FM_ch3_notes - Chapter 3: Financial Statement Analysis...

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Chapter 3: Financial Statement Analysis Summary: Using Financial Ratios Financial Ratios are measures of relative values of key financial information. Ratio Analysis involves methods of calculating and interpreting financial ratios to assess the firm’s performance. Ratios are measured as (1) percentages; (2) times or multiples; and (3) number of days. Parties interested in Ratios Ratios are of interest as key indicators of financial health to: o shareholders, o creditors, o management, and o prospective investors. Ratio analysis directs attention to potential areas of concern, but are not conclusive evidence of problems. Types of Ratio Comparisons Cross-Sectional Analysis involves the comparison of different firms at the same time. o Benchmarking firm performance against industry averages is very popular. Time-Series Analysis evaluates performance over time, allowing for comparisons of current and past ratio values. Combined Analysis mixes both features of Cross-Sectional and Time Series Analysis. Categories of Financial Ratios Ratios are grouped into four basic categories: o liquidity ratios, o activity ratios, o leverage ratios, and o profitability ratios. Analyzing Liquidity Liquidity refers to the firm’s ability to satisfy its short-term obligations as they come due. Three areas are of particular concern: o Net Working Capital, o The Current Ratio, and o The Quick (Acid-Test) Ratio. 1
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Net Working Capital Net Working Capital = Current Assets - Current Liabilities Current Ratio Commonly used, the Current Ratio measures the ability to meet short-term obligations. Current Ratio = Current Assets/Current Liabilities Quick (Acid Test) Ratio The Quick Ratio focuses on only the most liquid of the firm’s current assets: cash, marketable securities, and accounts receivable. Quick Ratio = Cash + Marketable Securities + Accounts Receivable Current Liabilities Analyzing Activity Activity Ratios measure the effectiveness of managing accounts receivable, inventory, accounts payable, fixed assets, and total assets. There are Activity Ratios for each of these management issues. Average Age of Inventory This ratio measures the effective management of inventory in terms of number of days inventory is held. Average Age of Inventory = Inventory Daily COGS Where Daily COGS equals the daily value of the Cost of Goods Sold. Average Collection Period Useful for evaluating credit and collections policies of the firm, this ratio is also measured in days. Average Collection Period = Accounts Receivable Average Sales Per Day Average Payment Period This ratio evaluates the speed of satisfying the Accounts Payable for the firm. Average Payment Period =
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This note was uploaded on 11/15/2009 for the course BBA ADMN3116 taught by Professor G.jensen during the Fall '09 term at Laurentian.

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FM_ch3_notes - Chapter 3: Financial Statement Analysis...

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