Financial Statement Analysis Page 23
ADVERTISEMENT
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51744
Chapter 15
Red Flags in Financial Statement Analyses
Analysts look for red flags in financial statements that may signal financial trouble.
Recent accounting scandals highlight the importance of these red flags. The follow-
ing conditions may reveal that the company is too risky.
Movement of Sales, Inventory, and Receivables. Sales, inventory, and receivables
●
generally move together. Increased sales lead to higher receivables and may
require more inventory (or higher inventory turnover) to meet demand.
Unexpected or inconsistent movements among sales, inventory, and receivables
make the financial statements look suspect.
Earnings Problems. Has net income decreased significantly for several years in a
●
row? Did the company report net income in previous years but now is reporting
net loss? Most companies cannot survive consecutive losses year after year.
Decreased Cash Flow. Cash flow validates net income. Is cash flow from operations
●
consistently lower than net income? If so, the company is in trouble. Are the sales of
plant assets a major source of cash? If so, the company may face a cash shortage.
Key Takeaway
Ratio analysis is used to analyze
Too Much Debt. How does the company’s debt ratio compare to that of major com-
●
financial statement data for
petitors? If the debt ratio is too high, the company may be unable to pay its debts.
many reasons. Ratios provide
Inability to Collect Receivables. Are days’ sales in receivables growing faster than
●
information about a company’s
for competitors? If so, a cash shortage may be looming.
performance and are best used
Buildup of Inventories. Is inventory turnover too slow? If so, the company may
to measure a company against
●
other firms in the same industry
be unable to sell goods, or it may be overstating inventory.
and to denote trends within the
Do any of these red flags apply to either Smart Touch or Greg’s Tunes from the
company. Ratios tell users
about a company’s liquidity,
analyses we did in the chapter? No, the financial statements of both companies
solvency, profitability, and asset
depict strong and growing companies. Will both Smart Touch and Greg’s Tunes con-
management. No one ratio can
tinue to grow? Time will tell.
provide the whole picture a
The Decision Guidelines on the following page summarize the most widely
decision maker needs.
used ratios.
ADVERTISEMENT
0 votes
Related Articles
Related forms
Related Categories
Parent category: Financial