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Chapter 12: Financial Statement Analysis

  • Page ID
    98050
    • Henry Dauderis and David Annand
    • Athabasca University via Lyryx Learning

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    Learning Objectives
    • LO1 – Describe ratio analysis, and explain how the liquidity, profitability, leverage, and market ratios are used to analyze and compare financial statements.
    • LO2 – Describe horizontal and vertical trend analysis, and explain how they are used to analyze financial statements.

    Financial statements can be used by shareholders, creditors, and other interested parties to analyze a corporation's liquidity, profitability, and financial structure compared to prior years and other similar companies. As part of this analysis, financial evaluation tools are used. Some of these tools are discussed in this chapter.

    • 12.1: Introduction to Ratio Analysis
      This page discusses ratio analysis as a method for evaluating financial statements, focusing on four key types of ratios: liquidity, profitability, leverage, and market ratios. It emphasizes the value of ratio analysis in comparing companies and assessing their financial health through various metrics. The analysis incorporates both quantitative and qualitative information. Additionally, it will evaluate the financial performance of Big Dog Carworks Corp.
    • 12.2: Liquidity Ratios- Analyzing Short-term Cash Needs
      This page discusses short-term vs long-term debt, emphasizing BDCC's reliance on short-term financing despite its liquidity risks. It highlights BDCC's declining current and acid-test ratios, indicating difficulties in meeting liabilities. Additionally, an increase in the accounts receivable collection period and days of sales in inventory suggests inefficient cash collection and inventory management, further exacerbating BDCC's liquidity problems.
    • 12.3: Profitability Ratios- Analyzing Operating Activities
      This page analyzes BDCC's profitability ratios, indicating efficient asset usage for revenue generation. The gross profit ratio remains steady, while the operating profit ratio is stable but may need cost reviews due to rising expenses. The net profit ratio shows consistent performance, though comparisons with industry standards are advised. Some efficiency metrics, like sales to total assets, are declining.
    • 12.4: Leverage Ratios - Analyzing Financial Structure
      This page analyzes BDCC's financial structure as of December 31, 2021, revealing that 50.48% of assets are financed by debt and 49.52% by equity, indicating a trend towards declining equity financing. The debt to equity ratio has risen to 1.02:1, showing increased reliance on creditors, while the times interest earned ratio fell from 4.49 to 3.37, raising concerns about financial stability and risk for creditors.
    • 12.5: Market Ratios- Analysis of Financial Returns to Investors
      This page discusses how investors evaluate the attractiveness of BDCC shares through market ratios. BDCC's Earnings-per-Share (EPS) remained stable from 2019 to 2021, while its Price-Earnings (P/E) ratio increased annually, signaling positive market expectations. Although the Dividend Yield decreased slightly during the same period, total declared dividends rose, raising some concerns. Overall, the higher P/E ratios contribute to a favorable investor outlook for BDCC.
    • 12.6: Overall Analysis of Big Dog's Financial Statements
      This page analyzes BDCC's financial performance, indicating sales growth but stagnant net income from 2019 to 2021 due to rising operating expenses. Liquidity is a concern due to increased current liabilities linked to property and equipment expansion. Although BDCC's ability to meet debt obligations is declining, the stock market remains optimistic about future profitability, suggesting the negative indicators may be temporary.
    • 12.7: Horizontal and Vertical Trend Analysis
      This page discusses trend analysis methods for evaluating financial statements, emphasizing horizontal and vertical analyses. Horizontal analysis looks at percentage changes over time, while vertical analysis presents figures as percentages of a base amount. Both methods reveal trends that necessitate further investigation into financial metrics. Additionally, the page offers insights into liquidity, profitability, leverage, and market ratios for a thorough financial analysis.
    • 12.8: Summary of Chapter 12 Learning Objectives
      This page discusses ratio analysis, which evaluates financial statements to analyze liquidity, profitability, leverage, and market performance. It covers liquidity ratios, profitability ratios, leverage measures, and market ratios. Additionally, it explains trend analysis, including horizontal and vertical methods, to assess performance over time. These analyses are crucial for understanding financial health and support decision-making for stakeholders such as management and investors.
    • 12.9: Exercises
      This page details financial exercises involving the analysis of transactions, calculating and interpreting financial ratios, and reconstructing balance sheets. It focuses on liquidity ratios and accounts receivable collections, presenting scenarios for practical application. The content aims to enhance understanding of corporate finance and accounting principles through various tasks related to financial metrics and their implications.

    Concept Self-Check

    Use the following as a self-check while working through Chapter 12.

    1. What is working capital?
    2. What is meant by liquidity?
    3. What are some ratios commonly used to evaluate liquidity?
    4. What is a company's revenue operating cycle and how is it measured?
    5. What profitability ratios can be used to evaluate a corporation?
    6. How is the amount of shareholder claims against a corporation's assets compared to the amount of creditor claims?
    7. What are the relative advantages of short-term and long-term debt?
    8. What are some measures used to evaluate the future financial prospects of a company for investors?
    9. What is a horizontal analysis? How does it differ from a vertical analysis?
    10. What is a common-size analysis?

    NOTE: The purpose of these questions is to prepare you for the concepts introduced in the chapter. Your goal should be to answer each of these questions as you read through the chapter. If, when you complete the chapter, you are unable to answer one or more the Concept Self-Check questions, go back through the content to find the answer(s). Solutions are not provided to these questions.


    This page titled Chapter 12: Financial Statement Analysis is shared under a CC BY-NC-SA 3.0 license and was authored, remixed, and/or curated by Henry Dauderis and David Annand (Lyryx Learning) .