Financial Statement
Analysis
Chapter 9
Liquidity and Solvency
Solvency – the ability of a business to
pay its debts
Liquidity – the ability of a business to
convert assets into cash.
Liquidity, solvency, and profitability
are interrelated!
Solvency Analysis
Normally assessed by examining
balance sheet relationships, using the
following major analyses:
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•
•
•
•
•
Current position analysis
Accounts receivable analysis
Inventory analysis
Ratio of fixed assets to long-term liabilities
Ratio of liabilities to stockholders’ equity
Number of times interest charges are
earned
Current Position Analysis
Using measures to assess a business’s
ability to pay its current liabilities
• Working capital – current assets less
current liabilities
• Current ratio – current assets divided by
current liabilities
• Quick ratio – total “quick” assets divided by
current liabilities
Current Position Analysis – Working Capital
and Current Ratio
Mooney Company
Accounts Receivable Analysis
 Measures efficiency of collection
 Reflects liquidity
Accounts Receivable Turnover =
Number of Days’ Sales in
Receivables
Net Sales
Average Accounts Receivable
= Average Accounts Receivable
Net Sales/365
Accounts Receivable Turnover
The company increased its accounts receivable turnover by 38%
measured in terms of the number of times receivables are collected
within the year.
Number of Days’ Sales in
Receivables
The company improved its collections of accounts
receivable by 10.9 days in 2012 measured in days
receivables have been outstanding.
Inventory Analysis
Measures inventory efficiency
• Avoid tying up funds in inventory
• Avoid obsolescence
Reflects liquidity
Inventory Turnover
=
Number of Days’ Sales =
in Inventory
Cost of Goods Sold
Average Inventory
Average Inventory
Cost of Goods Sold/365
Inventory Turnover
The company turned its inventory 1 time more in
2012, measured in terms of the number of times
inventory turns over within the year.
Days’ Sales in Inventory
The company reduced the time it held inventory by
nearly 28% in 2012 measured in days the inventory
was held in warehouses.
Profitability Analysis
 Normally assessed by examining the income
statement and balance sheet resources, using
the following major analyses:
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•
•
•
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Rate earned on total assets
Earnings per share on common stock
Price-earnings ratio
Dividends per share
Dividend yield
Rate Earned on Total Assets
• Measures the profitability of total assets without
considering how the assets are financed.
Interest Expense + Net Income
Avg. Total Assets
Earnings Per Share on Common
Stock
• The income earned for each share of common
stock.
Net Income – Preferred Dividends
Common Shares Outstanding
Price-Earnings Ratio
• Indicator of the firm’s future earnings prospects.
Market Price Per Share of Common Stock
Annual Earnings Per Share
Dividends per Share and Earnings
per Share
Dividends and Earnings per Share of Common Stock
Dividends per Share =
Dividends
Shares of Common Stock Outstanding
Dividends Per Share and Dividend
Yield
• Dividend yield shows the rate of return to common
stockholders in terms of cash dividends.
Dividend Yield =
Dividends per Share of Common Stock
Market Price per Share of Common Stock
Corporate Annual Reports
Summarize operating activities for the
past year and plans for the future.
Many variations in the order and form,
but all include:
• Management’s discussion and analysis
• Report on internal control
• Report on fairness of the financial statements
Management Discussion and
Analysis (MD&A)
Provides critical information in
interpreting the financial statements and
assessing the future of the company
Includes an analysis about past
performance and financial condition
Discusses management’s opinion about
future performance
Discusses significant risk exposure
Independent Auditors’ Report
Publicly traded companies must get an
independent opinion on the fairness of
the financial statements.
This opinion must be included in the
annual report along with an opinion on
the accuracy of management’s internal
control assertion.