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Financial Statement Analysis Tools
Financial Statement Analysis Tools
Analysis Tools
• Ratios are an analyst's
microscope; they allow us get a
better view of the firm's
financial health than just
looking at the raw financial
statements. Ratios are useful
both to internal and external
analysts of the firm.
• Internal purposes:
• Ratios can be useful in planning for the
future, setting goals, and evaluating the
performance of managers.
• External purposes:
• External analysts use ratios to decide
whether to grant credit, to monitor
financial performance, to forecast financial
performance, and to decide whether to
invest in the company.
Categories of Ratios:
1. Liquidity ratios: describe the ability of a firm to
meets its current obligations.
2. Efficiency ratios: describe how well the firm is
using its investment in assets to produce sales.
3. Leverage ratios: reveal the degree to which debt
has been used to finance the firm's asset
purchases.
4. Coverage ratios: are similar to liquidity ratios in
that they describe the ability of a firm to pay
certain expenses.
5. Profitability ratios: provide indications of how
profitable a firm has been over a period of time.
Liquidity Ratios
• The term liquidity refers to the speed with which an
asset can be converted into cash without large
discounts to its value. Some assets, such as
accounts receivable, can easily be converted to
cash with only small discounts. Other assets, such
as buildings, can be converted into cash very
quickly only if large price concessions are given.
We therefore say that accounts receivable are more
liquid than buildings. All other things being equal, a
firm with more liquid assets will be more able to
meet its maturing obligations (i.e., its bills) than a
firm with fewer liquid assets.
The Current Ratio
• Generally, a firm's current assets are
converted to cash (e.g., collecting on
accounts receivables or selling its
inventories) and this cash is used to retire
its current liabilities.