• Basics of Analysis
• Ratio Analysis, Common size analysis
(Vertical and Horizontal),
• Financial Statement Variations by type of Industry, Comparison,
• Trend Analysis,

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Ratio analysis is used to evaluate various aspects of a company’s operating and financial performance such as its efficiency, liquidity, profitability and solvency.
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The trend of these ratios over time is studied to check whether they are improving or weakening.
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Ratios are also compared across different companies in the same sector to see how they stack up, and to get an idea of comparative valuations. Ratio analysis is a cornerstone of fundamental analysis.
Liquidity
Measures a firm’s ability to meet its current obligations and Liquidity ratios are used to determine a company’s ability to meet its short-term debt obligations.
Leverage (borrowing capacity)
Measures the degree of protector for long-term creditors. A leverage ratio is meant to evaluate a company’s debt levels. The most common leverage ratios are the debt ratio and the debt-to-equity ratio.

Profitability
• Measures the earning ability of a firm.
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Measures that indicate how well a firm is performing in terms of its ability to generate profit
Investor-focused
Cash flow
Indicate liquidity, borrowing capacity, and profitability

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– Prior ratios
– Competitor ratios
– Industry ratios
– Predetermined standards

• Use of average data from balance sheet accounts
– Necessary when comparing against income statement data
– Does not
• Eliminate cyclical or seasonal variations
• Capture changes that occur unevenly throughout the year
• Analysis must be performed and understood within the context of
– Native accounting principles
– Accounting principles differ around the world, and countries usually have their own, slightly different, versions of GAAP.
– Native business practices and culture

• The use of percentages is usually preferable to the use of absolute amounts and analysis expresses comparisons in percentages.
• Vertical analysis
– Compares each amount with a base amount selected from the same year.
– All amounts of a year expressed as a percentage of a base amount (e.g., net sales revenue, total assets)
• Horizontal analysis
– Compares each amount with amounts for comparative years are expressed as a percentage of the base year amount

Sales revenue
Cost of goods sold
Gross profit
Operating expenses:
Selling expense
General expense
Total operating expense
Operating Income before taxes
Taxes related to operations
Net Income
Melcher Company
Income Statement
For the Years Ended December 31
2005 2004
$ 100,000
65,000
100.0%
65.0%
$ 95,000
60,800
100.0%
64.0%
$
2003
91,000
56,420
100.0%
62.0%
35,000
14,000
16,000
30,000
5,000
1,500
$ 3,500
35.0%
14.0%
16.0%
30.0%
5.0%
1.5%
3.5%
34,200
11,400
15,200
26,600
7,600
2,280
$ 5,320
36.0% 34,580
12.0% 10,000
16.0% 13,650
28.0% 23,650
8.0% 10,930
2.4% 3,279
5.6% $ 7,651
38.0%
11.0%
15.0%
26.0%
12.0%
3.6%
8.4%
Each financial statement element is presented as a percentage of a designated base.

Sales revenue
Cost of goods sold
Gross profit
Operating expenses:
Selling expense
General expense
Melcher Company
Income Statement
For the Years Ended December 31
2005 2004 2003 2005 2004
$ 100,000
65,000
$ 95,000
60,800
$ 91,000
56,420
109.9%
115.2%
104.4%
107.8%
Total operating expense
Operating Income before taxes
Taxes related to operations
Net Income
35,000
14,000
16,000
30,000
5,000
1,500
$ 3,500
34,200
11,400
15,200
26,600
7,600
2,280
$ 5,320
34,580
10,000
13,650
23,650
10,930
3,279
$ 7,651
101.2%
140.0%
117.2%
126.8%
45.7%
45.7%
45.7%
98.9%
114.0%
111.4%
112.5%
69.5%
69.5%
69.5%
2003
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
Each financial statement element is presented as a percentage of a base amount from a selected year.

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– When an item has value in the base year and none in the next period, the decrease is 100%
– A meaningful percent change cannot be computed when one number is positive and the other number is negative
– A percent change is incomputable when there is no figure for the base year.

• Financial components vary by type of industry
Merchandising
– Inventory is a principal asset a large amount of sales may be for cash in this case receivables balance will be low.
– Sales may be primarily for cash or on credit
Service
• A service firm generates its revenue from the service provided in this case Inventory is low or nonexistent
• Investment in property at equipment is low compare than to manufacturing firms.
Manufacturing
– Large inventory holdings
– Substantial investment in plant assets

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– Analyze information from the perspective of both investors and creditors
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– Analysis of past and present information to project the future prospects of the entity
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– Short-term: focus is on current resources
– Long-term: consider the future prospects of the firm

Tic-Tac Homes has had the following balance sheet statements the past four years (in thousands):