income statement items by net sales) More difficult to be useful for the statement of cash flows Example of Vertical Analysis Ratio Analysis - Used in assessing Liquidity ▪ Does this firm have the ability to pay its bills in the short run? Profitability ▪ How well does this company generate profits? Solvency ▪ Is this company positioned to survive for the long run? Operations ▪ How effectively are managers using company resources? Marketability
▪ How does the market value the stock in this company? Liquidity Analysis - The purpose is determine if the company appears able to pay its bills in the short run. Commonly used liquidity ratios: Current Ratio = Current Assets / Current Liabilities Quick Ratio = Quick Assets / Current Liabilities **Quick assets = Cash + short-term securities + accounts receivable) Working Capital = Current Assets – Current Liabilities Net Working Capital Ratio = Working Capital / Total Assets Profitability Analysis - To assess the ability to generate income Common Ratios: Return on Assets = Net Income/Total Assets Return on Equity = Net Income/*Avg. Stockholders’ Equity *Avg SE = (Beg SE + End SE) / 2 Profit Margin = Net Income / Sales Earnings per share = Net income – preferred dividends / Avg # Common Shares Outstanding Avg Shares Outstanding = (Beg OS Shares + End OS Shares) ./2 (Average number of shares outstanding computation may need to be more complex if number of OS shares changes a great deal) Solvency Analysis Ratios - to assess a company’s ability to pay its bills in the long run Common Ratios: Debt to Equity = Total debt / Total SH Equity Interest Coverage = Income before interest & tax expenses / interest expense I Activity Analysis Ratios (Operating Effectiveness) - To assess how management is using company resources Common ratios: Asset turnover = Sales Revenue / Average Total Assets* *(Avg’ Total Assets = (Beg Assets+ End Assets) / 2) A Rec Turnover = Sales/Average Accounts Receivable** (Average Acct Rec = (Beg AR+ End AR) / 2) Inventory Turnover = Cost of Goods Sold/ Average Inventories*** ***(Average Inventory = (Beg Inv + End Inv) / 2) Market Ratios - To assess how the market values the company
Common Ratios: Price Earnings = Market Price of Common Stock/ Earnings Per Share Market to Book = Market Price of Common Stock / Book Value per Common Share* *(Stockholders’ Equity – Preferred Equity) / # Common Shares Dividend Yield = Annual Dividends per Common Share / Market Price of Common Share Dividend Payout = Cash Dividends/ Net Income Analysis of the Footnotes Read the pages of footnotes for each company for both years of analysis. Search for off-balance sheet financing (liabilities that are not on the balance sheet) Learn about accounting methods and many other items.
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