Lecture Notes: Chapter 13 – Analyzing
Financial Statements
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
1. Introduction
Analyzing financial statements helps investors, creditors, and managers assess a company’s
financial health and performance. By applying a range of tools—including ratio analysis, trend
evaluation, and common-size comparisons—users can draw meaningful insights about
profitability, efficiency, liquidity, solvency, and market value. This chapter explores these
techniques, including how a company’s business strategy influences financial performance and
how to compute and interpret key ratios with clarity and precision.
2. How Business Strategy Affects Financial Analysis
A company's strategy—whether it pursues cost leadership or product differentiation—affects
how its financial data should be interpreted:
Cost Leadership Strategy (e.g., Walmart): Focuses on operating efficiency, often
leading to lower margins but higher turnover of inventory and assets.
Product Differentiation Strategy (e.g., Apple): Offers unique products at premium
prices, resulting in higher profit margins and increased R&D and marketing
expenses.
Implication: When analyzing financial ratios, it's essential to understand the context of a
company’s strategy to properly assess its performance.
3. Techniques for Analyzing Financial Statements
3.1 Horizontal Analysis (Trend Analysis)
This compares financial data over multiple periods to identify trends in performance.
Formula:
, Example:
Revenue in 2023 = $1,200,000
Revenue in 2022 = $1,000,000
3.2 Vertical Analysis (Common-Size Analysis)
This expresses each line item as a percentage of a base figure:
On the income statement, each item is shown as a percentage of total revenue.
On the balance sheet, items are shown as a percentage of total assets.
Example (Income Statement):
Sales = $1,000,000
Cost of Goods Sold = $600,000
This allows comparisons across companies regardless of size.
3.3 Ratio Analysis
Ratio analysis provides a deeper look into profitability, efficiency, liquidity, solvency, and
market valuation. It is the foundation of financial analysis.
4. Profitability Ratios
These ratios measure a company’s ability to generate earnings.
4.1 Gross Profit Margin
Financial Statements
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
1. Introduction
Analyzing financial statements helps investors, creditors, and managers assess a company’s
financial health and performance. By applying a range of tools—including ratio analysis, trend
evaluation, and common-size comparisons—users can draw meaningful insights about
profitability, efficiency, liquidity, solvency, and market value. This chapter explores these
techniques, including how a company’s business strategy influences financial performance and
how to compute and interpret key ratios with clarity and precision.
2. How Business Strategy Affects Financial Analysis
A company's strategy—whether it pursues cost leadership or product differentiation—affects
how its financial data should be interpreted:
Cost Leadership Strategy (e.g., Walmart): Focuses on operating efficiency, often
leading to lower margins but higher turnover of inventory and assets.
Product Differentiation Strategy (e.g., Apple): Offers unique products at premium
prices, resulting in higher profit margins and increased R&D and marketing
expenses.
Implication: When analyzing financial ratios, it's essential to understand the context of a
company’s strategy to properly assess its performance.
3. Techniques for Analyzing Financial Statements
3.1 Horizontal Analysis (Trend Analysis)
This compares financial data over multiple periods to identify trends in performance.
Formula:
, Example:
Revenue in 2023 = $1,200,000
Revenue in 2022 = $1,000,000
3.2 Vertical Analysis (Common-Size Analysis)
This expresses each line item as a percentage of a base figure:
On the income statement, each item is shown as a percentage of total revenue.
On the balance sheet, items are shown as a percentage of total assets.
Example (Income Statement):
Sales = $1,000,000
Cost of Goods Sold = $600,000
This allows comparisons across companies regardless of size.
3.3 Ratio Analysis
Ratio analysis provides a deeper look into profitability, efficiency, liquidity, solvency, and
market valuation. It is the foundation of financial analysis.
4. Profitability Ratios
These ratios measure a company’s ability to generate earnings.
4.1 Gross Profit Margin
