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ASSIGNMENT
Component of Financial Analysis
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Component of Financial Analysis
1. Income statement
The “top line” of the income statement displays the business revenue in a given
period of time. Cost of goods sold (COGS) and other operating expenses are
deducted from revenue. The net income, or “bottom line,” is the remainder after all
revenues and expenses have been accounted for.
Here are important analysis ratios to compute when reviewing your income
statement:
Gross profit margin is the percentage of revenue remaining after deducting your
cost of goods sold. This is calculated by dividing gross profit by revenue from
sales.
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Revenue concentration tells you which clients are generating the most revenue.
Take the revenue from a single client divided by total revenue. To mitigate risk, a
single client shouldn’t generate the bulk of your revenue.
2. Balance sheet
A balance sheet reports the company’s assets, liabilities, and shareholder equity at
a specific point in time. In every balance sheet, assets must equal the total of your
liabilities and equity, meaning the dollar amount must zero out.
Your balance sheet can help you determine how efficiently you’re generating
revenue and how quickly you’re selling inventory. There are three types of ratios
that can be computed from your balance sheet:
Liquidity ratios are portions of the company’s assets and current liabilities. They
are used to measure a business’s ability to pay short-term debts. A few liquidity
ratios include:
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Net working capital is the aggregate amount of all your current assets and
liabilities and is calculated by subtracting current liabilities from current assets.
Net Working Capital = Current Assets – Current Liabilities
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Efficiency ratios measure a company’s ability to use its assets and manage
liabilities to generate income. An efficiency ratio can help determine the following:
Inventory turnover measures how many times a business sold its total inventory
over the past year, in dollar amount. A high ratio implies strong sales while a low
turnover ratio implies weak sales and excess inventory. Take your cost of goods
sold divided by average inventory to determine your turnover.
Inventory Turnover = COGS ÷ Average Inventory
Account receivable days measures how efficiently a firm uses assets and is
calculated by dividing the net value of credit sales by the average accounts
receivable.
Account Receivable Days = Net Value of Credit Sales ÷ Average Accounts
Receivable
Total asset turnover showcases the business’s ability to generate sales from its
assets. You can determine this by dividing the net sales by the average total assets.
Total Asset Turnover = Net Sales ÷ Average Total Assets
Net asset turnover compares the value of a business’ sales relative to the value of
its assets. Calculate your net asset turnover by taking your sales divided by your
average total assets
Net Asset Turnover = Sales ÷ Average Total Assets
A cash flow statement reports the amount of cash generated during a given period
of time. It’s intended to provide information on a business’s current liquidity and
solvency as well as its ability to change cash flows in the future.
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These three sections highlight a company’s sources of cash and how that cash is
being used. Many investors consider the cash flow statement to be the most
important indicator of a business’s performance.
There are a variety of ratios you can pull in your cash flow statement. Here are a
few to help you start measuring the quality of your cash flow and create a cash
flow analysis:
Operating cash flow to net sales tells you how many dollars in cash are generated
for dollars of sales. It’s a percentage of a business’s operating cash flow to its net
sales from the income statement.
Operating Cash Flow to Net Sales (%) = Operating Cash Flow ÷ Net Sales
Free cash flow measures how efficient a company is at generating cash.
To calculate free cash flow, find the net cash from operating activities and subtract
capital expenditures required for current operations.
Free Cash Flow = Cash from Operating Activities – Capital Expenditures for
Current Operations
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