Unit 11: Using Managerial Accounting: Trends and Ratios
This unit examines 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 in the company's financial sphere, such as sales and earnings from one year to the next. Then, 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 7 hours.
Upon successful completion of this unit, you will be able to:
- perform trend analysis to evaluate financial statement information;
- perform common-size analysis to evaluate financial statement information;
- use ratio analysis to measure profitability, short-term liquidity, long-term solvency, and market valuation; and
- develop and analyze non-financial performance measures using a balanced scorecard.
11.1: Introduction
Financial stability is an important attribute of how customers, suppliers, stakeholders, and competitors perceive your company. Every company except for privately-held corporations publish annual financial information, and even privately-held corporations can are often 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, common size analysis, and ratio analysis are all used to make comparisons of performance. This chapter will give you a better idea of how financial stability is determined and used for any company.
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: Trends, Horizontal Analysis
You have already seen trend analysis in the form of least-squares regression analysis or linear regression analysis in Unit 3. Here, we will look at how relevant variables increase or decrease over time. That movement is used to spot problems like declining profits or decreasing sales. Trend analysis looks for both strengths and weaknesses by separating out one-time events. In doing so, it negates the need for anecdotal evidence and acts as an objective measure of performance over time (measured year-to-year or for multiple years). This method is also known as horizontal analysis.
Watch this horizontal/trend analysis for Elky Co.
11.3: Common-Size, Vertical Analysis
When you deal with large numbers, it can be difficult to distinguish those numbers' important attributes. With common-size analysis, you reduce numbers to percentages and then compare them. For example, if you have a company that has $450,000 in profit on sales of $2,220,000, while another has a 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, also known as vertical analysis.
This video shows how a client can compare his financial statements to another company's statements with vertical analysis.
11.4: 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.
Coca Cola
Pepsi Co.
Beverage Industry
Profit margin ratio
34%
11%
20%
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.
11.5: Chicken Deluxe's Choice
Review the problem Chicken Deluxe had at the beginning of this chapter, and then read sections 13.4 and 13.5. In coming to a management decision, numbers will rarely give an answer on their own. Good CEOs and teams also consider non-financial performance measures when coming to a decision. Notice how similar the process of considering non-financial performance measures is to those of financial performance measures.
Unit 11 Assessment
Take this assessment to see how well you understood this unit.
- This assessment does not count towards your grade. It is just for practice!
- You will see the correct answers when you submit your answers. Use this to help you study for the final exam!
- You can take this assessment as many times as you want, whenever you want.
Unit 11 Conclusion
This unit and course ended with a practical and important topic. You learned how to use managerial accounting to produce information that is relevant to management decisions. Trends and ratios are critical for successful decisions, as are non-financial analyses.
Approximately 50 to 80 percent of mergers fail! Although the numbers you can produce and analyze are important, they cannot answer complex management questions on their own. Management accounting information serves a critical role, but decision-makers always need to look beyond the numbers and use a balanced approach.