CHAPTER 7

FINANCIAL ANALYSIS TECHNIQUES

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

  • Describe tools and techniques used in financial analysis, including their uses and limitations.
  • Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
  • Describe the relationships among ratios and evaluate a company using ratio analysis.
  • Demonstrate the application of DuPont analysis of return on equity, and calculate and interpret the effects of changes in its components.
  • Calculate and interpret ratios used in equity analysis, credit analysis, and segment analysis.
  • Describe how ratio analysis and other techniques can be used to model and forecast earnings.

SUMMARY OVERVIEW

  • Common-size financial statements and financial ratios remove the effect of size, allowing comparisons of a company with peer companies (cross-sectional analysis) and comparison of a company’s results over time (trend or time-series analysis).
  • Activity ratios measure the efficiency of a company’s operations, such as collection of receivables or management of inventory. Major activity ratios include inventory turnover, days of inventory on hand, receivables turnover, days of sales outstanding, payables turnover, number of days of payables, working capital turnover, fixed asset turnover, and total asset turnover.
  • Liquidity ratios measure the ability of a company to meet short-term obligations. Major liquidity ratios include the current ratio, ...

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