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Financial Statement Analysis at different Stages
After studying this chapter, you
should be able to:
1. List basic financial statement
analytical procedures.
2. Apply financial statement analysis
to assess the solvency of a
business.
3. Apply financial statement analysis
to stress the profitability of a
business.
4. Describe the contents of
corporate annual reports.
WHY?
WHEN?
HOW?






How much money does the company need?
When is the money needed?
When will the company make money?
How much money will they make? When?
Shareholders equity, how much needed?
Credit, how much needed?







How much money does the company need?
When is the money needed?
When will the company make money?
How much money will they make? When?
Shareholders equity, is the mix correct?
Credit, are current arrangements correct?
Are actuals inline with forecasts?








How much money does the company need?
When is the money needed?
When will the company make money?
How much money will they make? When?
Shareholders equity, is the mix correct?
Credit, are current arrangements correct?
Are actuals inline with forecasts?
How to fund growth?

Internal Users
◦ Management
◦ Owner (s)

External Users
Investors
Creditors
Government
Customers
Labour Unions
(employees)
◦ Public
◦
◦
◦
◦
◦
Horizontal Analysis
The percentage analysis of
increases and decreases in
related items in comparative
financial statements is
called horizontal analysis.
10
Exhibit 1 Comparative Balance Sheets
Lincoln Company
Comparative Balance Sheet
December 31, 2008 and 2007
2008
2007
Increase (Decrease)
Amount
Percent
Assets
Current assets
$ 550,000 $ 533,000$ 17,000
Long-term investments
95,000
177,500 (82,500)
Prop., plant, and equip. (net) 444,500
470,000 (25,500)
Intangible assets
50,000
50,000
Total assets
$1,139,500 $1,230,500$ (91,000)
Liabilities
Current liabilities
$ 210,000 $ 243,000$ (33,000)
Long-term liabilities
100,000
200,000
100,000)
Total liabilities
$ 310,000 $ 443,000$(133,000)
Stockholders’ Equity
Preferred 6% stock, $100 par$ 150,000$ 150,000
—
Common stock, $10 par
500,000
500,000
—
Retained earnings
179,500
137,500$ 42,000
Total stockholders’ equity $ 829,500 $ 787,500$ 42,000
Total liab. & stockholders’ eq.$1,139,500$1,230,500$ (91,000)
3.2%
(46.5%)
(5.4%)
(7.4%)
(13.6%)
(50.0%)
(30.0%)
30.5%
5.3%
(7.4%)
11
Lincoln Company
Comparative Balance Sheet
December 31, 2008 and 2007
2008
2007
Increase (Decrease)
Amount
Percent
Assets
Current assets
$ 550,000 $ 533,000$ 17,000
3.2%
Long-term investments
95,000
177,500 (82,500)
(46.5%)
Prop., plant, and equip. (net) 444,500
470,000 (25,500)
(5.4%)
Horizontal
Analysis:
Intangible assets
50,000
50,000
Total assets
$1,139,500 $1,230,500$ (91,000)
(7.4%)
Difference
$17,000
Liabilities
= 3.2%
Current liabilities
$ 210,000
$ (2007)
243,000$ (33,000)
Base year
$533,000(13.6%)
Long-term liabilities
100,000
200,000
100,000) (50.0%)
Total liabilities
$ 310,000 $ 443,000$(133,000)
(30.0%)
Stockholders’ Equity
Preferred 6% stock, $100 par$ 150,000$ 150,000
