There are three types of financial statement comparisons: intra-company, inter-company, and industry averages. Three tools are used for analysis: horizontal analysis examines trends over time, vertical analysis expresses items as a percent of a base amount, and ratio analysis includes liquidity, solvency, turnover, profitability, and market value ratios. Ratios are calculated to measure different aspects of a company's financial health and are used by creditors, stockholders, and others to evaluate performance.

1. Financial Analysis & Ratios

2. Comparative Analysis
There are three types of comparisons to provide
decision usefulness of financial information:
• Intra-company basis
• Inter-company basis
• Industry averages

3. Comparative Analysis
• Intra-company basis – comparisons within the
company.
• Inter-company basis – comparisons with other
companies.
• Industry averages – comparisons with other
companies in the same industry.

4. Financial Statement Analysis
Three basic tools are used in financial statement
analysis :
1. Horizontal analysis
2. Vertical analysis
3. Ratio analysis

5. Horizontal Analysis
• Is a technique for evaluating a series of financial
statement data over a period of time.
• Did an increase or decrease take place?

7. Vertical Analysis
• Expresses each item in a financial statement as a
percent of a base amount.
• Total Assets is the base amount on a Balance Sheet.
• Common-size balance sheet
• Net Sales is the base amount on an Income
Statement.
• Common-size income statement

9. Ratio Analysis
➨ Five types:
➨ Liquidity ratios
➨ Solvency ratios
➨ Turnover ratios
➨ Profitability ratios
➨ Market value ratios

10. Liquidity Ratios
Measure the short-term ability of the
enterprise to pay its maturing
obligations and to meet unexpected
needs for cash.
WHO CARES?
Short-term creditors such as
bankers and suppliers

11. Current Ratio
Indicates short-term debt-paying
ability
Current Assets
Current Liabilities

12. Acid-Test Ratio
Indicates immediate short-term debtpaying ability
Current Assets - Inventory
Current Liabilities

13. Cash Ratio
Indicates short-term debt-paying ability
(cash basis)
Cash
_
Current Liabilities
_

14. Solvency Ratios
Measure the ability of the enterprise
to survive over a long period of time
WHO CARES?
Long-term creditors and
stockholders

15. Debt to Assets Ratio
Indicates % of total assets provided by
creditors
Total Liabilities
Total Assets

16. Times Interest Earned Ratio
Indicates company’s ability to meet
interest payments as they come due
_
EBIT
_
Interest Expense

17. Cash Debt Coverage Ratio
Indicates long-term debt-paying ability
(cash basis)
Cash provided by operations
Average total liabilities

18. Turnover Ratios
Measure how efficiently, or
intensively, a firm uses its assets to
generate sales
.
WHO CARES?
Short-term creditors such as
bankers and suppliers

19. Inventory Turnover Ratio
Indicates liquidity of inventory
Cost of Goods Sold
Inventory

20. Average Days in Inventory
Indicates liquidity of inventory and
inventory management
365 days
Inventory Turnover Ratio

21. Receivables Turnover Ratio
Indicates liquidity of receivables
Net Sales
Accounts Receivable

22. Average Collection Period
Indicates liquidity of receivables and
collection success
365 days
Receivables Turnover

23. Asset Turnover Ratio
Indicates how efficiently assets are
used to generate sales
Net Sales
Total Assets

24. Profitability Ratios
Measure the income or operating success of an
enterprise for a given period of time
WHO CARES? Everybody
WHY? A company’s income affects:
➩ its ability to obtain debt and equity financing
➩ its liquidity position
➩ its ability to grow

25. Profit Margin Ratio
Indicates net income generated by each
dollar of sales
Net Income
Net Sales

26. Return On Assets
Reveals the amount of net income
generated by each dollar invested
Net Income
Average Total Assets

27. Return on Equity
Indicates profitability of common
stockholders’ investment
Net Income
Average Total Equity

28. Market Value Ratios
Deals with market value of stock.
.
WHO CARES?
Stockholder’s

29. Earnings Per Share (EPS)
Indicates net income earned on each
share of common stock sales
Net Income
Shares Outstanding

30. Price Earnings Ratio
Indicates relationship between market
price per share and earnings per share
Stock Price
Earnings Per Share

31. Payout Ratio
Indicates % of earnings distributed in
the form of cash dividends
Dividends
Net Income

32. Retention Ratio
Indicates % of earnings plowed back
into the corporation.
Addition to Retained Earnings
Net Income

33. Limitations Of
Financial Analysis
• Horizontal, vertical, and ratio analysis are
frequently used in making significant
business decisions.
• One should be aware of the limitations of
these tools and the financial statements.