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5: Financial Statement Analysis and Decision Making - Coggle Diagram
5: Financial Statement Analysis and Decision Making
Comparative Analysis
Types of comparative analysis: Intra-entity, Industry averages, Inter-entity.
Tools of analysis: Horizontal analysis, Vertical analysis, and Ratio analysis.
Horizontal Analysis
Evaluates changes in financial data over time.
Base year comparison: measures increases or decreases in dollar amounts and percentages.
Vertical Analysis
Expresses each item in financial statements as a percentage of a base amount (common size).
Common bases: Sales revenue for income statements and total assets for balance sheets.
Ratio Analysis
Ratios express relationships among selected financial statement items.
Types of ratios: Liquidity, Solvency, and Profitability.
Liquidity Ratios
Measure short-term ability to pay debts and meet cash needs.
Key ratios
Current Ratio: Current assets to current liabilities
Quick Ratio: Excludes inventory and prepaid assets
Current Cash Debt Coverage: Cash basis measurement
Receivables Turnover and Average Collection Period
Inventory Turnover and Average Days in Inventory
Working Capital: Difference between current assets and current liabilities
Solvency Ratios
Assess long-term survival capability.
Key ratios
Debt to Total Assets: Degree of leverage.
Times Interest Earned: Ability to meet interest payments.
Cash Debt Coverage: Long-term debt-paying ability.
Free Cash Flow: Cash available after maintaining productive capacity.
Profitability Ratios
Measure operating success and impact on financing and growth.
Key ratios
Return on Equity: Profitability for shareholders.
Return on Assets: Efficiency in using assets to generate income.
Profit Margin: Profit per dollar of sales.
Asset Turnover: Sales volume associated with asset usage.
Gross Profit Rate and Operating Expenses to Sales Ratio.
Cash Return on Sales and Earnings Per Share (EPS).
Price-Earnings Ratio and Cash Dividend Payout Rate.
Assessment through time-series and cross-sectional analysis.
Cash Flow Analysis
Examines operating, investing, and financing cash flows to assess financial health.
Scenarios for interpreting cash flows: growth, financial problems, and cash management strategies.
Limitations of Financial Statement Analysis
Estimates: Impact of inaccurate estimates on ratios.
Cost: Historic cost limitation.
Alternative Accounting Methods: Variations in policies affect comparability.
Atypical Data and Diversification: Effects on data representation.
Accounting Policy Choice (APC) and Ethics
Impact of APC on financial statements.
Ethical considerations: Conservatism in measurement to avoid overstatement of assets and income.