FINANCIAL ANALYSIS GUIDE
One of the reasons to prepare data is to make decisions. This involves
analysis of data.
Comparative Financial Statements -
compare current years with prior years Condensed Statement
Trend (Horizontal) Analysis - use
percentage changes to compare results over years, e.g.,
Sales: 2002 $2m 2003 $2.5m
2004 $2.9m 2005 $3.1m. Good but % increases 25%, 16%, 7%
Vertical Analysis – compare
composition of major categories, e.g., Sales 100% COGS 40%, Gross Profit 60%,
Expenses 30%, Net Income 10%. Compare with previous year(s). Do also with
Balance Sheet.
Cash Flow Statement – use to measure sources and uses of cash.
Comparison with Similar Businesses - preferably in the same industry
Analysis of Non-financial Factors - e. g. management, personnel, years of operation,
patents, SWOT, etc.
Ratio Analysis - use key ratios to
summarize performance:
|
|
Formula |
Guide |
|
Liquidity Ratios: |
||
|
Working Capital ($) |
Current Assets - Current Liabilities |
Positive, Healthy |
|
Current Ratio |
Current Assets/Current Liabilities |
2:1 |
|
Quick Ratio |
Current Assets above Inventory |
1:1 |
|
Inventory Turnover |
Cost of Good Sold |
Higher Better |
|
Inventory Turnover Period (days) |
365/Inventory Turnover |
Lower better |
|
Accounts Receivable Turnover |
Net Sales on Credit |
Higher Better |
|
Accounts Receivable Turnover Period (days) |
365/A/R Turnover |
Lower Better |
|
Operating Cycle (days) |
Inv. Turnover Period + A/R Turnover Period |
Lower Better |
|
Borrowing Capacity/Solvency Ratios: |
||
|
Times Interest Earned |
Operating Income/Interest Expense |
Higher Better |
|
Equity Ratio (%) |
Equity/Total Assets x 100 |
> 50% |
|
Debt Ratio (%) |
Total Liabilities/Total Assets x 100 |
< 50% |
|
Debt to Equity |
Total Debt/Total Equity |
< 1 |
|
Profitability Ratios: |
||
|
Return on Net Sales (%) |
Net Income/Net Sales |
Higher Better |
|
Return on Equity (%) |
Net Income/Average Equity |
Higher Better |
|
Return on Assets (%) |
Operating Income/Average Assets |
Higher Better |
The guides above are general
rules only. For example, a Current Ratio of over 3:1 may indicate a
company is not using its cash well.
It’s best to compare a company to other companies in the same industry and look
at prior years performance.