CHAPTER 4 Financial Statement Analysis Tools Describe what financial ratios are and who uses them. Define the five major categories of ratios (liquidity, efficiency, leverage, coverage, and profitability). Calculate the common ratios for any firm by using income statement and balance sheet | 4 Financial Statement Analysis Tools After studying this chapter you should be able to 1. Describe what financial ratios are and who uses them. 2. Define the five major categories of ratios liquidity efficiency leverage coverage and profitability . 3. Calculate the common ratios for any firm by using income statement and balance sheet data. 4. Use financial ratios to assess a firm s past performance identify its current problems and suggest strategies for dealing with these problems. 5. Calculate the economic profit of a firm. In previous chapters we have seen how the firm s basic financial statements are constructed. In this chapter we will see how financial analysts can use the information contained in the income statement and balance sheet for various purposes. You can use several tools to evaluate a company but some of the most valuable are financial ratios. Ratios are an analyst s microscope they allow us get a better view of the firm s financial health than just looking at the raw financial statements. Ratios are useful both to internal and external analysts of the firm. For internal 101 102 Financial Statement Analysis Tools purposes ratios can be useful in planning for the future setting goals and evaluating the performance of managers. External analysts use ratios to decide whether to grant credit to monitor financial performance to forecast financial performance and to decide whether to invest in the company. We will look at many different ratios but you should be aware that these are of necessity only a sampling of the ratios that might be useful. Furthermore different analysts may calculate ratios slightly differently so you will need to know exactly how the ratios are calculated in a given situation. The keys to understanding ratio analysis are experience and an analytical mind. We will divide our discussion of the ratios into five categories based on the information provided 1. Liquidity ratios describe the ability of a firm to meets its current .
