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Financial accounting the impact on decision makers 9e chapter 13

Chapter 13
Financial Statement Analysis

Limitations and Considerations in
Financial Statement Analysis
Watch for alternative accounting principles
 Selection of a inventory valuation method
 Changes in accounting method
 Take care when making comparisons
 Recognizing trends in ratios
 Extra caution for extraordinary items and gains and
losses from discontinued operations

LO 1

Limitations and Considerations in
Financial Statement Analysis (continued)

Understand the possible effects of inflation
 Financial statements are based on historical costs
and are not adjusted for the effects of increasing

Analysis of Comparative Statements:
Horizontal Analysis

Comparison of financial statement items over a period
of time

LO 2

Example 13.1—Preparing and Reading
Comparative Balance Sheets—Horizontal Analysis

Example 13.2—Preparing and Reading Comparative Statements of
Income and Retained Earnings—Horizontal Analysis

Example 13.3—Preparing and Reading Comparative
Statements of Cash Flows—Horizontal Analysis

Analysis of Common-Size Statements:
Vertical Analysis
Comparison of various financial statement
items within a single period with the use of
common-size statements
 Common-size statements recast items as a
percentage of a selected item

LO 3

Example 13.4—Preparing and Reading
Common-Size Balance Sheets—Vertical Analysis

Example 13.5—Preparing and Reading
Common-Size Income Statements—Vertical Analysis

Liquidity Analysis

A relative measure of the nearness to cash of the
assets and liabilities of a company

LO 4

Working Capital

The excess of current assets over current liabilities at a
point in time

Current Ratio
The ratio of current assets to current liabilities
 One of the most widely used financial statement

Acid-Test Ratio
A stricter test of liquidity than the current ratio
 Excludes inventory and prepayments from the

Cash Flow from Operations to Current

A measure of the ability to pay current debts from
operating cash flows

Accounts Receivable Analysis

Accounts receivable turnover ratio: a measure of the
number of times accounts receivable are collected in a

Number of days’ sales in receivables: a measure of the
average age of accounts receivable

Inventory Analysis

Inventory turnover ratio: a measure of the number of
times inventory is sold during a period

Number of days’ sales in inventory: a measure of how
long it takes to sell inventory

Cash-to-Cash Operating Cycle

The length of time from the purchase of inventory to
the collection of any receivable from the sale

Solvency Analysis

The ability of a company to remain in business over
the long term
 The ability of the firm to stay financially healthy over
the period of time that existing debt (short- and
long-term) is outstanding

LO 5

Debt-to-Equity Ratio

The ratio of total liabilities to total stockholders’

The composition of debt and equity is an important
determinant of the cost of capital to a company

Times Interest Earned Ratio

Indicates the company’s ability to meet the current
year’s interest payments out of the current year’s

Debt Service Coverage Ratio

Measure of the amount of cash that is generated from
operating activities during the year and that is
available to repay interest due and any maturing
principal amounts

Cash Flow from Operations to Capital
Expenditures Ratio

A measure of the ability of a company to finance longterm asset acquisitions with cash from operations

Profitability Analysis

How well management is using company resources to
earn a return on the
= funds invested by various groups

Two frequently used profitability measures:

Gross Profit Ratio =

Profit Margin Ratio =

Gross Profit
Net Sales
Net Income
Net Sales
LO 6

Rate of Return on Assets

A measure of a company’s success in earning a return
for all providers of capital

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