- CFA Exams
- 2024 Level I
- Topic 5. Financial Statement Analysis
- Learning Module 3. Analyzing Balance Sheets
- Subject 5. Ratios and Common-Size Analysis
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Subject 5. Ratios and Common-Size Analysis PDF Download
Balance Sheet Ratios
Liquidity ratios measure the ability of a company to meet future short-term financial obligations from current assets and, more importantly, cash flows. Each of the following ratios takes a slightly different view of cash or near-cash items.
Solvency ratios measure a company's ability to meet long-term and other obligations.
Financial statement analysis aims to investigate a company's financial condition and operating performance. Using financial ratios helps to examine relationships among individual data items from financial statements. Although ratios by themselves cannot answer questions, they can help analysts ask the right questions in financial statement analysis. As analytical tools, ratios are attractive because they are simple and convenient. However, ratios are only as good as the data upon which they are based and the information with which they are compared.
From the earlier discussion it is obvious that there are a significant number of estimates and subjective information that go into financial statements and therefore it is imperative that the end user understands the numbers before calculating and relying on ratio analyses based on these numbers.
Cross-Sectional Analysis
It compares a company to the industry or other comparable companies for a particular ratio. Comparable companies should be from the same industry, employ the same technology, appeal to similar clienteles, pursue similar marketing strategies, and be similar in size (as measured by sales or total assets). The division of the industry into subsets according to size and characteristics may be valuable in making meaningful comparisons. For example, the "computer industry" covers a huge range of companies and it may not be meaningful to compare IBM to the ratios exhibited by small companies. Multi-industry companies can be handled by appropriate cross-sectional analysis with companies operating across the same range of industries, or alternatively by constructing composite industry average ratios to match a company's structure. However, comparability may be impaired due to the fact that no two firms are exactly the same, and companies may use different depreciation and inventory valuation methods.
User Contributed Comments 2
User | Comment |
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omya | Quick Ratio/ Acid Test Ratio - doesnt include Inventories. Cash Ratio - doesnt include debtors and inventories. Solvency ratios - for meeting long term debt obligations. Debt Equity Ratio- here debt means short term + long term debts both. Here non interest bearing debts are also considered. i.e. accounts payable.. FInancial Leverage Ratio = Total Assets/Total Equity. |
farhan92 | issue with fin lev is that you would assume theres debt involved in the formula |
I used your notes and passed ... highly recommended!
Lauren
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