Understanding

Financial Accounting
Third Canadian Edition
By Christopher D. Burnley
Prepared by Debbie Musil, FCPA, FCMA

Chapter 12

Financial Statement Analysis

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Learning Objective 7
Identify, calculate, and interpret specific ratios that are
used to analyze the liquidity, activity, solvency,
profitability and equity of a company

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Ratio Analysis
• Can be used to compare a company’s results from
one period to the next or compare one company with
others
• Also allows users to compare companies of different
sizes more easily

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Common Categories of Ratios
• Often several ways to calculate a given ratio
o Common categories:
• Liquidity ratios
• Activity ratios
• Solvency ratios
• Profitability ratios
• Equity Analysis ratios

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Liquidity Ratios
• Refers to a company’s ability to convert assets into
cash so that liabilities can be paid
• An important of part of liquidity analysis considers a
company’s ability to meet its short-term obligations
with its short-term assets
• Two commonly used ratios include:
o Current ratio
o Quick ratio

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Common Liquidity Ratios

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Liquidity Ratios – Current Ratio
Current Ratio

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Liquidity Ratios – Quick Ratio
Quick Ratio

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Activity Ratios
• Provide insight into how efficiently a company
manages its operations; also known as operating
efficiency ratios
• These ratios include:
o Accounts receivable turnover
o Inventory turnover
o Accounts payable turnover

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Receivable Activity Ratios

• Sometimes necessary to assume all sales are credit

sales
• Should be compared to company’s credit terms
• Large sales at end of reporting period may distort
turnover
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Activity Ratios – Accounts Receivable
Turnover
Accounts Receivable Turnover Ratio

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Activity Ratios – Average Collection
Period
Average Collection Period

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Inventory Activity Ratios

• Tells you how fast inventory is sold, or

• How many days, on average, does it take to sell
inventory

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Activity Ratios – Inventory Turnover
Inventory Turnover

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Activity Ratios – Days to Sell Inventory
Days to Sell Inventory

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Accounts Payable Turnover Activity
Ratios

• Provides information about the company’s payable policy

• Cost of goods sold can sometimes replace credit purchases
• Alternately, can adjust COGS for the change in inventory
levels and determine purchases.

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Activity Ratios – Accounts Payable
Turnover
Accounts Payable Turnover

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Activity Ratios – Accounts Payable
Payment Period
Accounts Payable Payment Period

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Solvency Ratios
• The ability of the company to pay its obligations in
the long term
o Key indicator of a company’s level of risk
• Leverage Ratios:
o Debt to equity
o Net debt as a percentage of total capitalization
• Coverage Ratios:
o Interest coverage

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Solvency - Leverage Ratios

• Measures the amount of debt a company has

relative to its shareholders’ equity

• This measures the total portion of financing

represented by debt
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Leverage Ratios – Debt to Equity
Debt to Equity

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Leverage Ratios – Net Debt as a % of
Total Capitalization
Net Debt as a % of Total Capitalization

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Solvency – Coverage Ratios – Interest
Coverage Ratio

• Measures the company’s ability to cover interest

expense from earnings
• This ratio provides comfort to lenders that the
company can pay the interest on debt

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Coverage Ratios – Interest Coverage
Ratio Calculation
Interest Coverage

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Profitability Ratios
• Used to assess a company’s overall performance.
These ratios include:
o Gross margin
o Profit margin
o Return on equity (ROE)
• Measures return to shareholders
o Return on assets (ROA)
• Measures overall profitability of the funds invested in a
company’s assets
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Profitability Ratios – Gross Margin and
Profit Margin

• Measures the profit remaining after product costs

available to cover other operating costs

• Measures net profit earned on each $1 in sales

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Profitability Ratios – Gross Margin
Gross Margin

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Profitability Ratios – Profit Margin
Profit Margin

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Profitability Ratios – Return Ratios

• Measures the return on the resources provided

by the investors

• Measures the return on the assets that are used by

the company

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Profitability Ratios – Return on Equity

Return on Equity (ROE) Ratio

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Profitability Ratios – Return on Assets
Return on Assets (ROA) Ratio

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Equity Analysis Ratios – Earnings per
Share
Earnings per Share:
• Two types must be reported:

Diluted Earnings per Share:

• The amount that earnings per share would become
if all of the dilutive convertible securities were
converted to common shares
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Equity Analysis Ratios – Earnings Per
Share Note
Excerpt from Saputo Inc.’s 2021 Annual Report: Earnings Per Share Note

When calculating diluted net earnings per share for the year ended March 31, 2021,
14,951,292 options were excluded from the calculation because their exercise price is
higher than the average market value of common shares (13,762,608 options, were
excluded for the year ended March 31, 2020).

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Equity Analysis Ratios – Price Earnings
(P/E) Ratio

• Compares the price per share on the stock market with

the company’s earnings per share
• Companies with high growth expectations or low
levels of risk will have higher P/E multiples

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Equity Analysis Ratios – P/E Ratio
P/E Ratio

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Equity Analysis Ratios – Dividend Payout

• Measures the portion of income paid out as

dividends

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Equity Analysis Ratios – Dividend Payout
Ratio
Dividend Payout Ratio

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Dividends Note
Excerpt from Saputo Inc.’s 2021 Annual Report: Dividends Note
NOTE 13 SHARE CAPITAL
Dividends and Dividend Reinvestment Plan
The Company implemented a dividend reinvestment plan (DRIP), which became
effective as of the dividend paid on July 9, 2020. The DRIP provides eligible shareholders
with the opportunity to have all or a portion of their cash dividends automatically
reinvested into additional common shares.
The dividends paid in cash and through the DRIP during the year are shown below:

For the year ended March 31, 2020, dividends totaling $269.7 million were fully paid in
cash.
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Equity Analysis Ratios – Dividend Yield

• Measures the dividends an investor will receive

relative to the price per share

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Equity Analysis Ratios – Dividend Yield
Ratio
Dividend Yield Ratio

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Equity Analysis Ratios – Net Free Cash
Flow
Net Free Cash Flow

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Exercising Caution When Using Non-IFRS
Financial Measures and Other
Performance Measures
• Caution should be exercised when using non-IFRS
financial measures and other performance measures:
o There are no standard definitions for these measures;
management is free to define
o Measures are often not comparable across companies
or across periods
o Information used in determining measures is
unaudited

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