings Per = Average Number of Share Common Shares Outstanding• Interpretation: o Measures the amount of Net Income generated for each share of common stock. • Very important performance measure – serious stock price effects on announcement of EPS. o Subtract preferred dividends from NI to determine the amount of profit available for distribution to common shareholders. o EPS of 2.45 tells you that the company earned $________ for each share of common stock. o Do companies prefer to have a higher or lower EPS? Financial Accounting-Eiler 10
- 12. Chapter 13: Key Concepts• Know how to calculate and interpret a variety of ratios and other measures from the financial statements. o Understand whether higher or lower amounts of a ratio or other measure is preferred. Financial Accounting-Eiler 11

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