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Analyzing and Interpreting Financial statements

5 important questions on Analyzing and Interpreting Financial statements

Financial ratios: Benchmarks for comparison

In the analysis of financial statements, a company’s actual ratios for a certain period need to be compared to different benchmarks, for example:
- company’s ratios for the previous periods,
- company’s planned performance (targets),
- competitors’ ratios for the same period,
- industry average ratios for the same period.

What financial ratio show?

Ratios are not very difficult to calculate, but they can be difficult to interpret. Ratio interpretation will be the topic of the next lesson (Financial statement analysis part II).
Ratios can help to highlight the financial strengths and weaknesses of a business,but cannot explain why those strengths and weaknesses exist. Ratios provide a starting point for further analysis.

Depreciation expense: Calculation

To calculate depreciation expense, the following information is required:

the cost of the asset
the residual value of the asset
the expected useful life of the asset (in years)
depreciation rate (for the reducing-balance method)

Depreciable amount (or amount to depreciate) = Cost – Residual value

Weighted average cost (AVCO

This assumption values all inventories — units sold and units remaining in closing inventories — at the average per-unit cost. (In effect, the average- cost method assumes that units are withdrawn from the inventory in random order.)

Income statement vs statement of cash flows

If a business is profitable, it does not necessarily have sufficient cash, and vice versa – a business with a good liquidity position is not always profitable.
While the profitability of the business is shown in the income statement,
the cash position (or liquidity) of the business is shown in the statement of cash flows.