FINANCIAL
STATEMENT ANALYSIS 1-33
v- 1.1
FINANCIAL RATIOS
Financial
statements used to
predict future
earnings
So far, we have seen how the Balance Sheet reports a company's
position at a point in time, how the Income Statement reports a
company's operations over a period of time, and how the Cash Flow
Statement reports a company's sources and uses of funds over that
period. The real value of financial statement analysis is to use these
statements to forecast a firm's future earnings.
From an investor's point of view, forecasting the future is the main
purpose of financial statement analysis. From a manager's viewpoint,
financial statement analysis is useful as a way to anticipate future
conditions and, most important, as a starting point for developing
strategies that influence a company's future course of business.
Ratios highlight
relationships
between accounts
An important step toward achieving these goals is to analyze the firm's
financial ratios. Ratios are designed to highlight relationships between
the financial statement accounts. These relationships begin to reveal
how well a company is doing in its primary goal of creating value for
its shareholders.
Useful with
application of
analytical
techniques
The ratios, alone, usually give the analyst very little information. There
are two ratio analysis techniques that provide additional insight into a
company. The first technique is to compare the ratios of one company
with other similar companies within the same industry. The second
technique is to observe trends of the ratios over a period of time.
These trends give clues about a company's performance.
Five ratio
categories
The most common financial ratios can be grouped into five broad
categories:
·
Liquidity Ratios
·
Asset Management Ratios
·
Debt Management Ratios
·
Profitability Ratios
·
Market Value Ratios