Financial Analysis

order of looking at financial statement.

start with income statement, then balance sheet, then statement of cash flow.

when looking at income statement look at profits first then operating profit, then gross profit then the revenue. if its a growth stock then look at the revenue first. measure profitability and growth potential.

measure gross profit ratio then look at operating margin ratio. OMR shows how profitable a company is from its primary business. can also look at the net income ratio. measure ROA and ROE but also know that companies with large debt and less equity tend to have inflated ROE and it doesnt mean its always good. to look at the growth potential look at the rate of growth in sales and rate of growth in income. if income growth rate is less than or equal to revenue growth rate then it means the company’s not efficient with expenses. also look at the operating income and net income growth rate. and then compare it to other companies in the industry.

look at the balance sheet from equities first, then asset, then the liabilities. this is to determine the stability.

equities, look to see if it has big retained earnings. big retained earning has good stability. for assets, look at current assets and noncurrent assets. bigger current assets, the better. for liability look to see current liabilty and noncurrent liability. less current liability means less risk. non-interest liability means better for cash flow. avoid capital impairement.

look at current ratio. current assets/current liab. above 1.5 is good more cash in than liab going out. below .5 is risky liabs goin out less cash in. quick ratio (current liab-inventory)/current liab. more conservative ratio. if ratio is above 1 then its good for short term. also look at D/E but know that difference between current liab and noncurrent liab. D/A ratio, less than 3 preferred. unearned revenue is a liability but it can also be used to pay off debts, invested, etc. unearned revenue increase liability but it isnt always bad. lastly look at interest coverage ratio, operating profit/interest expense. if this ratio is under 1. then stay away from that stock.

then cross examine the income and balance sheet by looking at turn over ratio to analyze the activity of the company.

look at the turn over ratio. inventory turnover ratio. COGS/avg inventory. see if it gets bigger or smaller. if the ratio gets smaller then speed of sales is slowing down, meaning inventory is piling. 365/inv turnover ratio, we can get inventory turnover period. that is the number of days it takes to sell 1 inventory.

accounts receivable turnover ratio. net credit sales/avg receivable. if it gets smaller then it takes longer to get money from receivables. 365/art ratio then we get art period number of days it takes to get paid on receivable.

accounts payable turnover ratio. credit purch/avg ap. if ratio getting smaller by time then longer for company to pay payables. 365/apt ratio gives how long it takes to pay

add inventory turnover period and AR turnover period and you get operating cycle. if the number of days in operating cycle get longer then its not good. then take that number and minus accounts payable turnover period then we get cash conversion cycle of buying the ingredients, making the product, selling the product as an AR and then reciving the cash. shorter the cash conversion cycle, the better it is.

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