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chap_03 - Chapter 3 WORKING WITH FINANCIAL STATEMENTS...

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Chapter 3 WORKING WITH FINANCIAL STATEMENTS ANNOTATED CHAPTER OUTLINE Slide 3.1 Key Concepts and Skills Slide 3.2 Chapter Outline Lecture Tip, page 49: Students sometimes get the impression that accounting data is useless because care must be used when interpreting some of the results. They sometimes ask why we bother with financial statement analysis at all. Robert Higgins provides a good answer to this question: “objectively determinable current values of many assets do not exist. Faced with a trade-off between relevant, but subjective current values, and irrelevant, but objective historical costs, accountants have opted for irrelevant, but objective historical costs. This means that it is the user’s responsibility to make adjustments” Financial statement information is often our ONLY source of information. Consequently, we use the information we have and make adjustments where appropriate. 3.1. Standardized Financial Statements Standardized statements allow users to compare companies of different sizes or better compare a company as it grows through time. Slide 3.3 Standardized Financial Statements .A Common-Size Balance Sheets All accounts are expressed as a percent of total assets. .B Common-Size Income Statements All items are expressed as a percent of sales. 3.2. Ratio Analysis

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A-28 WORKING WITH FINANCIAL STATEMENTS Slide 3.4 Ratio Analysis Things to consider concerning financial ratios: -What aspects of the firm are we attempting to analyze? -What information goes into computing a particular ratio and how does that information relate to the aspect of the firm being analyzed? -What is the unit of measurement (times, days, percent)? -What are the benchmarks used for comparison? What makes a ratio “good” or “bad?” Categories of Financial Ratios: -Short-term solvency, or liquidity, ratios attempt to measure a firm’s ability to pay bills in the short-run -Long-term solvency, or financial leverage, ratios attempt to measure a firm’s ability to meet long-term obligations -Asset management, or turnover, ratios attempt to measure how efficiently, and effectively, a firm uses its assets -Profitability ratios attempt to measure how efficiently a firm operates and how that translates to the “bottom line” -Market value ratios attempt to measure how the market views the firm value relative to its book value Slide 3.5 Categories of Financial Ratios Lecture Tip, page 53: Students often fail to see the “forest” for all the “trees” (equations) when they are first learning financial statement analysis. It’s important to remind them that we aren’t just computing ratios; we are computing ratios to help us make better decisions. Teaching the ratios by category and showing how each category can answer different questions related to the financial strength of the firm may help students see the overall picture painted by financial statement analysis.
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