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Financial Statement Analysis

Analysis can be made in many ways. Financial Ratios can be used


to understand and measure how well a company is doing in an
area. Ratios can be used to compare one company against
another, or one time period against another. Common size
statements are used to compare different companies, as each line
item is expressed as a ratio of another, and therefore can be used
for accurate comparison against different sized companies. Trend
analysis is helpful to understand the change in a companys
financial statements from one period to another.

Liquidity Ratios
The Current Ratio is used to test the company's ability to pay its
short term obligations. Below 1 means the company does not
have sufficient incoming cash flow to meet its obligations over the
coming year.

The Quick Ratio is an indicator of a company's short-term


liquidity. The quick ratio measures a company's ability to meet its
short-term obligations with its most liquid assets. The higher the
quick ratio, the better the position of the company.

Profitability Ratios
Return on Assets is an indicator of how profitable a company is
relative to its total assets. ROA gives an idea as to how efficient
management is at using its assets to generate earnings.

Return on Equity provides the amount of net income returned


as a percentage of shareholders equity. Return on equity
measures a corporation's profitability by revealing how much
profit a company generates with the money shareholders have
invested.

The Return on Invested Capital measure gives a sense of how


well a company is using its money to generate returns. Comparing
a company's return on capital (ROIC) with its cost of capital
(WACC) reveals whether invested capital was used effectively.

Return on Common Equity measures a corporation's


profitability by revealing how much profit a company generates
with the money shareholders have invested.

Gross Profit Margin (Gross Margin) is used to assess a firm's


financial health by revealing the proportion of money left over
from revenues after accounting for the cost of goods sold.

Profit Margin is used to determine the profitability of each dollar


of sales that company makes.

Operating Margin shows the profitability of the ongoing


operations of the company, before financing expenses and taxes.

Earnings Per Share is the portion of a company's profit


allocated to each outstanding share of common stock.

Activity Analysis
Asset Turnover measures a firm's efficiency at using its assets
to generate sales revenue, the higher the better.

Accounts Receivable Turnover is used to quantify a firm's


effectiveness in extending credit as well as collecting debts. The
receivables turnover ratio is an activity ratio, measuring how
efficiently a firm uses its assets.

Days Receivables indicates the average number of days that


receivables are outstanding. High numbers indicate long
collection periods, low numbers indicate efficient collection of
receivables.

Average Days Sales

Inventory Turnover measures how many times a company's


inventory will be sold and replaced in a year.

Inventory Turnover Period in Days measures how many days


it takes for a company to turnover its entire inventory.

Fixed Asset Turnover measures the efficiency of fixed assets to


generate profit. The higher the number, the more efficient
managements use of fixed assets.

Working Capital Turnover measures the depletion of working


capital to the generation of sales over a given period. This
provides some useful information as to how effectively a company
is using its working capital to generate sales.

Capital Structure Analysis


The Debt Ratio indicates what proportion of debt a company has
relative to its assets. The measure gives an idea to the leverage

of the company along with the potential risks the company faces
in terms of its debt-load.

The Debt to Equity Ratio is a measure of a company's financial


leverage. It indicates what proportion of equity and debt the
company is using to finance its assets.

The Debt to Tangible Net Worth Ratio is a measure of a


company's financial leverage to the tangible asset value of
owner's equity. It indicates what proportion of equity and debt the
company is using to finance its tangible assets.

Times Interest Earned is used to measure a company's ability


to meet its debt obligations. Failing to meet these obligations
could force a company into bankruptcy.

Debt Servicing Ratio is used to assess a companys ability to


meet all of its debt repayment obligations, both interest and
principal repayments.

Market Analysis

The Price to Earnings Ratio tells us how many years it will take
for earnings to repay the current market share price. This is a
useful measure to compare companies in the same industry.

The Dividend Yield shows how much a company pays out in


dividends each year relative to its share price. In the absence of
any capital gains, the dividend yield is the return on investment
for a stock.

The Dividend Payout Ratio is the percentage of earnings that


are paid out to shareholders. Earnings not paid to shareholders
are expected to be retained by the company and invested in
further operations.

Price to Book Ratio tells us the relative value the market places
on the company to the accounting valuation. This ratio provides a
basic understanding of residual value of a company should it go
bankrupt.

Earnings Per Share is the portion of a company's profit


allocated to each outstanding share of common stock.

DuPont Analysis
Du Pont Analysis is used to identify the components of business
operations that lead to shareholders return. Total return on equity
is the profitability, multiplied by the rate of asset turnover,
multiplied by the ratio of assets to equity (leverage). By
identifying each component and evaluating, strength and
weakness can be evaluated, as well as insight into competitive
advantage. Understanding how each element leads to return on
equity will help a researcher investigate further into the
operations of a company.

Profit Margin is used to determine the profitability of each dollar


of sales that company makes.

Asset Turnover measures a firm's efficiency at using its assets


to generate sales revenue, the higher the better.

Leverage of Assets measures the ratio between assets and


owner's equity of a company. The higher the number, the higher
the leverage.

Analysis of Leverage
Analysis of Leverage is used to evaluate how effectively
management is using borrowed funds to make a return for

income. Typically, funds are raised by debt in order to enhance


the return to shareholders. This is done by financing the
companys assets with debt, which requires a fixed payment of
interest. If the assets financed by debt generate pretax net
income sufficient to repay this interest, then any additional net
income is profit that goes to the shareholders.
A companys assets can be divided into assets funded by equity,
and assets funded by debt. It is possible to analyze the efficiency
with which a companys assets generate pretax income, and
allocate this income in proportion to the capital structure. We can
then determine the amount that each set of assets contributes to
net income. We would expect that management would be able
to use assets financed by debt to generate enough net income to
pay the borrowing costs, and hopefully produce additional income
for the shareholders. If the income generated by the borrowed
assets is negative, then it may be advisable for a company to
alter its capital structure, or focus on improving the efficiency of
its assets in regards to generating net income.

Gross Efficiency of Assets tells us how much income each


dollar of assets generates before paying out taxes and interest.
This tells us how efficiently management uses its assets.

Pretax Income is a made up of two sources, income from assets


funded by shareholders equity, and assets funded by borrowed
debt.

Income from Unleveraged Assets is the income generated by


the assets funded by shareholders equity and operations.

Income from Leveraged Assets is the income generated by


assets funded by borrowed debt.

Leveraged Assets Contribution to NI is the percentage of the


pretax income that is provided by managements use of debt to
fund assets. Higher numbers show good use of debt. Negative
number show losses generated by the assets financed by debt.

Sustainable Growth Rate


Sustainable Growth Rate is the maximum growth rate of a
company if none of its ratios change and it does not raise new
capital through selling shares.