WEB CHAPTER 19
ANALYSIS OF FINANCIAL STATEMENTS
I. Major Financial Statements
Balance Sheet
A. Generally Accepted Accounting Principles (GAAP)
Formulated by the Canadian Institute of Chartered Accountants (CICA)
B. Balance Sheet – indicates at a certain point in time, what resources (assets) the firm
controls and how it has financed these assets
C. Income Statement – indicates the flow of sales, expenses and earnings during a period
D. Statement of Cash Flows – integrates the two prior statements, indicating how the balance
F. Purpose of Financial Statement Analysis – aids in the evaluation of management
performance in several important areas, including profitability, efficiency, and risk
II. Analysis of Financial Ratios
Financial ratios are used because numbers in isolation are of little value.
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III. Financial Ratios (5 major categories)
A. Common Size Statements
1. Normalize balance sheet and income statement items to allow easier comparison
of different-size firms
IV. Evaluating Internal Liquidity
A. Internal Liquidity (Solvency) Ratios – measure the ability of a firm to meet its short-term
obligations
1. Current Ratio
2. Quick Ratio
V. Evaluating Operating Performance
A. Operating Efficiency Ratios – examine how the management uses its assets and capital,
measured by dollars of sales generated by various asset or capital categories
1. Total Asset Turnover
2. Capital Asset Turnover
VI. Risk Analysis
A. Business Risk
Uncertainty of operating income caused by the firm’s industry
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1. Sales Variability
2. Operating Leverage
B. Financial Risk
Additional uncertainty of returns to equity holders due to a firm’s use of fixed
Consideration of Lease Obligations
The accounting for lease obligation depends on the type of lease
If it is a capital lease, the value of the asset and the lease obligation is included on
the balance sheet as an asset and liability
C. Proportion of Debt (Balance Sheet) Ratios
Debt-Equity Ratio
Long-Term Debt/Total Capital Ratio
Total Debt Ratios
D. Earnings and Cash Flow Coverage Ratios
Interest Coverage
Fixed Financial Cost Coverage
VII. Analysis of Growth Potential
The analysis of sustainable growth potential examines ratios that indicate how fast
a firm should grow
A. Importance of Growth Potential
For owners
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The rate of return earned on the resources retained
VIII. Comparative Analysis of Ratios (in this case, for Shoppers Drug Mart)
A. Internal Liquidity
E. Comparator Numbers
IX. Analysis of Non-Canadian Financial Statements
X. The Quality of Financial Statements
A. Balance Sheet – A high-quality balance sheet typically has a conservative use of debt or
leverage
XI. The Value of Financial Statement Analysis
XII. Specific Uses of Financial Ratios
A. Stock Valuation Models