Analyzing Financial Statements. Financial Statements enhance the decision making ability and offer a means to assess the status of a business. They are.

Analyzing Analyzing Financial Financial StatementsStatements

Analyzing Financial StatementsAnalyzing Financial Statements

Financial Statements enhance the decision making ability and offer a

means to assess the status of a business.

They are not a substitute for common sense.

Analyzing Financial Analyzing Financial StatementsStatements

4 Key Financial Criteria4 Key Financial Criteria

▸Liquidity▸Solvency

▸Profitability▸Financial Efficiency


LiquidityLiquidity

Ability to meet financial obligations without disrupting normal ongoing

operations.


LiquidityLiquidity

1. Working capital Total current assets

- Total current liabilities Working capital

should be positive!


LiquidityLiquidity1. Working capital

Current Assets = $34,000 - Current Liabilities = $23,000 TOTAL $11,000


LiquidityLiquidity2. Current Ratio

(CA) $65,000 (CL) $20,000 = 3.25:1

Expressed as xx:1


LiquidityLiquidity

2. Current Ratioa. If the ratio is greater than (1:1), the business is considered liquid.”b. If the ratio is less than 1:1, the business is considered “Not liquid”

reflecting a high degree of short-term cash flow risks.c. The higher the ratio, the more liquid the business

d. As a ratio, it is not dependent on the size of a business and comparisons to other businesses can be made.


SolvencySolvency

Ability of a business’ debt repayment capacity if all assets are liquidated.

Ability to continue as a viable business after financial adversity.


SolvencySolvency

1. Debt to Asset Ratio

Total Liabilities Total Assets


SolvencySolvency


Total liabilities Total Assets

The higher the ratio, the greater the risk exposure.


SolvencySolvency


(TL) $ 560,000 = .51:1 (TA) $1,100,000


SolvencySolvency2. Equity to Asset Ratio (% ownership)

Total Equity Total Assets

the lower the ratio, the more creditors have in the business. (Higher is better)


SolvencySolvency

3. Debt to Equity Ratio (Leverage)

Total Liabilities Total Equity


SolvencySolvency

3. Debt to Equity Ratio (Leverage)

$345,000 = 1.47:1 $234,000


SolvencySolvency

3. Debt to Equity Ratio (leverage)

Total Liabilities Total Equity

the lower the ratio, then creditors have less money in the business that the owner (lower is better)


ProfitabilityProfitability

Measures the extent to which a business generates a profit from the use of labor,

management, and capital


ProfitabilityProfitability1. Return on Assets

Net income from operation +interest expense

- value of unpaid operator and family labor and management

Average total assets

the higher the ratio, the more profitable the business


ProfitabilityProfitability

2. Return on Equity Net income from operation

- value of unpaid operator and family labor and management

Average total equity


ProfitabilityProfitability2. Return on Equity

Net income from operation - value of unpaid operator and family

labor and management Average total equity

the higher the ratio, the more profitable the business


ProfitablityProfitablity

2. Return on Equity $75,000

- $23,000 = 9 % $560,000


Financial EfficiencyFinancial Efficiency

Measures the degree of efficiency in using labor, management, and capital

Financial Efficiency analysis deals with the relationships between inputs and outputs.



1. Asset Turnover Ratio Gross revenues Average total assets



1. Asset Turnover Ratio $300,000 = .23:1

$1,300,000


Financial EfficiencyFinancial Efficiency1. Asset turnover ratio

Gross revenues Average total assets

measures how effective assets generate revenue

the higher the ratio, the more efficiently assets are being used to generate revenue.

Analyzing Financial Statements. Financial Statements enhance the decision making ability and offer a means to assess the status of a business. They are.

Documents

financial statements

financial obligations

financial adversity

financial statementsliquidity1

financial statementssolvency3

financial statements

current ratio ca

asset ratio tl