How well is the business doing? Evaluating a firm's financial condition

Extract

[...] Activity RatiosOperations and Asset management Accounts Receivable Turnover Average Collection Period Aging of Accounts Receivable Accounts Payable Turnover Inventory Turnover Total Asset Turnover Accounts Receivable Turnover How many times a credit sale is made and subsequently collected A lower ratio than industry average should prompt the company to put under scanner its receivable policy and the quality of its receivables. Accounts Receivable Turnover Net Credit Sales $21,015 $27,450 $21,900 Accounts Receivable Receivables Turnover 4.62 X 6.23 X 6.95 X Industry Average = 6.79 X Falling trend may be attributable to company's lenient credit policy or failure to collect its receivable in time. [...]

[...] Risk Analysis Business risk Determined by volatility of operating income Arises from fluctuations in sales and production costs Financial risk Arises due to the use of financial leverage (debt) Rather than using numbers from the income statement for assessment purposes, we use numbers from the statement of cash flows. Accrual-based measures allows too much management discretion. One disadvantage to the cash-based measures is no readily available published industry averages for comparison. Liquidity Liquidity is the ability of a business to meet its immediate obligations. [...]

[...] The loss is $70,000 before applicable income taxes of $21,000, the income statement presentation will show a deduction of $49,000. Presentation of Extraordinary Items . Extraordinary Items Change in Accounting Principle Occur when the principle used in the current year is different from the one used in the preceding year. Is permitted, when management can show that the new principle is preferable to the old and Most changes are reported retroactively improves comparability Example: a change in inventory costing methods (such as FIFO to average cost). [...]

[...] Bottom Line for use of Financial Ratios Financial ratios can be distorted by Disclosure Levels Inflation Different accounting methods Mergers Industry Differences Business Environment Changes Adjustments may be needed to financial data before preparing ratios Understand the definitions of ratios used in our analysis Bottom Line for use of Financial Ratios Controls for size differences Controls for currency differences Evaluate related components of different financial statements simultaneously Ratios are easily (and commonly) modified Limitations of Ratio Analysis A firm's industry category is often difficult to identify Published industry averages are only guidelines Accounting practices differ across firms Sometimes difficult to interpret deviations in ratios Industry ratios may not be desirable targets Seasonality affects ratios Sustainable Income . [...]

[...] Profitability Ratios Gross Profit Margin Operating Profit Margin Net Profit Margin Return on Assets(ROA) Return on Equity (ROE) Return on Invested Capital (ROIC) Measuring Margins Ratio of earnings to business volumes is called as Margins A company that fails to sell its products or services to its customers at above their cost is doomed Profitability is the ease with which a company generates income. Profitability (margin) trends are a reflection of a company's strategic position Measuring Margins Why do some managers try to improve their company's apparent performance? [...]