Meaning of Financial Statement Analysis and Financial Statement Ratios essay


Meaningof Financial Statement Analysis and Financial Statement Ratios

Meaningof financial statement analysis and financial statement ratios

Financialstatement analysis refers to a thorough scrutiny of financialdeclarations of a given company or companies to come up with a moremeaningful a detailed understanding of the company`s financialperformance. It involves a systematic review of the financialstatements of the organization with an aim of assessing the financialhealth of the firm. It helps to identify the strengths and weaknessof the firm. Financial statement analysis helps the firm or person inconcern to answer the following questions: Liquidity position of thefirm, Profitability conditions of the firm, Operating efficiency ofthe firm as well as, the firm`s financial position. To arrive at thismeaningful conclusion, financial analysts employ the use of financialratios which aid in their results.

Financialratios are obtained by comparing two items in the financialstatements which give a more meaningful figure which is easy tounderstand. Financial ratios are grouped/ classified intoprofitability ratios, liquidity ratios, management ratios, leverageratios as well as valuation and growth ratios. Each of the ratiosgives a different indication on the financial health of the firm inits operations in both internal and external environment. Profitability ratios help to measure how effectively a firm cangenerate profit from its sales. Liquidity ratios, on the other hand,measure the ability of a company to manage and pay off its debts (Hogan, Rezae , Riley &amp Velury, 2008).Management ratios help to measure the ability of a firm to collectits receivable effectively in its operations. Leverage ratios helpto measure the financing of the firm by both the debt percentage andequity percentage.

Ratioanalysis can be categorized into two: cross sectional analysis andtrend analysis. Cross sectional analysis helps the firm to compareits financial performance with other firms in the same industry. Onthe other hand, trend analysis involves comparisons of firm’sperformance with that of its previous financial years. In this reportI will apply trend analysis in calculating the firm’s ratio in itsfinancial statements 2012 and 2013(De Franco, Kothari, &amp Verdi, 2011)..

Financialstatement analysis of Starbucks Corporation financial year 2012-2013

Currentratio-thisratio helps the firm to measure its ability to pay short-termobligations using current assets in their due time. It’s obtainedas follows:

Currentratio=currentassets /current liabilities.

2013Current ratio =1.017thisratio is below the recommended ratio of 2:1 and therefore Starbuckscorporation is not capable of meeting its current obligations as theyfall due. This also implies that the firm is experiencing cash flowdifficulties in comparison with other firms in that industry.

2012currentratio=1.9008thisratio again shows that the corporation is incapable to meet itscurrent obligations as they fall due though slightly better comparedto its 2013 performance.

Quickratio/ acid ratio-measure the company`s ability to offset its current obligations usingmore liquid types of assets. These assets are cash, marketablesecurities, and receivables. The ratio is given as follows

Quickratio=cash+ equivalents + short term investment + accountsreceivables/ current liabilities.

2013Quick ratio=0.7058theratio is below recommended levels and hence the corporation isincapable of meeting its current obligations as when they fall due.

2012Quick ratio==1.1416theratio is below recommended levels and hence the corporation isincapable of meeting its current obligations as when they fall due.

Equityratio-this ratio helps to measure the amount of total assets provided byequity. Its calculated as follows

Equityratio= total equity/ total debt

2013equity ratio==0.3892thisindicates that the company is financed with more debt than equity.

2012equity ratio ==0.6223thecompany leverage was higher in 2012 than 2013 a factor that mayinfluence its net profit. More levered firms value tends to be higheras compared to less levered due to the tax shield advantage.

Debtratio-this ratio measures the amount of company assets financed by debt.

It`scalculated as indicated below

Debtratio= total liabilities/ total assets

2013debt ratio ==0.6108thepercentage ratio of debt ratio is too low than recommended levels.

2012debt ratio==0.3777theratio is still low than the recommended

Profitmargin, return on sales-this ratio measures the amount of income derived from all the sales.It’s calculated as below

Profitmargin=net income/ net sales

2013profit margin==5.9773higherratio indicates good performance of the business. The business wasable to attain higher income as a result of high sales.