—
Common stock, $10 par
500,000
500,000
—
Retained earnings
179,500
137,500$ 42,000
30.5%
Total stockholders’ equity $ 829,500 $ 787,500$ 42,000
5.3%
Total liab. & stockholders’ eq.$1,139,500$1,230,500$ (91,000) (7.4%)
12
Lincoln Company
Comparative Balance Sheet
December 31, 2008 and 2007
2008
2007
Increase (Decrease)
Amount
Percent
Assets
Current assets
$ 550,000 $ 533,000$ 17,000
Long-term investments
95,000
177,500 (82,500)
Prop., plant, and equip. (net) 444,500
470,000 (25,500)
Intangible assets
50,000
50,000
Horizontal Analysis:
Total assets
$1,139,500
$1,230,500$ (91,000)
Liabilities
Difference
$(82,500)
Current liabilities
$ 210,000
$ 243,000$ (33,000)
Long-term liabilities
100,000
200,000
100,000)
Base
year (2007)
$177,500
Total liabilities
$ 310,000 $ 443,000$(133,000)
Stockholders’ Equity
Preferred 6% stock, $100 par$ 150,000$ 150,000
—
Common stock, $10 par
500,000
500,000
—
Retained earnings
179,500
137,500$ 42,000
Total stockholders’ equity $ 829,500 $ 787,500$ 42,000
Total liab. & stockholders’ eq.$1,139,500$1,230,500$ (91,000)
3.2%
(46.5%)
(5.4%)
(7.4%)
(13.6%)
= (46.5%)
(50.0%)
(30.0%)
30.5%
5.3%
(7.4%)
7
13
Exhibit 2
Comparative Schedule of
Current Assets
Lincoln Company
Comparative Schedule of Current Assets
December 31, 2008 and 2007
Cash
Marketable securities
Accounts receivable (net)
Inventories
Prepaid expenses
Total current assets
2008
$ 90,500
75,000
115,000
264,000
5,500
$550,000
Increase (Decrease)
2007
Amount Percent
$ 64,700 $ 25,800
39.9%
60,000
15,000
25.0%
120,000
(5,000)
(4.2%)
283,000 (19,000)
(6.7%)
5,300
200
3.8%
$533,000 $17,000
3.2%
14
Lincoln Company
Comparative Schedule of Current Assets
December 31, 2008 and 2007
Increase (Decrease)
2008
2007
Amount Percent
Cash
$ 90,500 $ 64,700 $ 25,800
39.9%
Marketable securities
75,000
60,000
15,000
25.0%
Accounts receivable (net)Horizontal
115,000
120,000
(5,000)
(4.2%)
Analysis:
Inventories
264,000 283,000 (19,000)
(6.7%)
Difference
Prepaid expenses
5,500
5,300 $25,800
200
3.8%
Total current assets
$550,000
$533,000 $64,700
$17,000 = 39.9%
3.2%
Base
year (2007)
9
9
15
Exhibit 3 Comparative Income Statement
Lincoln Company
Comparative Income Statement
For the Year Ended December 31, 2008 and 2007
Increase (Decrease)
2008
2007
Amount
Percent
Sales
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Other income
Other expense (interest)
Income before income tax
Income tax expense
Net income
$1,530,500 $1,234,000
32,500
34,000
$1,498,000 $1,200,000
1,043,000
820,000
$ 455,000 $ 380,000
$ 191,000 $ 147,000
104,000
97,400
$ 295,000 $ 244,400
$ 160,000 $ 135,600
8,500
11,000
$ 168,500 $ 146,600
6,000
12,000
$ 162,500 $ 134,600
71,500
58,100
$ 91,000 $ 76,500
$296,500
(1,500)
$298,000
223,000
$ 75,000
$ 44,000
6,600
$ 50,600
$ 24,400
(2,500)
$ 21,900
(6,000)
$ 27,900
13,400
$ 14,500
24.0%
(4.4%)
24.8%
27.2%
19.7%
29.9%
6.8%
20.7%
18.0%
(22.7%)
14.9%
(50.0%)
20.7%
23.1%
19.0%
16
Lincoln Company
Comparative Income Statement
For the Year Ended December 31, 2008 and 2007
Increase (Decrease)
2008
2007
