Financial statement analysis is a crucial skill for understanding a company's health. By examining key ratios, we can assess liquidity, profitability, solvency, and efficiency, giving us a clear picture of performance and financial stability.

Ratio analysis helps identify strengths and weaknesses, guiding decision-making for managers and investors. By comparing ratios to industry benchmarks or past performance, we can spot areas for improvement and make informed choices about a company's financial future.

Financial Statement Analysis

Ratio Analysis

• Ratio analysis calculates and interprets financial ratios from a company's financial statements to assess performance and financial health for stakeholders (managers, investors, creditors)
• Ratios provide insights into liquidity (short-term obligations), profitability (generating profits), solvency (long-term debt obligations), and efficiency (managing assets and liabilities)
• Comparing ratios to industry benchmarks or historical performance reveals strengths (outperforming ratios) and weaknesses (underperforming ratios)
• Ratio analysis identifies areas for improvement, guides decision-making for managers to address weaknesses and leverage strengths, and informs investors about financial health

Liquidity Ratios

• Current ratio measures ability to pay short-term obligations using current assets, calculated as $\frac{Current Assets}{Current Liabilities}$, with 1.5 or higher considered good (sufficient current assets)
• Quick ratio (acid-test ratio) measures ability to pay short-term obligations using only quick assets (cash, marketable securities, accounts receivable), calculated as $\frac{Cash + Marketable Securities + Accounts Receivable}{Current Liabilities}$, with 1.0 or higher considered good (sufficient quick assets)
• Cash ratio measures ability to pay short-term obligations using only cash and cash equivalents, calculated as $\frac{Cash + Cash Equivalents}{Current Liabilities}$, with higher ratio indicating stronger liquidity but too high suggesting inefficient cash management

Profitability Ratios

• Gross profit margin measures percentage of revenue retained after COGS, calculated as $\frac{Gross Profit}{Net Sales} \times 100%$, with higher margin indicating better profitability and pricing power
• Operating profit margin measures percentage of revenue retained after COGS and operating expenses, calculated as $\frac{Operating Profit}{Net Sales} \times 100%$, with higher margin indicating better operational efficiency and cost management
• Net profit margin measures percentage of revenue retained as net income after all expenses and taxes, calculated as $\frac{Net Income}{Net Sales} \times 100%$, with higher margin indicating better overall profitability and expense management
• Return on assets (ROA) measures efficiency in generating profits using total assets, calculated as $\frac{Net Income}{Average Total Assets} \times 100%$, with higher ROA indicating better asset utilization and profitability
• Return on equity (ROE) measures efficiency in generating profits using shareholders' equity, calculated as $\frac{Net Income}{Average Shareholders' Equity} \times 100%$, with higher ROE indicating better profitability and effective use of shareholders' investments