Chapter 28 Financial Analysis 733
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Figure 28.1 summarizes these questions in more detail. The boxes on the left are for invest-
ment, those on the right for financing. In each box we have posed a question and given exam-
ples of financial ratios or other measures that can help to answer it. For example, the bottom
box on the far left asks about efficient use of assets. Three ratios that measure asset efficiency
are turnover ratios for assets, inventory, and accounts receivable. The two bottom boxes on the
right ask whether financial leverage is prudent and whether the firm has sufficient liquidity
for the coming year. The ratios for tracking financial leverage include various debt ratios; the
ratios for liquidity are the current, quick, and cash ratios.
Figure 28.1 serves as a road map for this chapter. We will show how to calculate these and
other common financial ratios and explain how they relate to the objective of shareholder value.
Shareholder Value
How much value has been generated?
Market value added
Market–book ratioTurnover ratios for assets,
inventory, and receivablesEfficient use of assets? Profits from sales?
Operating profit marginSustainable growth rateHow fast could the firm grow by
plowing back earnings?Prudent financial
leverage?Sufficient liquidity for
the coming year?
Current, quick, and cash
ratiosDebt ratios
Interest coverage ratiosEconomic value added (EVA)
Returns on capital, assets, and equityHow profitable?Investment Financing◗ FIGURE 28.1
An organization chart for financial ratios, showing how common financial ratios and other measures relate to shareholder value.28-2 Financial Statements
Public companies have a variety of stakeholders, such as shareholders, bondholders, bankers,
suppliers, employees, and management. All these stakeholders need to monitor the firm and
to ensure that their interests are being served. They rely on the company’s financial statements
to provide the necessary information. Public companies report to their shareholders quarterly
and annually. The annual financial statements are filed with the SEC on form 10-K and the
quarterly statements are filed on form 10-Q. Therefore you often hear financial analysts refer
loosely to the company’s “10-K” or its “10-Q.”
When reviewing a company’s financial statements, it is important to remember that accountants
still have a fair degree of leeway in reporting earnings and book values. For example, they have dis-
cretion in the choice of depreciation method and the speed at which the firm’s assets are written off.
Although accountants around the world are working toward common practices, there are
still considerable variations in the accounting rules of different countries. In Anglo-Saxon
countries such as the United States or the U.K., which have large and active equity markets,