Unit 11: Using Managerial Accounting: Trends and Ratios
In this unit we examine the three-pronged approach managerial accountants and potential investors typically use to analyze a company’s financial information. First, we use trend analysis and common-size analysis to examine trends the company has experienced
within its own financial sphere, such as sales and earnings from one year to the next. Secondly, we compare the company's financial measures with its main competitors in the industry. Finally, we compare the company's financial ratios with industry-wide
averages or standards.
Completing this unit should take you approximately 6 hours.
Upon successful completion of this unit, you will be able to:
- use a trend analysis and a common-size analysis to evaluate financial statement information;
- use ratio analysis to measure profitability, short-term liquidity, long-term solvency, and market valuation; and
- create a balanced scorecard to analyze non-financial performance.
11.1: Trend Analysis
Financial stability is an important attribute of how your company is perceived by customers and competitors. Similarly, your company will be evaluated by others: customers, suppliers and stakeholders. All publicly traded corporations publish annual financial information; even privately held corporation can be and often are asked for their financials. The principles of managerial accounting are used to determine trends and ratios to evaluate the strength of each company’s income statement and balance sheet. Trends and "common size analysis" and ratio analysis are all used to make intra- and inter- comparisons of performance. This unit should give you a better idea about how financial stability is determined and used for any company. Read the Chapter 13 Introduction, then click "Next Section" to read Section 13.1.
Watch this horizontal/trend analysis for Elky Co.
Financial analysis is an important skill set that integrates everything we have discussed so far in this course. Think about your own skills. Can you do what this video is talking about?
11.2: Common-Size Analysis
Read section 13.2. When you are dealing with many numbers of comparatively large magnitudes, it becomes difficult to distinguish important features or attributes of those numbers. With common size analysis, you reduce numbers to percentages and then compare percent difference. For example if you have a company that has $450,000 in profit on sales of $2,220,000, while another has profit of only $375,000 on sales of $1,500,000, how do you compare these numbers? This is the strength of common size analysis, which is also known as vertical analysis.
This video shows how a client can compare his financial statements to another company's statements with vertical analysis.
11.3: Ratio Analysis
The most robust type of analysis is ratio analysis. A ratio is a comparison of two numbers and normally takes the form of a fraction, decimal, or percentage. A ratio can be specific to a company, to companies within a region, to an industry, or to a stock exchange. Ratios are versatile and powerful. This section will show you how to use ratios to explain and compare companies to other companies or industries as a whole.
Profit margin ratio
There are four basic types of ratios, which are used to measure profitability, short-term liquidity, long-term solvency, and market valuation.
These videos examine the financial statements for Squirrel Co. and give several examples of useful ratios.
11.4: Chicken Deluxe’s Choice
Before you read the final sections of Chapter 13 regarding Chicken Deluxe, go back to the beginning of this chapter and review their problem. Review the analysis that the management accountants at Chicken Deluxe produced and note the use of all the elements you have been reading about in this unit. In coming to a management decision, seldom will numbers provide an answer on their own. A good CEO and a good team will also consider nonfinancial performance measures in coming to a decision. This process of considering nonfinancial performance measures is considered and you will note how similar the methodology is to those we have discussed above for financial performance measures. Read section 13.4 and 13.5. The end of chapter exercises are optional.