Chap15 Class Notes 2010

Chap15 Class Notes 2010 - Chapter 15 Analyzing Financial...

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Victor Leung 1 ACCT2111 (2010) Chapter 15 Chapter 15 Analyzing Financial Statements I. Basics of Financial Statement Analysis 1. Financial statement analysis enables 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 measures the short-term ability of the company to pay its maturing obligations (bills) and to meet unexpected needs for cash. A short-term creditor (a bank) is primarily interested in company liquidity . (b) Profitability measures the income or operating success of a company for a given period of time. (c) Solvency measures the company’s ability to survive over a long period of time. A long-term creditor (a bondholder) looks to profitability and solvency Stockholders are interested in the profitability and solvency of the company. They want to assess the likelihood of dividends and the growth potential of the stock. II. Need for Comparative analysis (Object. 1) Comparative analysis may be made on a number of different bases. 1. Intra-company 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. To detect changes in financial relationships and significant trends within a company. 2. Industry averages (norms) — Compares an item or financial relationship of a company with industry averages. To provide information as to a company’s relative performance within the industry. 3. Inter-company basis — Compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. To provide insight into a company’s competitive position.
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Victor Leung 2 ACCT2111 (2010) Chapter 15 III. Tools of Financial Statement Analysis There are three basic tools of analysis: (a) horizontal, (b) vertical, and (c) ratio. Horizontal Analysis (Object. 3) Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time to determine the changes from the previous year (base year) to the current year, expressed as either an amount or a percentage of the selected base year amount. Trend analysis is a variation of horizontal analysis in which changes are calculated for several successive years instead of for two years. ILLUSTRATION 15-1 Horizontal analysis
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Victor Leung 3 ACCT2111 (2010) Chapter 15 Vertical Analysis (Object. 4) Vertical analysis, also called common 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. Useful to identify changes of a specific component from one year to the next.
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This note was uploaded on 02/04/2012 for the course ACCT 2111 taught by Professor Eric during the Spring '11 term at CUHK.

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Chap15 Class Notes 2010 - Chapter 15 Analyzing Financial...

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