2012profit margin==0.9823lowratio is not conducive to the business environment.

DuPontanalysis-this is a type of financial statement analysis that helps investorsto identify superior and inferior returns by comparison with otherfirms in the same industry or between industries. DuPont analysis iscalculated as follows

DuPontanalysis= net income/equity

2013DuPont analysis===0.00196

2012DuPont analysis==0.2710

Returnon Asset (ROA)-this ratio breaks down DuPont analysis in two three parts for furtheranalysis in the company`s industry

Highmargin industries- a good example is the fashion industry whichrequires a firm to sell at the higher margin at the expense of highersales to obtain high profit.

Highturnover industries- in this category the best industry to show casemaybe the stores. Higher sales are of considerable importance in thiscategory for maximum profits.

Highleverage industries- this comprise of highly levered firms whichobtain the acceptable ROA by being highly levered.

Returnon asset is calculated as ROA=net income/ average total assets.



Historicalfinancial statement analysis

Thisanalysis tries to give a comparison between the items of balancesheet and profit and loss account of a company between differentfinancial years to measure whether the company is financiallyhealthy. A financially healthy company in this scenario should showpositive growth in its financial statements size. In this case itemsof financial statement of the previous year would be used as the baseitem as shown below

Historicalanalysis of Starbucks Corporation balances sheet

Thetwo years under consideration are 2012 and 2013. 2012 financialstatements items are used as the base year.

Totalcurrent assets==1.3028thisis a strong indication that the company`s current assets increased by1.3 percent. This is a positive contribution.

Totalassets==1.401againthis indicate a positive growth of total assets in that period

Totalcurrent liability=2.433thecompany`s loan book obligations are seen to have grown more than itsassets. This may pose a challenge to its ability to offset theseobligations.

Totalliabilities==2.266againit`s clear that the company`s total assets increased by 2.266% overthe year. This may again pose a challenge to its ability to offsetthese obligations.

Totalequity==0.8764.The effort by the company to increases its leverage only increased by0.87 %. Leverage is seen to increase a company value as it reducestaxable income.

Historicalanalysis of Starbucks Corporation statement of comprehensive income

Totalsales==0.00636.The company`s sales in the year 2013 decreased significantly leadingto a decrease in its income.

Totalincome=0.0387.There was again a decline in the company`s net income which is highlyattributable to its low sales in the period.

Returnon net operating assets(RNOA) – this ratio is arrived by adding all operational returns.It`s calculated as follows

RNOA=net operating profit after tax (NOPAT)/ average net operating assets(NOA)

Thisratio is more preferable than ROE as it gives more details on therole played by leverage towards shareholders return.


Meaningof Disclosers

Disclosersrefer to all information provided by the firm both financial andnon-financial that is required by all the stakeholders of the firm toaid in decision making. This information should be availed it theright time and with the right content that discloses all theinformation affecting the firms operations. Companies should avoidtailoring their discloser on material information only,repetitiveness in their information as well as the inclusion ofoutdated and immaterial information (Kogan, 2007). Well, disclosedinformation benefits the stakeholders by increasing the investors`confidence as a result of getting more meaningful information. Italso improves on the organization coordination between its plays.This goes equally increases the company`s market reputation as wellas greater efficiency in investor`s communication disclosers (Kiman,S.2013).

Meaningof earning properties of a firm

Earningproperties of the firm refer to the ability of a company to registercontinued growth in its stock as well as the company value in large.This is seen in the company earning quality, earning stability andearnings growth. Earning quality refers to a company ability toregister consistent growth in its revenue while earning growth refersto the ability of a company to register continued increased in itstotal revenue consistently over time. Earning stability refers to theability of a company to have a stable earning pattern over a certainperiod. A company`s stock increase in stock value is a good indicatorits growth properties.

Informationenvironment of the firm

Thisrefers to all forms of information about a business that impact onits stakeholder`s decision making about the firm. Any informationabout a firms operation greatly affects all the stakeholders eithernegatively or positively. Any business is thus expected to releasequality and timely information about its underlying financialposition among other factors like management efficiency. Informationshould be released to all stakeholders equally. All publicinformation should be of equal benefit to all the investors(Hun &amp Subramanyam 2007).Private information or the insider information should be treatedwisely to avoid shock in the business environment which if notcarefully controlled would lead to fluctuations of the firms stockvalue.

