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Financial Analysis

1. Ratio Analysis
1. Calculating and analyzing a firm's financial ratios are one form of financial analysis. Financial ratios are used to objectively evaluate the performance of a business firm. They are useful to judge comparative firm performance. ____ or trend analysis allows the financial analyst to evaluate firm performance across several time periods by comparing ratios across those time periods(Key Term). ____ allows the financial analyst to compare thaeir firm's financial ratios against other firms in the same industry in order to determine how the firm does compared to its peers(Key Term). See Slide Financial Analysis and Ratios (41.0K) .
2. There are many sources of financial ratio data. One excellent resource is located at ValuationResources.com and references a number of excellent sources of industry financial ratio data.
3. There are four main categories of financial ratios that financial managers should analyze. They are ____, ____, ____ and ____(Critical Concept). See Slide 4 Categories of Ratios (33.0K) . Different groups of users of this information will find particular ratios more helpful than others. For example ____, find profitability ratios most helpful(Critical Concept). Bondholders would find ____ helpful(Critical Concept ). Potential creditors may use ____ ratios to determine whether the firm can pay its short-term debt on time(Critical Concept ).
2. Categories of Financial Ratios
1. Profitability Ratios. This group of ratios indicates how profitable the business firm is as well as its return to its shareholders. The three main ratios that comprise the profitability group are the net profit margin, return on assets and return on equity. The ____ indicates how much of each sales dollar goes to net income and how much goes to expenses(Key Term)Return on assets (or return on investment) is a combination of the net profit margin and total asset turnover. It will tell the analyst where the bulk of their return is coming from. ____ equity indicates how much the shareholders are earning on their equity investment in the firm(Key Term). The only difference between return on assets and return on equity is the firm's equity multiplier. The equity multiplier is the ratio of Total Assets to Stockholder's Equity. It indicates the debt position of the firm. Calculations for these ratios are shown here (64.0K) . One of the major online brokerages provides a tutorial on using profitability ratios. See Slide Profitability Ratios (38.0K) . Profitability and turnover ratios can be used together to perform Dupont analysis. See Slide 2 (4910.0K) and Profitability and Turnover Ratios (31.0K) .
2. Asset Utilization Ratios. These ratios tell the financial manager how well the firm generates sales from its asset base. Receivables turnover and ____ can be used together to determine the firm's efficiency with regard to its accounts receivable(Critical Concept). Inventory turnover determines how rapidly the firm sells and restocks its inventory. Fixed asset turnover relates to the firm's utilization of its plant and equipment. Total asset turnover is the summary ratio in this group. Any problems that show up in the firm's assets will be reflected by the total asset turnover ratio. Take a look at these calculations (41.0K) . See Slide Asset Utilization Ratios (45.0K) .
3. Liquidity Ratios. Liquidity ratios indicate how easily the firm can pay its short term liabilities like accounts payable and are calculated here. The ____ shows the financial manager how many times over the firm can meet its short-term debt obligations(Key Term). The ____ is a more refined measure of liquidity showing how well the firm can pay its short-term debt without selling inventory(Key Term). See Slide Liquidity Ratios (38.0K)
4. Debt Utilization Ratios. The debt ratio group allows the financial manager to determine the optimal amount of debt for the firm. Two of the debt ratios deal with how the firm meets its fixed charge obligations, such as interest, lease payments and others. Those ratios are the times interest earned ratio and the fixed charge coverage ratio. The ____ is a more refined measure of liquidity showing how well the firm can pay its short-term debt without selling inventory(Key Term). These ratios can be compared to industry averages to determine their appropriateness. Check out the calculationshere (53.0K) . See Slide Debt Utilization Ratios (44.0K) .
5. Summary. Financial ratio analysis is a powerful financial analysis tool but it is not the only tool. Ratio analysis also has its limitations.
3. Factors That Impact Financial Analysis
1. Inflation effects. During periods of economy-wide inflation, sales revenue is stated in current dollars while assets like plant and equipment are stated as historical costs. This can distort ratio analysis. See Slide Inflation's Impact on Profits (40.0K) .
2. Disinflation effects. If a period of falling prices, corporate profits fall and, again, ratio analysis is distorted when revenue is stated in current dollars and assets like plant and equipment are stated as historical costs.
3. Other effects. Differences in reporting revenue, different methods of inventory accounting and extraordinary gains and losses can also impact ratio analysis.