1. Introduction to Financial Statement Analysis:
- Financial statement analysis helps users, such as investors, creditors, and analysts, assess a company's financial health and performance.
- It involves analyzing financial statements (balance sheets, income statements, and cash flow statements) and financial ratios.
2. Liquidity Ratios:
- Liquidity ratios measure the ability of a company to meet its short-term obligations.
- Common ratios include the current ratio (current assets / current liabilities) and the quick ratio (current assets - inventory / current liabilities).
3. Solvency Ratios:
- Solvency ratios assess the long-term ability of a company to meet its financial obligations.
- The debt-to-equity ratio (total debt / total equity) and the debt-to-assets ratio (total debt / total assets) are widely used solvency ratios.
4. Profitability Ratios:
- Profitability ratios evaluate the company's ability to generate profits.
- Return on assets (ROA) measures the efficiency of a company in using its assets to generate profits.
- Return on equity (ROE) assesses how effectively the company uses its shareholders' equity to generate profits.
5. Efficiency Ratios:
- Efficiency ratios measure how efficiently a company uses its resources.
- Asset turnover ratio (net sales / average total assets) evaluates a company's efficiency in using its assets to generate sales.
- Accounts receivable turnover (net credit sales / average accounts receivable) assesses the effectiveness of managing accounts receivable.
6. Market Value Ratios:
- Market value ratios relate the market value of a company's stock to its financial performance.
- Price-to-earnings ratio (P/E) measures the price investors are willing to pay for each unit of a company's earnings.
- Dividend yield assesses the income investors receive from dividends relative to the company's stock price.
7. Limitations of Financial Statement Analysis:
- Financial statement analysis is based on historical financial data, which may not reflect future performance accurately.
- Financial ratios can be influenced by accounting choices and estimates, potentially affecting their reliability.
- External factors, such as economic conditions and industry dynamics, can impact a company's financial ratios.
8. Conclusion:
- Financial statement analysis provides valuable information for decision-making by identifying strengths, weaknesses, and potential risks in a company's financial performance and position.
- However, it should be used alongside other relevant information and judgment to gain a comprehensive understanding of a company's financial health.