Amount
Percent
Current assets
$1,530,500 $1,234,000 $296,500
24.0%
Sales returns and allowances
32,500
34,000
(1,500)
(4.4%)
Net sales
$1,498,000 $1,200,000 $298,000
24.8%
Cost of goods sold
1,043,000
820,000 223,000
27.2%
Gross profit
$ 455,000 $ 380,000 $ 75,000
19.7%
Selling expenses
$ 191,000 $ 147,000 $ 44,000
29.9%
Horizontal104,000
Analysis: 97,400
Administrative expenses
6,600
6,.8%
Total operating expenses
$ 295,000 $ 244,400 $ 50,600
20.7%
Increase$ amount
$296,500
Income from operations
160,000 $ 135,600
$ 24,400
18.0%
= 24.0% (22.7%)
Other income
8,500
11,000
(2,500)
Base year (2007)
$1,234,000
$ 168,500 $ 146,600 $ 21,900
14.9%
Other expense (interest)
6,000
12,000
(6,000)
(50.0%)
Income before income tax
$ 162,500 $ 134,600 $ 27,900
20.7%
Income tax expense
71,500
58,100
13,400
23.1%
Net income
$ 91,000 $ 76,500 $ 14,500
19.0%
17
Exhibit 4 Comparative RE Statement
Lincoln Company
Comparative Retained Earnings Statement
December 31, 2008 and 2007
A percentage analysis that
Increase (Decrease)
shows the2008
relationship
of Percent
2007
Amount
Retained earnings, Jan. 1
$137,500 $100,000 $37,500
37.5%
each
component
to
the
Net income for year
91,000
76,500
14,500
19.0%
Total
$228,500 a
$176,500
total within
single$52,000 29.5%)
Dividends:
statement
called
vertical—
On preferred
stock
$ is
9,000
$ 9,000
On common stock
40,000
30,000
10,000
33.3%
analysis.
Total
Total current assets
$ 49,000 $ 39,000
$179,500 $137,500
$10,000
$42,000
25.6%
30.5%
18
Exhibit 4 Comparative RE Statement
Lincoln Company
Comparative Retained Earnings Statement
December 31, 2008 and 2007
A percentage analysis that
Increase (Decrease)
shows the2008
relationship
of Percent
2007
Amount
Retained earnings, Jan. 1
$137,500 $100,000 $37,500
37.5%
each
component
to
the
Net income for year
91,000
76,500
14,500
19.0%
Total
$228,500 a
$176,500
total within
single$52,000 29.5%)
Dividends:
statement
called
vertical—
On preferred
stock
$ is
9,000
$ 9,000
Horizontal Analysis:
On common stock
40,000
30,000
10,000
33.3%
analysis.
Total
Total current assets
$ 49,000
$10,000
25.6%
Increase
amount $ 39,000$37,500
= 37.5%30.5%
$179,500
$42,000
Base year
(2007) $137,500
$100,000
19
Vertical Analysis
A percentage analysis used
to show the relationship of
each component to the total
within a single statement is
called vertical analysis.
20
Vertical Analysis of Balance Sheet
In a vertical analysis of the balance
sheet, each asset item is stated as
a percent of the total assets. Each
liability and stockholders’ equity
item is stated as a percent of the
total liabilities and stockholders’
equity.
21
Lincoln Company
Comparative Balance Sheet
For the Years Ended December 31, 2008 and 2007
2008
2007
Amount
Percent
Amount Percent
Assets
Current assets
Long-term investments
Property, plant, & equip. (net)
Intangible assets
Total
assets
Total
assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Stockholders’ Equity
Preferred 6% stock, $100 par
2.2% Common stock, $10 par
Retained earnings
Total stockholders’ equity
Totalliab.