Informationat all times should be symmetrical towards all the firms`beneficiaries though this hardly. Insider information is normallyavailable to a small group of individuals including the managementand thus puts other plays at a risk. The article market for lemons byGeorge A Akerlof, (1970) indicate how uncertainty in the businessworld lead to poor quality products due to the impact of informationasymmetry.

Informationenvironment is thus a very crucial determinant of business success inthe market, and business should strive to make their environment ascertain as possible. They should avail information to all itsstakeholders timely as well as making sure that the same informationis of high quality so as to boost their confidence.

Marketreaction to financial information

Capitalmarket normally behaves differently towards financial informationannouncements. In an efficient market announcement of earning alwaysimpact the stock prices immediately. Lower earnings lead to negativemarket reaction (Hussein, A.2010), and this leads to a reduction inthe company stock prices.

Financialstatement earning announcement are critical as they indicate acompany financial health, they are the major component of identifyingthe future prospect of the firm. Is the firm value going to increaseor decrease in the future? These are some of the questions answeredby such announcement. A firm that is indicating a strong futuregrowth will attract more investors as the later aim at maximumreturns on their investment.

Post-earningsannouncement drifts (PEAD) is defined by Chordia and Shivakumar(2005), Sadka and Shivakumar (2009) as the propensity for a stock`scollective returns to float in the direction of a current earningsdisclosure for several weeks succeeding an earnings declaration. Thisimpression, also standardized unexpected earnings (SUE), denotesthat, after a firm publicizes earnings that surpass (or fall shortof) a proxy for the market`s prospect of earnings, succeedingabnormal yields tend to be higher (or lower) than standard ones forsome weeks or even months. The authors conclude that the drift isconsiderably larger when using the analysts` predictions and thoseinvestors who view the drift as a defilement of market efficiency andexpect to exploit it should as well make use of earnings surprisesignal, or combine signals, which maximize the drift.

Impactof management earnings release

Accordingto Agency Theory managers are the agents while shareholders are theprinciples, and thus, managers should put the interest of theshareholders first before their interest. The reverse normallyhappens where by managers aim to increase their gains at the expenseof the shareholders a condition known as agency conflicts. In mostcases managers having more information about the firm tend to exploitthe shareholders who in turn get a low return on their investments.This tends to reduce greatly the shareholders confidence in thefirm`s management which may even lead to the sacking of thesemanagers.

Roleof financial analysts

Financialanalysts play a critical role in analyzing the business environmentto help both individual and institutional investors to make informeddecisions on investment. They do this by viewing complex financialstatements as well as using other critical indicators of a companyperformance. They provide information and reports to help stockmarket traders, stockholders and mutual managers to make prudentdecisions about their capital investment. They help investors toidentify the stocks with higher returns and also advise on riskdiversification and hence employment of a strong, efficientportfolio. Financial analysts equally help the company to predict itsfuture growth pattern hence long-term investment decisions.


Akerof,G. (1970). TheMarket for Lemons.London: Oxford Press.

B,K. (2014). FinancialStatement Analysis.New York Longhorn press.

DeFranco, G., Kothari, S. P., &amp Verdi, R. S. (2011). The benefitsof financial statement comparability.&nbspJournalof Accounting Research,&nbsp49(4),895-931.

Hogan,C. E., Rezaee, Z., Riley Jr, R. A., &amp Velury, U. K. (2008).Financial statement fraud: Insights from the academicliterature.&nbspAuditing:A Journal of Practice &amp Theory,&nbsp27(2),231-252.

Hung,M., &amp Subramanyam, K. R. (2007). Financial statement effects ofadopting international accounting standards: the case ofGermany.&nbspReviewof accounting studies,&nbsp12(4),623-657.

Kogan,S. (2007). InformationEnvironment and the Geografy of Frms and investors.London: longhorn.