Chapter-3- Firm's Financial Perform Ace

8/8/2019 Chapter-3- Firm's Financial Perform Ace

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Why Do We Analyze Financial Statements?

A firms financial statements can be analyzed

internally (by employees, managers) and

externally (by bankers, investors, customers,

and other interested parties).


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(cont.) An internal financial analysis might be done:

To evaluate the performance of employees and determine their pay

raises and bonuses.

To compare the financial performance of the firms different

divisions.

To prepare financial projections, such as those associated with the

launch of a new product.

To evaluate the firms financial performance in light of its

competitors and determine how the firm might improve its

operations.


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(cont.) A variety of firms and individuals that have an

economic interest might also undertake an

external financial analysis: Banks and other lenders deciding whether to loan

money to the firm.

Suppliers who are considering whether to grant credit

to the firm.

Credit-rating agencies trying to determine the firms

creditworthiness.


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(cont.) Professional analysts who work for investment

companies considering investing in the firm or

advising others about investing.

Individual investors deciding whether to invest

in the firm.


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Using Financial Ratios

Financial ratios provide a second method for standardizing

the financial information on the income statement and

balance sheet.

A ratio by itself may have no meaning. Hence, a given ratiois compared to: (a) ratios from previous years; or (b) ratiosof other firms in the same industry.

If the differences in the ratios are significant, more in-depth

analysis must be done.


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Using Financial Ratios (cont.)

Question Category of Ratios Used

1. How liquid is the firm? Will it beable to pay its bills as theybecome due?

Liquidity ratios

2. How has the firm financed thepurchase of its assets?

Capital structure ratios

3. How efficient has the firmsmanagement been in utilizing itassets to generate sales?

Asset management efficiencyratios

4. Has the firm earned adequatereturns on its investments? Profitability ratios

5. Are the firms managers creatingvalue for shareholders?

Market value ratios


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Liquidity Ratios

Liquidity ratios address a basic question: How

liquid is the firm?

A firm is financially liquid if it is able to pay its

bills on time. We can analyze a firms liquidity

from two perspectives:

Overall or general firm liquidity

Liquidity of specific current asset accounts


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Liquidity Ratios (cont.)

Overall liquidity is analyzed by comparing the

firms current assets to the firms current

liabilities.

Liquidity of specific assets is analyzed by

examining the timeliness in which the firms

primary liquid assets accounts receivable andinventories are converted into cash.


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Liquidity Ratios: Current Ratio

The overall liquidity of a firm is analyzed bycomputing the current ratio and acid-test ratio.

Current Ratio: Current Ratio compares a firmscurrent (liquid) assets to its current (short-term)liabilities.


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Liquidity Ratios: Quick Ratio

The overall liquidity of a firm is also analyzed by

computing the Acid-Test (Quick) Ratio. This ratio

excludes the inventory from current assets as

inventory may not always be very liquid.


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Liquidity Ratios: Accounts Receivable

Average Collection Period measures the

number of days it takes the firm to collects its

receivables.


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Liquidity Ratios: Accounts Receivable

Turnover Ratio Accounts Receivable Turnover Ratio measures

how many times accounts receivable are rolled

over during a year.


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Liquidity Ratios:

Inventory Turnover Ratio

Inventory turnover ratio measures how many

times the company turns over its inventory

during the year. Shorter inventory cycles lead to

greater liquidity since the items in inventory are

converted to cash more quickly.


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Liquidity Ratios:

Days Sales in Inventory We can express the inventory turnover ratio in terms of the

number of days the inventory sits unsold on the firms

shelves.

Days Sales in Inventory= 365 inventory turnover ratio

= 365 8.63 = 42.29 days

The firm, on average, holds it inventory for about 42 days.


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Checkpoint 4.1

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Chapter-3- Firm's Financial Perform Ace