liab.&&stockholders’
Stockholders’equity
equity
Total
$ 550,000
48.3% $ 533,000
43.3%
95,000
8.3
177,500
14.4
444,500
39.0
470,000
38.2
50,000
4.4
50,000
4.1
$1,139,500
100.0%
$1,230,500 100.0%
$1,139,500
100.0%$1,230,500100.0%
$ 210,000
100,000
$ 310,000
18.4%
8.8
27.2%
$ 243,000
200,000
$ 443,000
19.7%
16.3
36.0%
$ 150,000
13.2% $ 150,000
12.2%
500,000
43.9
500,000
40.6
179,500
15.7
137,500
11.2
$ 829,500
72.8% $ 787,500
64.0%
$1,139,500
$1,230,500 100.0%
$1,139,500 100.0%
100.0% $1,230,500100.0%
22
To demonstrate how vertical
analysis percentages are
calculated for the balance
sheet, let’s see how the 48.3
percent was calculated for the
2008 current assets in the
next slide.
23
Lincoln Company
Comparative Balance Sheet
For the Years Ended December 31, 2008 and 2007
2008
2007
Amount
Percent
Amount Percent
Assets
Current assets
$ 550,000
48.3% $ 533,000
43.3%
Long-term investments
95,000
8.3
177,500
14.4
Property, plant, & equip. (net)
444,500
39.0
470,000
38.2
Intangible assets
50,000
4.4
50,000
4.1
Total
assets
$1,139,500
100.0%
$1,230,500 100.0%
Total
assets
$1,139,500
100.0%$1,230,500100.0%
Liabilities
Current liabilities
$ 210,000
18.4% $ 243,000
19.7%
Long-term liabilities
100,000
8.8
200,000
16.3
Total liabilities
$ 310,000
27.2% $ 443,000
36.0%
Stockholders’
Equity
Vertical Analysis:
Preferred 6% stock, $100 par
$ 150,000
13.2% $ 150,000
1
Current
assets
$550,000
2.2%
Common
stock, $10
par
500,000
43.9
500,000
40.6
48.3% 137,500
Retained
earnings
179,500 = 15.7
11.2
Total assets
$1,139,500
Total stockholders’ equity
$ 829,500
72.8% $ 787,500
64.0%
Totalliab.
liab.&&stockholders’
Stockholders’equity
equity $1,139,500
$1,230,500 100.0%
Total
$1,139,500 100.0%
100.0% $1,230,500100.0%
24
Vertical Analysis of Income Statement
In a vertical analysis of the
income statement, each item
is stated as a percent of net
sales. As an example, let’s
see how the percent of 12.8%
was calculated for 2008
selling expenses.
25
Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2008 and 2007
2008
Amount
Percent
Amount
2007
Percent
Sales
$1,530,500 102.2% $1,234,000
102.8%
Sales returns and allow.
32,500
2.2
34,000
2.8
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Other income
$1,498,000
1,043,000
$ 455,000
$ 191,000
104,000
$ 295,000
$ 160,000
8,500
$ 168,500
Other expense (interest)
6,000
Income before income tax $ 162,500
Income tax expense
71,500
Net income
$ 91,000
100.0%
69.6
30.4%
12.8%
6.9
19.7%
10.7
0.6
11.3%
0.4
10.9%
4.8
6.1%
$1,200,000
820,000
$ 380,000
$ 147,000
97,400
$ 244,400
$ 135,600
11,000
$ 146,600
12,000
$ 134,600
58,100
$ 76,500
100.0%
68.3
31.7%
12.3%
8.1
20.4%
11.3%
0.9
12.2%
1.0
11.2%
4.8
6.4%
26
Lincoln Company
Comparative Income Statement
For the Years Ended December 31, 2008 and 2007
2008
Amount
Percent
Amount
2007
Percent
Sales
$1,530,500 102.2% $1,234,000
102.8%
Sales returns and allow.
