Chapter 3: Analyzing Financial Statements

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ratio analysis

the process of calculating and analyzing financial ratios to assess the firm's performance and to identify actions needed to improve firm performance

liquidity ratios

measure the relation between a firm's liquid (or current) assets and its current liabilities

asset management ratios

measure how efficiently a firm uses its assets (inventory, accounts receivable, and fixed assets) as well as its accounts payable

current ratio

measures the dollars of current assets available to pay each dollar of current liabilities

quick ratios (acid-test)

measures a firm's ability to pay off short-term obligations without relying on inventory sales

cash ratio

measures a firm's ability to pay short-term obligations with its available cash and marketable securities

inventory turnover ratio

measures the number of dollars of sales produced per dollar of inventory

days' sales in inventory ratio

measure the number of days that inventory is held before the final product is sold

average collection period (ACP)

measures the number of days accounts receivable are held before the firm collects cash from the sale

accounts receivable turnover ratio

measures the number of dollars of sales produced per dollar of accounts receivable

average payment period (APP)

measures the number of days that the firm holds accounts payable before it has to extend cash to buy raw materials

accounts payable turnover ratio

measures the dollar cost of goods sold per dollar of accounts payable

fixed asset turnover ratio

measures the number of dollars of sales produced per dollar of fixed assets

sales to working capital ratio

measure the number of dollars of sales produced per dollar of net working capital

total asset turnover ratio

measures the number of dollars of sales produced per dollar of total assets

capital intensity ratio

measure the dollars of total assets needed to produce a dollar of sales

debt management ratios

measure the extent to which the firm uses debt (or financial leverage) versus equity to finance its assets

debt ratio

measure the percentage of total assets financed with debt

debt-to-equity ratio

measures the dollars of debt financing used for every dollar of equity financing

equity multiplier ratio

measures the dollars of assets on the balance sheet for every dollar of equity financing

capital structure

amount of debt versus equity to hold on the balance sheet

times interest earned ratio

measures the number of dollars of operating earnings available to meet each dollar of interest obligations on the firm's debt

fixed-charge coverage ratio

measures the number of dollars of operating earnings available to meet the firm's interest dollars and other fixed charges

cash coverage ratio

measure the number of dollars of operating cash available to meet each dollar of interest and other fixed charges that the firm owes

profitability ratios

show the combined effects of liquidity, asset management, and debt management on the overall operating results of the firm

profit margin

the percentage of sales left after all firm expenses are paid

basic earnings power ratio

measures the operating return on the firm's assets, irrespective of financial leverage and taxes

return on assets (ROA)

measures the overall return on the firm's assets, inclusive of financial leverage and taxes

return on equity (ROE)

measures the return on the common stockholder's investment in the assets of the firm

dividend payout ratio

the percentage of net income available to common stockholders that the firm actually pays as cash to these investors

market value ratios

relate a firm's stock price to its earnings and its book value

market-to-book ratio

measures the amount that investors will pay for the firm's stock per dollar of equity used to finance the firm's assets

book value per share

accounting based number reflecting the firm's assets' historical costs and value

price-earnings ratio

measures how much investors are willing to pay for each dollar the firm earns per share of its stock

DuPont analysis system

an analytical method that used the balance sheet and income statement to break the ROA and ROE ratios into component pieces

common-size financial statements

dividing all balance sheet amounts by total assets and all income statement amounts by net sales

internal growth rate

the growth rate a firm can sustain if it uses only internal financing (retained earnings) to finance future growth

substantial growth rate

the growth rate a firm can sustain if it finances growth using both debt and internal financing such that the debt ration remains constant

time series analysis

analyzing firm performance by monitoring ratio trends

cross-sectional analysis

analyzing the performance of a firm against one or more companies in the same industry

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