Financial Management
Chapter 3
Analysis of Financial Statements
LEARNING OBJECTIVES
After reading this chapter, students should be able to:
• Explain why ratio analysis is usually the first step in the analysis of a company’s financial statements.
• List the five groups of ratios, specify which ratios belong in each group, and explain what information each group gives us about the firm’s financial position.
• State what trend analysis is, and why it is important.
• Describe how the Du Pont equation is used, and how it may be modified to include the effect of financial leverage.
• Explain “benchmarking” and its purpose.
• List several limitations of ratio analysis.
• Identify some of the problems with ROE that can arise when firms use it as a sole measure of performance.
• Identify some of the qualitative factors that must be considered when evaluating a company’s financial performance.
LECTURE SUGGESTIONS
Chapter 3 shows how financial statements are analyzed to determine firms’ strengths and weaknesses. On the basis of this information, management can take actions to exploit strengths and correct weaknesses. At Florida, we find a significant difference in preparation between our accounting and non-accounting students. The accountants are relatively familiar with financial statements, and they have covered in depth in their financial accounting course many of the ratios dealt with in Chapter 3. We pitch our lectures to the non-accountants, which means concentrating on the use of statements and ratios, and the “big picture,” rather than on details such as seasonal adjustments and the effects of different accounting procedures. Details are important, but so are general principles, and there are courses other than the introductory finance course where details can be addressed. What we cover, and the way we cover it, can be seen by scanning Blueprints, Chapter 3. For other suggestions about
Analysis of Financial Statements
LEARNING OBJECTIVES
After reading this chapter, students should be able to:
• Explain why ratio analysis is usually the first step in the analysis of a company’s financial statements.
• List the five groups of ratios, specify which ratios belong in each group, and explain what information each group gives us about the firm’s financial position.
• State what trend analysis is, and why it is important.
• Describe how the Du Pont equation is used, and how it may be modified to include the effect of financial leverage.
• Explain “benchmarking” and its purpose.
• List several limitations of ratio analysis.
• Identify some of the problems with ROE that can arise when firms use it as a sole measure of performance.
• Identify some of the qualitative factors that must be considered when evaluating a company’s financial performance.
LECTURE SUGGESTIONS
Chapter 3 shows how financial statements are analyzed to determine firms’ strengths and weaknesses. On the basis of this information, management can take actions to exploit strengths and correct weaknesses. At Florida, we find a significant difference in preparation between our accounting and non-accounting students. The accountants are relatively familiar with financial statements, and they have covered in depth in their financial accounting course many of the ratios dealt with in Chapter 3. We pitch our lectures to the non-accountants, which means concentrating on the use of statements and ratios, and the “big picture,” rather than on details such as seasonal adjustments and the effects of different accounting procedures. Details are important, but so are general principles, and there are courses other than the introductory finance course where details can be addressed. What we cover, and the way we cover it, can be seen by scanning Blueprints, Chapter 3. For other suggestions about