32,500
2.2
34,000
2.8
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Other income
$1,498,000
1,043,000
$ 455,000
$ 191,000
104,000
$ 295,000
$ 160,000
8,500
Vertical Analysis:
$ 168,500
Other expense (interest)
6,000
Selling
expenses
$191,000
Income before income tax $ 162,500
71,500
NetIncome
sales tax expense $1,498,000
Net income
$ 91,000
100.0% $1,200,000
69.6
820,000
30.4% $ 380,000
12.8% $ 147,000
6.9
97,400
19.7% $ 244,400
10.7
$ 135,600
0.6
11,000
11.3% $ 146,600
0.4
12,000
10.9% $ 134,600
=4.8
12.8%
58,100
6.1% $ 76,500
100.0%
68.3
31.7%
12.3%
8.1
20.4%
11.3%
0.9
12.2%
1.0
11.2%
4.8
6.4%
27
Solvency Analysis
The ability of a business to
meet its financial obligations
(debts) is called solvency.
The ability of a business to
earn income is called
profitability.
28
Current Position Analysis
Using measures to assess a
business’s ability to pay its
current liabilities is called
current position analysis.
Such analysis is of special
interest to short-term
creditors.
29
Working Capital
The excess of current assets of
a business over its current
liabilities is called working
capital. The working capital is
often used in evaluating a
company’s ability to meet
currently maturing debts.
30
Lincoln Company
Current asset:
Cash
Marketable securities
Accounts receivable (net)
Inventories
Prepaid expenses
a. Total current assets
b. Current liabilities
Working capital (a – b)
$ 90,500
75,000
115,000
264,000
5,500
$550,000
210,000
$340,000
31
Current Ratio
The current ratio,
sometimes called the
working capital ratio or
bankers’ ratio, is computed
by dividing the total current
assets by the total current
liabilities.
32
Lincoln Company
2008
a. Current assets
b. Current liabilities
Working capital (a – b)
Current ratio (a/b)
2007
$550,000
210,000
$340,000
2.6
$533,000
243,000
$290,000
2.2
33
Quick Ratio
A ratio that measures the
“instant’ debt-paying ability
of a company is called the
quick ratio or acid-test
ratio.
34
Quick assets are
cash and other
current assets that
can be quickly
converted to cash.
Lincoln Company
2008
Quick assets:
Cash
Marketable securities
Accounts receivable (net)
a. Total quick assets
b. Current liabilities
Quick ratio (a/b)
$ 90,500
75,000
115,000
$280,500
$210,000
1.3
2007
$ 64,700
60,000
120,000
$244,700
$243,000
1.0
35
Accounts Receivable Turnover
The relationship between sales
and accounts receivable may be
stated as the accounts receivable
turnover. The ratio is to assess
the efficiency of the firm in
collecting receivables and in the
managing of credit.
37
Number of Days’ Sales in
Receivables
The number of days’ sales in
receivables is an estimate of the
length of time (in days) the accounts
receivable have been outstanding.
Comparing this measure with the
credit terms provides information on
the efficiency in collecting
receivables.
38
Lincoln Company
a.
b.
Average (Total/2)
Net sales
Average daily sales on
account (Sales/365)
Number of days’ sales in
receivables (a/b)
28.6
2008
2007
$ 117,500
$1,498,000
$ 130,000
$1,200,000
$
$
4,104
3,288
39.5
39
Financial Statement Analysis at different Stages 2
Inventory Turnover
The relationship between the
volume of goods
(merchandise) sold and
inventory may be stated as the
inventory turnover. The
purpose of this ratio is to
assess the efficiency of the
firm in managing its inventory.
41
Lincoln Company
2008
a. Cost of goods sold
Inventories:
Beginning of year
End of year
Total
b. Average (Total/2)
Inventory turnover (a/b)
3.8
2007
$1,043,000
$ 820,000
$ 283,000
264,000
$ 547,000
$ 273,500
$ 311,000
283,000
$ 594,000
$ 297,000
2.8
42
Number of Days’ Sales in Inventory
Lincoln Company
a. Average (Total/2)
Cost of goods sold
b. Average daily cost of goods
sold (COGS/365 days)
Number of days’ sales in
inventory (a/b)
95.7
2008
2007
$ 273,500
$1,043,000
$ 297,000
$ 820,000
$2,858
$2,247
132.2
43
Ratio of Fixed Assets to Long-Term
Liabilities
The ratio of fixed assets to longterm liabilities is a solvency
measure that indicates the
margin of safety of the
noteholders or bondholders. It
also indicates the ability of the
business to borrow additional
funds on a long-term basis.
