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Unformatted text preview: 154 CHAPTER REVIEW Characteristics1. Financial statement analysisenables the financial statement user to make informed decisions about a company. 2. When analyzing financial statements, three major characteristics of a company are generally evaluated: (a) liquidity, (b) profitability, and (c) solvency. 3. (S.O. 1) Comparative analysis may be made on a number of different bases. a. Intracompany basis—Compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years. b. Industry averages—Compares an item or financial relationship of a company with industry averages. c. Intercompany basis—Compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. Tools of Financial Analysis4. (S.O. 2) There are three basic tools of analysis: (a) horizontal, (b) vertical, and (c) ratio. Horizontal Analysis5. (S.O. 3) Horizontal analysis,also called trend analysis,is a technique for evaluating a series of financial statement data over a period of time to determine the increase or decrease that has taken place, expressed as either an amount or a percentage. In horizontal analysis, a base year is selected and changes are expressed as percentages of the base year amount. Vertical Analysis6. (S.O. 4) Vertical analysis,also calledcommon size analysis,expresses each item within a financial statement as a percent of a base amount. Generally, the base amount is total assets for the balance sheet, and net sales for the income statement. For example, it may be determined that current assets are 22% of total assets, and selling expenses are 15% of net sales. Ratio Analysis7. (S.O. 5) A ratio expresses the mathematical relationship between one quantity and another as either a percentage, rate, or proportion. Ratios can be classified as: a. Liquidity ratios—measures of the shortterm debtpaying ability. b. Profitability ratios—measures of the income or operating success of an enterprise for a given period of time. c. Solvency ratios—measures of the ability of the enterprise to survive over a long period of time. 8. There are fourliquidity ratios:the current ratio, the acid test ratio, receivables turnover, and inventory turnover. 155 9. The current ratioexpresses the relationship of current assets to current liabilities. It is a widely used measure for evaluating a company’s liquidity and shortterm debt paying ability. The formula for this ratio is: Current assets Current ratio = Current liabilities 10. The acidtest or quick ratio relates cash, shortterm investments, and net receivables to current liabilities. This ratio indicates a company’s immediate liquidity. It is an important complement to s immediate liquidity....
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This note was uploaded on 01/27/2010 for the course MGT 011A taught by Professor Hancock,john during the Spring '07 term at UC Davis.
 Spring '07
 Hancock,John

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