## Unit 18 - Financial Statement Analysis

Image by Getty Images via Daylife What does the Acid-test (quick) ratio measure? The acid-test ratio, also called quick ration, measures the company’s short-term liquidity; it is computed by dividing the sum of cash, short-term investments, and net receivable by current liabilities. What does the asset turnover measure? Asset turnover measures the ability of the company to generate sales; it is computed by dividing net sales by average assets. What is a change in accounting principle? When a company prefers to use, in the current year, one accounting principle that is different from the one used the previous year it is said to have a ‘change in accounting principle.’ An example of a change is switching from the average cost method of inventory costing to LIFO. What does Comprehensive income include? Comprehensive income includes the net income plus all changes in shareholders’ equity during a period, except those resulting from investments by stockholders and distributions to stockholders. What does the Current ratio measure? The current ratio measures the company’s liquidity and short-term debt-paying ability; it is computed by dividing the current assets by current liabilities. What does the debt to total assets ratio measure? This ratio measures the percentage of total assets provided by creditors; it is computed by dividing total debt by total assets. What is meant by discontinued operations? ‘Discontinued operations’ takes place when a significant segment of a business is sold or disposed of. What does Earnings per share (EPS) measure? EPS measures the net income earned by each share of common stock; it is computed by dividing net income minus preferred dividends (if any) by the number of common shares outstanding. When additional shares of common stock are issued during the year, use the weighted average for the denominator. What are extraordinary items? Extraordinary items are events and transactions that are unusual in nature and infrequent in occurrence. What is Horizontal analysis? Horizontal analysis is a technique that accountants use to evaluate financial statements over a period of time; usually over two years. The analysis shows the increase or decrease between the years and it may be shown in dollars or percentages. What does the inventory turnover measure? Inventory turnover measures the liquidity of the merchandise inventory; it is computed by dividing cost of goods sold by average inventory. What is meant by leveraging? Leveraging or trading on the equity at a gain occurs when the company borrows money at an interest rate that is lower than its return on assets. What are liquidity ratios? Liquidity ratios are measures of the short-term ability of a company to pay its current bills and to keep solvent by maintaining a reasonable cash cushion for unplanned needs. What is a payout ratio? The payout ratio is a ratio that measure the percentage of earnings distributed as cash dividends; it is computed by dividing cash dividends by net income. What does the Price-earning (P-E) ratio measure? This ratio shows the relationship between the market value of a share of common stock and its actual earnings per share. The resulting ratio is referred to as “multiples.” The importance of this ratio lies in its usefulness, as investors will compare a company’s multiples to the average multiples of the whole market. The ratio is computed by dividing the market price of the stock by its earnings per share (EPS). What does the Profit Margin measure? The profit margin measures the percentage of each dollar of sales that results in net income; it is computed by dividing net income by net sales. What are profitability ratios? Profitability ratios measure the degree of success of a company in producing income from operations and net income. What is pro forma income? Pro forma income is a measure of income that usually excludes items that may be unusual or infrequent. What is meant by quality of earnings? Quality of earnings makes clear to reader of a company’s financial statements that the net income is earned by the operation of the main line of business, and not by transfers, changes of accounting principles, or murky bookkeeping practices. What is a ratio? A ratio is a mathematical relationship between two quantities which may be expressed as a percentage (12%), a decimal (0.12), a proportion (3:1), a fraction (12/100), or in words (twelve per cent). What is ratio analysis? Ratio analysis is a technique for evaluating financial statements; they evaluate liquidity, profitability, and solvency. What does the receivables turnover measure? The receivables turnover measures the liquidity and collectability of the receivables; it is computed by dividing net credit sales by average net receivables. What is return on assets? Return on assets is a measure of profitability; it is computed by dividing net income by average assets. What does return on common stockholders’ equity measure? The return on common stockholders’ equity measures the dollars of net income earned for each dollar invested by the shareholders; it is computed by dividing net income minus preferred dividends (if any) by average common stockholders’ equity. Ch1 Accounting in Action Ch2 Recording Process Ch3 Adjusting the Accounts Ch4 Completing the Accounting Cycle Ch5 Merchandising Operations Ch6 Inventories Ch7 Accounting Information Systems Ch8 Internal Control and Cash Ch9 Accounting for Receivables Ch10 PP&E, Natural Resources, and Intangible Assets Ch11 Current Liabilities and Payroll Ch12 Partnerships Ch13 Corporations Ch14 Corporations:Dividends, RE Ch15 Long Term Liabilities Ch16 Investment Ch17 Statement of Cash Flows Ch18 Financial Statement Analysis Plato and Accounting Price/Earnings Ratio Plant Assets Luca Pacioli and DaVinci Labels: accounting101, banking, bookkeeping, college accounting, finance |

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