44
Lincoln Company
2008
a. Fixed assets (net)
b. Long-term liabilities
Ratio of fixed assets to
long-term liabilities (a/b)
$444,500
$100,000
4.4
2007
$470,000
$200,000
2.4
45
Ratio of Liabilities to Stockholders’
Equity
The relationship between the
total claims of the creditors
and owners—the ratio of
liabilities to stockholders’
equity—is a solvency measure
that indicates the margin of
safety for creditors.
46
Lincoln Company
2008
a. Total liabilities
b. Total stockholders’ equity
Ratio of liabilities to
stockholders’ equity (a/b)
$310,000
$829,500
0.4
2007
$443,000
$787,500
0.6
47
Profitability Analysis
 Profitability is the ability of an entity to
earn profits.
 This ability to earn profits depends on
the effectiveness and efficiency of
operations as well as resources available
as reported in the balance sheet.
 Profitability analysis focuses primarily on
the relationship between operating
results reported in the income statement
and resources reported in the balance
sheet.
48
Ratio of Net Sales to Assets
The ratio of net sales to
assets is a profitability
measure that shows how
effectively a firm utilizes its
assets.
49
Lincoln Company
a.
b.
Net sales
Total assets:
Beginning of year
End of year
Total
Average (Total/2)
2008
2007
$1,498,000
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
Excludes long-term investments
50
Lincoln Company
a.
b.
Net sales
Total assets:
Beginning of year
End of year
Total
Average (Total/2)
Ratio of net sales to assets (a/b)
1.4
2008
2007
$1,498,000
$1,200,000
$1,053,000
1,044,500
$2,097,500
$1,048,750
$1,010,000
1,053,000
$2,063,000
$1,031,500
1.2
51
Leverage
Leverage is a business term that refers to borrowing. If a
business is "leveraged," it means that the business has
borrowed money to finance the purchase of assets. The
other way to purchase assets is through use of owner
funds, or equity.
One way to determine leverage is to calculate the Debt-toEquity ratio, showing how much of the assets of the
business are financed by debt and how much by
equity(ownership).
Leverage is not necessarily a bad thing. Leverage is useful
to fund company growth and development through the
purchase of assets. But if the company has too much
borrowing, it may not be able to pay back all of its debts.
52
Earnings per Share on Common Stock
One of the profitability
measures often quoted by
the financial press is earning
per share (EPS) on common
stock. It is also normally
reported in the income
statement in corporate
annual reports.
53
Lincoln Company
a.
b.
Net income
Preferred dividends
Remainder—identified with
common stock
Shares of common stock
Earnings per share on common
stock (a/b)
$1.64
2008
2007
$ 91,000
9,000
$ 76,500
9,000
$ 82,000
50,000
$ 67,500
50,000
$1.35
54
Price-Earnings Ratio
Another profitability
measure quoted by the
financial press is the priceearnings (P/E) ratio on
common stock. The priceearnings ratio is an
indicator of a firm’s future
earnings prospects.
55
Lincoln Company
2008
Market price per share of
common stock
Earnings per share on common
stock
Price-earnings ratio on
common stock
25
2007
$41.00
$27.00
÷ 1.64
÷ 1.35
20
56
Dividend Yield
The dividend yield on
common stock is a
profitability measure that
shows the rate of return to
common stockholders in
terms of cash dividends.
