Learning Outcomes
- Define financial statement analysis
We previously introduced the four financial statements. We discussed how these statements provide information about a company’s performance and financial position. Here, we extend this discussion by showing you specific tools you can use to analyze financial statements in order to make a more meaningful evaluation of a company.
Ratio Analysis
Ratio analysis expresses the relationship among selected items of financial statement data. A ratio expresses the mathematical relationship between one quantity and another. For analysis of the primary financial statements, we classify ratios as:
- Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected cash needs.
- Operating efficiency ratios measure how efficiently a firm is paying its bills, collecting cash from customers, and turning inventory into sales.
- Profitability ratios measure the income or operating success of a company for a given period of time.
- Solvency ratios measure the ability of the company to survive over a long period of time.
Comparative Analysis
A single ratio by itself is not very meaningful. Accordingly, we will use various comparisons to shed light on company performance:
- Intracompany comparisons covering two years for the same company.
- Industry-average comparisons based on average ratios for particular industries.
- Intercompany comparisons based on comparisons with a competitor in the same industry.
PRACTICE QUESTIONS
Candela Citations
CC licensed content, Original
- Financial Statement Analysis Defined. Authored by: Joseph Cooke. Provided by: Lumen Learning. License: CC BY: Attribution
CC licensed content, Shared previously
- Principles of Financial Accounting. Authored by: Christine Jonick. Located at: https://web.ung.edu/media/university-press/Principles-of-Financial-Accounting.pdf?t=1601063299615. License: CC BY-SA: Attribution-ShareAlike
- Authored by: GraphicMama-team. Located at: https://pixabay.com/illustrations/presentation-statistic-boy-1454403/. License: CC0: No Rights Reserved. License Terms: https://pixabay.com/service/terms/#license