Chapter3nt[1]

# Chapter3nt[1] - Analyzing Financial Statements Chapter 3 1...

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1 Analyzing Financial Statements Chapter 3

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2 Chapter 3 Learning Goals LG1: Calculate and interpret major liquidity ratios LG2: Calculate and interpret major asset management ratios LG3: Calculate and interpret major debt ratios LG4: Calculate and interpret major profitability ratios LG5: Calculate and interpret major market value ratios LG6: ppreciate how various ratios relate to one another LG7: iscuss the differences between time series and cross-sectional ratio analysis and decide which is most appropriate given an analytical situation LG8: xplain cautions that should be taken when examining financial ratios and financial information in general
3 Introduction The real value of financial statements lies in the fact that managers, investors, and analysts can use the information in the statements to: Analyze firm performance Plan changes to improve performance Ratio Analysis Calculating and analyzing financial ratios to assess a firm’s performance

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4 Ratios fall into five groups: Liquidity ratios Asset management ratios Debt management ratios Profitability ratios Market value ratios After managers, analysts, or investors calculate a firm’s ratios they make two comparisons: Trend – comparison to the same firm over time Competitors – comparison to other firms in the same industry We will use the financial statements for DPH Tree Farm to illustrate the use of ratios
5 Table 3-1

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6 Liquidity Ratios Liquidity ratios provide an indication of the ability of the firm to meet its obligations as they come due The three most common liquidity ratios are the current ratio, the quick (or acid- test) ratio, and the cash ratio
7 The broadest liquidity measure is the current ratio , which measures the dollars of current assets available to pay each dollar of current liabilities Current Ratio = CA / CL Inventory is the least liquid of the current assets, and is the current asset for which book values are the least reliable measure of market value. The quick, or acid-test ratio excludes inventory in the numerator, and measures the firm’s ability to pay off short-term obligations without relying on inventory sales: Quick Ratio = (CA – Inventory) / CL The cash ratio measures a firm’s ability to pay short-term obligations with its available cash and marketable securities Cash Ratio = Cash / CL

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Example 3.1: Calculating Liquidity Ratios Use the balance sheet ( Table 2.1) and income statement ( Table 2.2) for DPH Tree Farm, Inc. to calculate the firm’s 2008 values for the liquidity ratios. SOLUTION: The liquidity ratios for DPH Tree Farm, Inc. are calculated as follows. Current ratio=\$205m/\$120m=1.71 times \$ . \$ Industry average 1.50 times Quick ratio (acid- test ratio)=(\$205m-\$111m)/\$120m=0.78 times Industry average 0.50 times Cash ratio=\$24mS120m=0 20 times Industry average 0.15 times All three liquidity ratios show that DPH Tree Farm, Inc. has more
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## This note was uploaded on 10/20/2011 for the course FIN 500 taught by Professor Yi during the Spring '10 term at CSU Dominguez Hills.

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Chapter3nt[1] - Analyzing Financial Statements Chapter 3 1...

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