Ch18 Louderback Analyzing FS

Ch18 Louderback Analyzing FS - Chapter Eighteen ANALYZING...

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794 Chapter Eighteen A NALYZING F INANCIAL S TATEMENTS LEARNING OBJECTIVES After reading this chapter, you should be able to Explain why financial analysts use ratios to evaluate companies. •E xplain liquidity and show how ratios can measure a company’s liquidity. Explain profitability and show how ratios can measure a company’s profitability. Explain solvency and show how ratios can measure a company’s solvency. Describe leverage and show how it changes returns to stockholders. Explain some limitations of ratio analysis. The financial performance of a company is of major interest to its employ- ees and shareholders, among others. A company’s goals are often stated in terms of financial results. For example: Minnesota Mining & Manufacturing (3M) has stated its financial goals as follows: “We strive to maximize shareholder value through solid, profitable growth and effective use of capital. Specific financial goals are to achieve (1) at least 30 percent of sales from products in- troduced during the past four years; (2) growth in earnings per share of more than 10 percent a year, on average; (3) growth in economic profit exceeding earnings per share growth, and return on invested capital among the highest of industrial companies.” Walt Disney Company has stated: “The company’s primary finan- cial objective remains 20% compound annual earnings per share growth over future five-year periods and, secondarily, steady im- provement in return on equity.” Boise Cascade has stated: “We are moving rapidly to achieve fully competitive positions in all of our businesses and products and are focused on achieving our financial goals: To be profitable throughout the business cycle and to be EVA-positive over the cycle.” Sources: 3M 1997 annual report. Walt Disney Company 1997 Factbook. Boise Cascade 1997 annual report.
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Chapter Eighteen Analyzing Financial Statements 795 Throughout this book we have stressed the importance of expectations and the ways that accounting and other information help managers form reasonable ex- pectations. We have also used ratios among financial statement elements. Chapter 2 showed that managers often express target profits as a ratio of income to sales (return on sales). In Chapter 11 you saw that managers commonly use the ratio of income to total assets (or some other measure of return on investment) to measure divisional performance. Chapter 7 illustrated the cash squeeze that can accom- pany buildups of inventories and receivables, as well as how managers use ratios when developing long-term plans. This chapter addresses the analysis of finan- cial statements, including the calculation, interpretation, and evaluation of finan- cial ratios. Many people and organizations outside a company, such as suppliers and in- vestors in debt or equity securities, are interested in the company’s activities.
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Ch18 Louderback Analyzing FS - Chapter Eighteen ANALYZING...

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