57
Lincoln Company
Dividends per share of
common stock
Market price per share of
common stock
Dividend yield on
common stock
2.0%
2008
2007
$ 0.80
$ 0.60
÷41.00
÷27.00
2.2%
58
Corporate Annual Reports
In addition to the financial statements
and the accompanying notes,
corporate annual reports usually
include the following sections:
 Management Discussion and Analysis
 Report on adequacy of internal control
 Report on fairness of financial statements
59
Accounting is the process of measuring, interpreting, and
communicating financial information to support internal and
external business decision making.

Financing activities provide necessary funds

Investing activities provide valuable assets

Operating activities focus on selling goods
to start a business and expand it after it
begins operating.
required to run a business.
and services, but they also consider
expenses as important elements of sound
financial management.
• Generally accepted accounting principles (GAAP) encompass the
conventions, rules, and procedures for determining acceptable
accounting practices at a particular time.
• Financial Accounting Standards Board (FASB) is primarily
responsible for evaluating, setting, or modifying GAAP in the U.S.
• Sarbanes-Oxley Act responded to cases of accounting fraud.
– Created the Public Accounting Oversight Board, which sets audit
standards and investigates and sanctions accounting firms that certify the
books of publicly traded firms.
– Senior executives must personally certify that the financial information
reported by the company is correct.
– Resulted in increase in demand for accountants.
Accounting process - set of activities involved in converting information
about transactions
into financial statements.
• Assets - anything of value owned or leased by a business.
• Liability - claim against a firm’s assets by a creditor.
• Owner’s equity - all claims of the proprietor, partners, or
stockholders against the assets of a firm, equal to the excess of
assets over liabilities.
• Basic accounting equation - relationship that states that
assets equal liabilities plus owners’ equity.
• Double-entry bookkeeping - process by which accounting
transactions are entered; each individual transaction always has
an offsetting transaction.
 Balance sheet - statement of a firm’s financial position—what it owns
and the claims against its assets—at a particular point in time.
 Photograph of firm’s assets together with its liabilities and owner’s
equity
 Follows the accounting equation
 Income Statement - financial record of a company’s revenues and
expenses, and profits over a period of time.
 Firm’s financial performance in terms of revenues, expenses, and
profits over a given time period.
 Reports profit or loss.
 Focus on revenues and costs associated with revenues.
 Statement of Owner’s Equity - is designed to show the components
of the change in equity from the end of one fiscal year to the end of the
next.
 Begins with the amount of equity shown on the balance sheet.
 Net income is added, and cash dividends paid to owners are
subtracted.
 Statement of cash flows - a firm’s cash receipts and cash payments
that presents information on its sources and uses of cash.
 Accrual accounting - method that records revenue and expenses when
they occur, not necessarily when cash actually changes hands.
Ratio analysis - tool for measuring a firm’s liquidity, profitability,
and reliance on debt financing, as well as the effectiveness of
management’s resource utilization.
Total current assets
Current ratio compares
current assets to current
liabilities.
Total current liabilities
Acid-test (or quick)
ratio measures the
ability of a firm to meet
its debt payments on
short notice.
Cash and equivalents
+ short-term investments
+ accounts receivable
Total current liabilities
Net sales
Inventory turnover
ratio indicates the
number of times
merchandise moves
through a business.
Average of inventory
Net sales
Total asset turnover ratio
indicates how much in
sales each dollar invested
in assets generates.
Average of total assets
Profitability ratios measure the organization’s overall financial
performance by evaluating its ability to generate revenues in excess of
operating costs and other expenses.
• Leverage ratios measure the extent to which a firm relies on
debt financing.
• Total liabilities to total assets ratio > 50 percent indicates that a
firm is relying more on borrowed money than owners’ equity.
• Budget - planning and control tool that reflects a
firm’s expected sales revenues, operating
expenses, and cash receipts and outlays.
• Management estimates of expected sales, cash
inflows and outflows, and costs.
• Budgets are a financial blueprint that serves as a
financial plan.
• Cash budget - tracks the firm’s cash inflows and
outflows.